Vanke, the developer that will break China’s back

Shuli Ren, Bloomberg

A third year into a property downturn, China is still seeking market-oriented solutions. Insolvent developers must be prepared for bankruptcy, the housing ministry warned at the weekend. As for projects with decent prospects but under temporary credit stress, state-owned banks have earmarked billions of dollars in loans to ensure their completion.

Unusual times call for extraordinary measures. As China Vanke Co., one of the nation’s largest developers, faces a liquidity crunch, it is clear that market forces have turned toxic and a state-engineered bailout is in order. Moody’s Ratings cut the well-regarded Vanke to junk on Monday.

The company’s biggest hurdle is the lack of clarity on future sales. Thanks to managerial prudence, it fared fairly well in 2023 next to peers such as Country Garden Holdings Co. Contracted sales fell by only 10% to 376 billion yuan ($52.4 billion). However, the overall market may be turning for the worse this year. A recent survey by China Index Academy indicates that less than 20% of respondents plan to buy a home in the next six months, versus close to 30% a year ago. Moody’s estimates that Vanke’s contracted sales declined around 40% to 34.5 billion yuan in January and February, a sharp deterioration from a year ago.

Property development is a scale business. Vanke’s operating margin has tumbled from 29% at its 2019 peak to 8.4% in the September quarter, according to the latest data available. In the first nine months of 2023, it notched only 31 billion yuan in operating profit, a 23% drop from a year earlier.

The developer’s volatile operating conditions perhaps explain why even state-owned financial institutions are apprehensive. Vanke is facing resistance from China’s two state-owned banks on a new HK$4.5 billion ($575 million) offshore syndicated loan. In a rare intervention, China’s cabinet has asked large lenders to step up their support, Reuters reported.

As of September, Vanke had 101 billion yuan of unrestricted cash, which should be sufficient to cover its short-term debt. It will have around 34 billion yuan of bonds due before June 2025, according to Moody’s. However, just like everyone else, Vanke relies heavily on pre-sales, where apartments are bought before they are built. As of September, it had about 408 billion yuan in contract liabilities, mostly comprised of deposits consumers had paid for unfinished homes. Seen in that light, Vanke’s cash position is not so sound.

A state bailout will be in the government’s own interest. After all, municipalities need a few developers to survive, to build projects and purchase land, without which China may fall off a fiscal cliff this year. According to the budget report released at the National People’s Congress last week, revenues of local government managed funds, made up mostly of land sales, are expected to grow by 0.1% this year. This target is looking overly optimistic — or even outlandish — if Vanke also defaults and the nation’s property slump worsens further.

So far, the Chinese government has sat on the sidelines, letting its biggest developers, such as China Evergrande Group and Country Garden, go into default after they embarked on debt-fueled, reckless expansions. But Vanke has sound management and a storied past. It is intensely intertwined with Shenzhen, which morphed into a tech hub in just decades, as well as private home ownership. It went public in 1991, one of the first companies on the then-nascent Shenzhen Stock Exchange, and counts state-owned Shenzhen Metro Group Co. as its largest shareholder, with a 27% stake. Bailing out Vanke won’t be as onerous as letting it fail.

Courtesy Bloomberg/Shuli Ren