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China Credit: Property Flops Seen As US$33b In Trusts Due
Perspective | 25 June 2014

Chinese property trusts face record repayments next year as the real-estate market cools, fuelling speculation among bond funds that more developers will collapse.

The trusts, which channel money from wealthy individuals to smaller builders that have trouble obtaining financing elsewhere, must repay Rmb203.5 billion (US$32.7 billion) in 2015, according to Use Trust, a Chinese research firm. That’s almost double the Rmb109 billion due this year. New issuance of the products slumped to Rmb40.7 billion in 2Q14, the least in more than two years, Use Trust data show.

“Trust loan defaults will rise substantially,” said Fiona Cheung, head of Asia credit at Manulife Asset Management’s fixed-income team which oversees US$44 billion globally. “It won’t be surprising if there are more collapses of China’s property companies. Those companies that suffer from weak sales, that bought land too aggressively last year funded by debt and that have poor access to capital markets will potentially experience cash flow pressure.”

JPMorgan Chase & Co. says the real-estate industry poses the biggest near-term risk to growth in the world’s second-largest economy after new home prices dropped in the most cities in two years in May. China’s banking regulator said on 6 June it will monitor developer finances, a sign of concern defaults may spread after the March collapse of Zhejiang Xingrun Real Estate, a builder south of Shanghai.

‘Turning Point’
Prices fell in 35 of the 70 cities tracked by the government last month from April, according to a statement by the National Bureau of Statistics on 18 June, the most since May 2012. In the financial centre of Shanghai, prices decreased 0.3 percent from April, the first decline in two years.

“It’s unavoidable that property trusts will have defaults this and next year,” said Yao Wei, Hong Kong-based China economist at Societe Generale. “The industry has come to a turning point. The imbalance between supply and demand is so big that adjustments are needed.”

China is cracking down on off-balance sheet lending known as shadow banking, which includes trust companies and wealth management products issued by banks. The industry was worth Rmb38.8 trillion as of the end of last year, according to a Barclays report last month. Concern that defaults could spread mounted in January after a Rmb3 billion trust product called Credit Equals Gold No. 1, which had raised money for a failed coal miner, had to be bailed out days before maturing.

Smaller-Developer Vulnerability
The yuan has fallen 2.8 percent against the US dollar this year, the worst-performing Asian currency. The yield on the benchmark 10-year government bond has dropped 52 basis points to 4.04 percent in the same period as investors seek safe havens.

Defaults on shadow-bank borrowings including trust loans by property companies will increase, with smaller builders particularly vulnerable, according to Frank Chen, head of China research at CBRE Group, a commercial real-estate services company based in Los Angeles.

“The key risk lies with small- and medium-sized local developers which have limited access to bank lending and capital markets,” said Chen in Shanghai. “The slowdown in the residential market is more acute in lower-tier cities.”

Even as larger Chinese property companies are able to tap the international bond market to raise funds, offerings there have also declined. While offshore note issuance from developers in China and Hong Kong has more than doubled in 2Q14 compared with the same period last year to US$6.1 billion, that’s down 26 percent from the first three months of the year, Bloomberg-compiled data show.

‘Higher Risk’
“The decline in issuance is due in part to the weaker sentiment among investors,” said Franco Leung, an analyst in Hong Kong at Moody’s Investors Service. “Investors are seeing higher risk in the property sector than last year.”

Moody’s revised its credit outlook for Chinese developers to negative from stable on 21 May. The Shanghai Stock Exchange Property Index, which tracks 24 developers listed in the city, has slumped 6.3 percent this year, exceeding the 4.2 percent decline for the Shanghai Composite Index.

CBRE’s Chen said while the central government may not officially lift restrictions on home purchases meant to prevent overheating of the market, local governments have been trying to provide support in a subtle way, according to CBRE’s Chen.

Nanning, capital of the southern province of Guangxi, has allowed residents in some nearby cities to purchase apartments in the city, where only people with the city’s hukou are permitted to buy, the Xinhua News Agency reported on 2 May.

‘Big Impact’
“Local governments are keen to see a stabilising property market,” Chen said. “At the end of the day, the property sector and related industries are critical to China’s economy. No country in the world would like to see a crash in the property market, which would be disastrous.”

Outstanding property trust products totalled Rmb1.15 trillion as of 31 March, accounting for 10.4 percent of all types of trusts, according to data posted on the website of China Trustee Association.

“There may be corrections in the property market of some cities,” said Societe Generale’s Yao. “Given the amount of bank loans and shadow banking lending developers have borrowed, the weakening property sector will definitely have a big impact on the financial system.”

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