Yet Another Ghost Town in China Shows Extent of Regional Debt Crisis

Ordos City
Empty apartment developments stand in the city of Ordos, Inner Mongolia on Sept. 12, 2011. Photographer: Mark Ralston/AFP/Getty Images

China’s Ordos city, where towers that sprang from Inner Mongolian farmland now sit empty, is showing the hangover has just begun from a decade-long building boom.

Ordos City Huayan Investment Group Co., a developer whose chairman headed a group of livestock researchers, is at high risk of defaulting on 1.2 billion yuan ($194 million) of bonds if investors exercise an option to offload them in December, said Haitong Securities Co. and China Investment Securities Co. Also in the city, Inner Mongolia Hengda Highway Development Co. asked noteholders to defer rights to sell back private securities in April due to cash shortages, according to China International Capital Corp.

The city whose fortunes reversed as a coal boom turned to bust is grappling with China’s slumping property market that researcher SouFun Holdings Ltd. said led to more than 10 “ghost towns.” Five years after the first building was finished in the eastern city of Tianjin’s replica of Manhattan, the district remains almost deserted. Locals in the city of Handan, where a burst property bubble left half-constructed high-rises, have blocked streets to protest soured investments.

“Many small-city developers are running into financial trouble,” said Liu Yuan, a Shanghai-based research director for Centaline Group, China’s biggest property agency. “It’s the problem Ordos faces after its property bubble burst.”

High-Risk Regions

China’s slowest economic growth since 1990 and a shift toward the service sector from traditional smokestack industries are adding to stresses in less developed areas. That’s frustrating long-standing efforts to boost the regions through steps including the “Go West” campaign launched in 2000 to cover six provinces including Inner Mongolia.

Cities suffering from declines in fiscal revenue need close scrutiny for potential debt failures, according to Zhang Chao, a bond analyst at China Investment Securities in Shenzhen. The highest-risk areas rely on resource production like Inner Mongolia and Shanxi, and also include northeastern provinces such as Heilongjiang and Liaoning, he said.

President Xi Jinping must balance efforts to rein in record regional borrowings that swelled after a 4 trillion yuan stimulus package in 2008, with steps to prevent contagion in the nation’s money markets. Two landmark bond defaults in April, one at a state-owned company and another at a homebuilder based in the southern city of Shenzhen, showed that companies in larger cities have also become vulnerable.

Default Watch

Financial difficulties are even worse among developers in smaller cities, according to Liu Dongliang, a senior analyst at China Merchants Bank Co. in Shanghai.

An official who wouldn’t disclose her name in Ordos City Huayan’s accounting department said the company will be able to meet any bond payments in December given that the notes are guaranteed by a local government financing vehicle.

The developer said in 2012 it would spend the majority of its bond proceeds building a commercial center covering 232,514 square meters, almost the size of the “Bird’s Nest” Olympic stadium in Beijing, with a shopping mall, furniture and home appliance stores and supermarket.

That year marked a turning point in the Ordos real estate market, as floor area under construction started sliding from an all-time high in 2011, according to city annual reports.

‘Big Slump’

“The city’s property market is experiencing a big slump following the over-expansion in previous years,” said China Investment Securities’ Zhang. That’s contributed to the financing crisis at Ordos City Huayan, which faces a high chance of default on its borrowings due this year, Zhang said.

Ordos City Huayan, which builds apartments as well as commercial properties, had only 21.33 million yuan of cash compared with 6.69 billion yuan of debt as of the end of 2014, according to its annual financial statement. It had a total of 170 million yuan of overdue bank loans as of Dec. 31, after suffering a loss of 726.1 million yuan last year.

Firms based in Ordos have stepped up efforts to raise capital in the debt market before they must repay a record 16.7 billion yuan of bonds next year. They issued 22.1 billion yuan of notes last year, the most on record, according to data compiled by Bloomberg.

Ordos Premium

Bond investors have demanded higher premiums to hold notes from the city. Elion Resources Group Co., which focuses on desertification prevention, sold 1 billion yuan of three-year AA rated debentures at 7.8 percent on May 7. That was 256 basis points higher than the average yield on similarly rated securities the same day.

The yield on Ordos City Huayan’s 2018 bond has climbed this year to 9.63 percent since Pengyuan Credit Rating Co. cut the issuer rating from AA- to A and changed the outlook from stable to negative on Dec. 31.

In the rating statement, Pengyuan described the Ordos property market as “extremely not optimistic” because of the slowing economy and pressure the coal industry is facing.

Even companies with government backing have stumbled. China Lianhe Credit Rating Co. on Dec. 30 lowered its outlook for Erdos City Infrastructure Construction Investment Co. to negative from stable, citing the city’s slower growth and weaker finances. The LGFV is guarantor of the Ordos City Huayan 2018 bond. Lianhe also downgraded the rating for Erdos Dongsheng City Development & Investment Group Co. to AA- from AA, citing its defaults on entrusted loans.

Fiscal income of Ordos, which sits on one sixth of China’s coal reserves, declined to 43 billion yuan in 2014, according to official data. Job growth in the city slowed to 4,169 new hirings in the first quarter, 967 less than the same period of last year due to falling demand from the mining and construction industries, municipal data show.

Premier Li Keqiang has pledged to allow market forces to play a bigger role in the economy and strip power from the government since he took office in March 2013.

“Whether the central and local governments will allow builders in smaller cities to default will depend on their determination to restructure the economy and on whether the possible defaults will cause any systemic risk,” said Liu at China Merchants Bank.