China

Why the Evergrande-Shengjing Bank tie-up is a worrying sign

The marriage between a heavily-indebted real estate developer and a poor capitalised bank could be a bad example for other lenders to follow.

China Evergrande Group’s Rmb13.2 billion ($1.9 billion) investment in Shengjing Bank is touted as a key move for the property developer to tap into the financial sector. However, the seemingly straightforward transaction raises a host of potentially difficult questions for the Chinese economy.

The Chinese property giant announced last week that it intended to subscribe for 2.2 billion domestic shares in Shengjing Bank as part of the lender’s $2.6 billion fundraising programme.

Already the single-largest shareholder with a 17.3% stake, the investment would increase Evergrande’s interest to 36.4%, implying that it will having more voting power than all other domestic shareholders combined.

Post-transaction, other domestic shareholders will own 32.45% of the bank and other holders of Hong Kong-listed shareholders will own 17.16%. 

This transaction would solidify Evergrande's control over Shengjing Bank – the first case in which a real estate developer owns a major stake in a Chinese commercial bank. 

Many industry observers believe Evergrande’s bet aligns with its masterplan to diversify away from the business of property. Since 2016, the group has set its sights on three new businesses, namely financial services, tourism and healthcare.

There is a strategic angle to the transaction too because Shengjing Bank was granted a consumer banking license in January, making it an indispensable part of Evergrande’s plan to build a one-stop financial services platform for internet finance, life insurance and online payment.

Yet the combination is worrying from a balance sheet perspective because both Evergrande and Shengjing Bank’s financials are weak compared with their peers.

HIDDEN RISKS

Evergrande’s finances have long been in the spotlight as it is China’s most indebted developer. As of the end of last year, it was sitting on as much as $98 billion of outstanding debt – more than its full-year sales of $68 billion last year.

It is also due to settle $46 billion of debt within a year but it has only $19 billion of cash.

Meanwhile, Shengjing Bank is one of China’s least-capitalised regional commercial banks. Its core tier-1 capital ratio, which stood at 8.52% as of the end of last year, was only marginally above the 8.5% statuary requirement and ranked last among all Hong Kong-listed Chinese banks.

Last year, Shengjing Bank posted its first earnings decline since it went public in 2014, with net profit falling 32.3% year-on-year to $744 million.

The most worrying element of the tie-up, however, is that Shengjing Bank will favour Evergrande when it comes to lending and gradually become a major financing vehicle for the property giant. This is not a distant possibility now that Evergrande looks set to hold more than one-third of the bank's voting rights.

For Evergrande, owning more of Shengjing Bank could be a good bit of business as it could open up a new low-cost funding channel at a time when the company is seeing significantly higher funding costs in the offshore market,

Evergrande, for example, recently sold US dollar bonds that cost about one-third more compared with two years ago. The developer's $400m four-year bond was issued at a 10% coupon in April, costing much more than a 6.25% note of the same tenor issued in 2017.

To be sure, China's banking regulator has a tight control over lending between related parties. However, instead of securing direct borrowing from Shengjing Bank, Evergrande could potentially raise funds through the bank’s investment funds, trusts, structural and other financial products to avoid scrutiny by the regulator.

Compliance concerns aside, the investment also doesn't make sense from a geographical perspective. There is clearly little synergy between Shengjing Bank, located in northeastern China’s Liaoning province, and Evergrande, which is based in Guangdong province and operates most of its projects in the country's central and southern regions.

Evergrande's projects as of end 2018

The regulator’s view of the tie-up will likely determine whether Evergrande sets an example for other property developers to follow. Evergrande said the deal is subject to approval from the China Banking and Insurance Regulatory Commission’s Liaoning bureau.

While this might be a smart move for property developers, it could become a concern for the Chinese banking sector as a whole.

Worst still, if Beijing is seen sanctioning such a move, it might also imply that the government is worried about the levels of debt that have built up in the Chinese real estate sector and the capacity for some developers to continue refinancing that into the future.

¬ Haymarket Media Limited. All rights reserved.

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