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China Property Trust Defaults Forecast as Risks Flagged

China’s property trusts, grappling with repayments equivalent to the size of Puerto Rico’s economy, face rising default risks as a former central bank adviser dubs real estate the biggest threat to the economy.

The trust funds must repay 634 billion yuan ($103 billion) of debt this year, up 50 percent from 2013, according to estimates from Haitong Securities Co., the nation’s second-biggest brokerage. The yield on the 2014 notes of Myhome Real Estate Development Group Co. (000667), based in the central city of Wuhan, jumped 185 basis points in the past year to 7.78 percent. That compares with 3.13 percent on property bonds globally, according to Bank of America Merrill Lynch indexes.

The real estate market is “the root of all risks” as falling prices erode local governments’ ability to raise funds for spending that helps the economy, Li Daokui, former People’s Bank of China adviser, said Feb. 25. Property shares slid to a 16-month low last week after Industrial Bank Co. suspended a riskier form of financing for developers, adding to concern as 82 of 181 publicly listed builders have more debt than equity.

“The second wave of defaults may be in property trust products, following the first wave in the coal mining sector,” said David Cui, China strategist at Bank of America Merrill Lynch. “Like the subprime crisis, it’s a problem with leverage. In the U.S., it was the individual who borrowed too much money. In China, it’s the companies which borrowed too much money.”

Policy Tightening

At least 10 Chinese cities, many of them provincial capitals, have tightened local property policies since November, with Shenzhen, Shanghai and Guangzhou raising the minimum down payments for second homes to 70 percent from 60 percent. More than 90 percent of the 42 major Chinese cities tracked by SouFun Holdings Ltd., China’s biggest real-estate website owner, posted a decline in property sales in the week ended Feb. 21 from a year earlier.

The Shanghai Property Index (CPMINDX) dropped to 2,959 on Feb. 27, the lowest since October 2012. The declines came amid speculation lenders may pare real-estate funding after Industrial Bank said on Feb. 24 that it is delaying mezzanine financing for property-related projects until the end of March as it prepares new guidelines.

“The probability of a default in third- or fourth-tier cities’ property trust products is high,” said Li Ning, a bond analyst in Shanghai at Haitong. “Some property companies may see short-term cash flow disruption because of the sluggish sales and the high debt repayment burden.”

‘Gradually Squeezed’

A total of 452 property collective trust products, which are sold to more than one investor, will be redeemed this year, totaling 131.6 billion yuan, Hwabao Securities Co. estimated in a January-dated report.

China’s National People’s Congress, a meeting of top legislators that begins March 5, must balance efforts to sustain the economy with steps to contain home prices. Authorities will likely introduce a property tax in coming quarters in areas that have had excessive price inflation, Qu Hongbin and Sun Junwei, economists at HSBC Holdings Plc, wrote in a Feb. 27 report.

The China Banking Regulatory Commission will “strictly control” lending risks to developers in 2014, according to a report posted on the regulator’s website Feb. 28. The authority also recently issued a notice on a new rule to hold trust executives responsible for defaults even if the products go bust after they’ve left their jobs, two people with knowledge of the matter said last week.

Property bubbles in smaller cities this year “will be gradually squeezed and risks of a collapse are brewing,” said Hu Ligang, an analyst at Hwabao Securities in Shanghai.

Default Brink

As default concerns escalate, the cost of insuring China’s sovereign debt against non-payment is rising. The nation’s credit-default swaps have increased 10.5 basis points in 2014 to 90.5. The yuan weakened 0.03 percent to 6.1467 per dollar as of 10:52 a.m. in Shanghai. It declined almost 1.4 percent in February, the biggest slump since China unified official and market exchange rates at the start of 1994.

China Credit Trust Co. reached an agreement in January to repay investors in a 3 billion yuan high-yield plan after a coal miner collapsed and was unable to meet liabilities. The trust firm didn’t tell the source of the funds.

The government may bail out property trusts that are headed to the brink of default to avoid social unrest, according to Hao Hong, chief China strategist at Bocom International Holdings Co.

Excessive Leverage

“In technical terms, a default in property trust products is very likely, in the form of delay or a reduction of interest payment,” said Hong in Hong Kong. “But principal is likely to be protected, for now. A government bailout would create moral hazard, further raise the interest-rate level and push funds to projects that are not worthwhile.”

The world’s second-biggest economy slowed in the fourth quarter to 7.7 percent from 7.8 percent in the previous three months as Premier Li Keqiang drove up money-market rates to encourage companies and local governments to deleverage. The official Purchasing Manager’s Index of manufacturing declined to an eight-month low in February.

The yield gap on China’s one-year AA- notes over AAA debt has jumped 18 basis points this year to 152, according to Chinabond. The yield on the benchmark 10-year government bond has dropped 13 basis points to 4.43 percent.

Property companies also face record redemptions, with 25.8 billion yuan up for repayment this year according to data compiled by China International Capital Corp.

China Calxon Group Co. (000918) said its board had approved scrapping a planned note offering because of “the change in the onshore bond market,” according to a Feb. 20 statement. The Hangzhou-based builder of high-end apartments has a debt-to-equity ratio of 276 percent. Myhome Real Estate’s debt was 119 percent of equity as of the third quarter of last year, up from 92 percent a year before that.

“Property companies’ leverage is too high,” said Shi Lei, head of fixed-income research in Beijing at Ping An Securities Co., a unit of the nation’s second-biggest insurance company. “When liquidity turns tight, the problems are exposed.”

To contact Bloomberg News staff for this story: Judy Chen in Shanghai at xchen45@bloomberg.net

To contact the editors responsible for this story: Sandy Hendry at shendry@bloomberg.net; Katrina Nicholas at knicholas2@bloomberg.net

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