An extraordinarily large surge in the number of Hong Kong-listed Chinese developers that have failed to report their financial results on time, means that some will probably default. Those most likely are firms that have delayed their annual results, and that have had their external auditors changed, experts suggest.
Since late last year, China’s property sector has suffered contagion from the credit crisis of China Evergrande Group, the world’s most indebted developer. In December, the Chinese firm admitted it was close to bankruptcy, as it struggled to manage US$300 billion of debt, as reported by FinanceAsia. On March 22, the Hong Kong-listed company announced it would be unable to publish its financial results for 2021, by the end-of-March deadline.
For China’s real estate sector, another tough year awaits, said an S&P Global Ratings report on April 6. “Residential property sales will be rocky. Financing conditions are dire, and stricter escrow requirements are adding to cash strain. Another layer of strain is coming from delays in audited financial reports and sudden changes of auditors has added to uncertainties. In our view, more defaults are in the pipeline.”
As of earlier this month, 40 of the 147 Hong Kong Main Board-listed companies that had not yet filed their financial results for 2021 were property developers, making up 27.2 percent of the total, Keith Williamson, managing director and head of Disputes and Investigations practice in Asia, Alvarez & Marsal told FA.
This marked a huge increase from the past two years. Last year, just eight Hong Kong Main Board-listed developers filed tardily, accounting for 10 percent of the total. Research by the firm also indicates that the real estate sector has taken over from Industrials in terms of unreliability with regards to filing, which it used to lag behind in both 2020 and 2021.
“While Covid-19 challenges to audit completion are reported as the most common reason for delay in filing financial results, the likely primary reason for the big jump is that there is considerable distress in China’s property markets,” Williamson told FA.
“The spike in real estate companies signals that there are widespread issues in the sector. All sectors have faced Covid-19 as a challenge to filing timely financial results, so the pandemic cannot explain the disproportionate spike compared to other sectors,” he added.
Auditors quitting
Shimao Group, a Hong Kong-listed developer, announced on March 31 that it was unable to publish its financial results by the deadline, due to the Covid-19 outbreak in Shanghai that has resulted in the lockdown of the company’s headquarters in the city. On March 25, the company warned of an expectation that its net profit for 2021 would fall by 62 percent, adding that Pricewaterhouse Coopers (PwC) had resigned as its auditor on March 24. PwC stated in its resignation letter that it had requested information on trust loan arrangements involving Shimao’s joint ventures and associate companies, but that the firm would be unable to provide all relevant information due to pandemic conditions.
In March, the Big Four accounting firm also quit its role as auditor of two other Chinese developers, Ronshine China Holdings and Powerlong Real Estate Holdings, according to announcements by these Hong Kong-listed firms.
Williamson cited the knock-on effects of Evergrande’s debt woes, combined with change of audit teams, as among the factors responsible for impacting the ability to report earnings in a timely manner. He added that some of the auditors that went on to resign may have had concerns over the companies’ financial statements, around the valuation of the company assets, and their ability to continue with business.
Although there are valid reasons for delays in audit work due to travel restrictions and lockdowns, many companies and auditing firms have adapted to remote or virtual due diligence processes in the two years since the start of the pandemic, he noted. “For some of these companies, the pretext of Covid-19 may possibly hide other real reasons for the delay in releasing their annual results.”
Alicia Garcia-Herrero, Asia Pacific chief economist of Natixis, shared with FA her perspective: “For investors, the absence of financial results is not a good sign, especially if it is caused by the resignation of auditors. It can be a bigger worry for bond investors concerned about potential defaults, than the equity investors betting on a rebound.”
She added that the delayed results reflected a credit polarisation among Chinese real estate developers, adding that whether the pandemic should be blamed depends on the circumstances of individual firms.
“However, one would wonder why the auditing disruption is higher for property developers... If the property developer is exposed to lockdown areas, there may be a disruption in auditing. But it can also be the case that there are hidden problems in their businesses, implying risks on corporate governance, transparency, and liquidity conditions.”
“Auditor resignations flag governance problems for China developers,” detailed the findings of the S&P report.
The S&P report pinpointed four Chinese developers with auditor change or resignation, as not having filed their annual results on time; China Evergrande Group, China Aoyuan Group, Sunac China Holdings and Sunshine 100 China Holdings.
Among the Chinese property developers rated by S&P, more than a quarter with a credit rating of B+ (non-investment grade) or lower, had delayed releasing their results for 2021, the report found.
Such failure to report on time underlines the continued need for board of directors, and in particular, audit committees, to monitor actively the audit process and to understand fully the resolution of issues arising from an audit, said Chris Fordham, partner in forensic accounting and commercial damages of HKA, a global consultancy in risk mitigation and dispute resolution.
