The house that China built

The house that China built
David Keohane | Mar 18 10:55 | 1 comment | Share
From the FT:
China’s central bank and one of its largest state lenders are holding emergency talks over whether or not to bail out a defaulting real estate developer…
In a case which offers a microcosm of the cracks emerging in China’s shadow banking system, Zhejiang Xingrun Real Estate, the provincial developer, had been offering usurious rates of interest to individuals after being shut out by conventional banks.

Officials from the government of Fenghua, a town in eastern china with a population of about 500,000, the People’s Bank of China and China Construction Bank, which was the main lender to the developer, were on Tuesday thrashing out ways to repay the company’s Rmb3.5bn ($566m) of debt.
Local government officials were keen to downplay the fate of the troubled developer, Zhejiang Xingrun Real Estate, which quickly added fuel to markets already jittery after Chaori, the solar cell maker, this month became China’s first bond default.
Who on earth could have seen trouble in the property market coming… Here’s J-Cap’s Anne Stevenson-Yang acting as the voice of many:
In solar and coal, analysts would be hard-pressed to find a single profitable company for nearly two years before defaults began to be threatened.
Property is moving into the same situation as the solar and coal industries, despite the glorious company reports. High sales numbers obscure the fact that a large but unknown proportion of what are reported as sales actually represents loan transactions, as Chinese institutions take tranches of housing units as collateral for debt. Maturities in property trusts came and went in 2013 Q4, but the next, much higher peak is in the second quarter of 2015, with about RMB 80 bln coming due in that quarter.
Tbh, there’s not a huge lot to add here — Ambrose wrote up a thorough Nomura note and there’s more in the usual place — except to reiterate that even though this particular property developer is small, it seems unwise to write off anything as a trigger (or continuation) of China’s unwind. As the FT said, Xingrun appears to have been hammered by the fact that local prices for land have collapsed by a third, while prices for individual apartments and houses in Fenghua have dropped by more than half since their peak in early 2011. But even putting supply arguments aside, the fact is that much of the market is opaque and uncertainty has no small potential part to play here — Pettis’s SARS analogy remains apt.

More so, the property market in China may well pose the kind of systemic risk that banks and LGFVs do not — it’s not clear at all that China can cover up a crash in the sector. Since it made up 16 per cent of GDP, 33 per cent of fixed asset investment, 20 per cent of outstanding loans, 26 per cent of new loans, and 39 per cent of government revenues in 2013, according to Nomura, it’s doubly unclear where alternative growth might come from.
Maybe urbanisation will save the day and continue to support the property market but we really don’t recommend going out and buying into a third or fourth tier city any time soon.

And as Nomura note, it appears most foreign investors and many Chinese investors are not aware that first-tier cities only account for 5 per cent of housing under construction. Comforting.
More generally, this from Minxin Pei in the FT on Tuesday seemed fair:
Mr Li’s remarks last week suggest that Beijing may have decided to accept some intense pain now to forestall a future calamity. If so, we should applaud the Chinese leaders’ courage. Nevertheless, Mr Li and his colleagues will encounter serious difficulties in restructuring China’s debt-laden economy. Four challenges stand out.
First, Beijing’s newfound reluctance to offer bailouts indiscriminately may have the unintended effect of undermining confidence in the solvency of a wide range of borrowers. This could prompt a credit squeeze that produces more default than is desired.
The withdrawal of the government’s implicit guarantee will make lenders less willing to extend new credit or to renew old loans. This will almost certainly force a large number of borrowers into default – including some with viable plans that would eventually have enabled them to repay their debts. Even relatively healthy borrowers are likely to suffer.
Second, many Chinese debt contracts are guaranteed by third parties. If one borrower is unable to make good on its promises, the event could trigger a series of further failures, as entities that have stood behind the defaulting borrower are themselves unable to fulfil their obligations. Systemic risks could be far bigger than the Chinese authorities assume, and may reside in unexpected corners of the financial system. The ensuing shocks could cause severe damage to the real economy.
Third, the task of determining which borrower should go bust is unavoidably political. At present China lacks market-based institutions and procedures for bankruptcy, restructuring and liquidation. Government officials will be deciding which borrowers should be bailed out, and which should be allowed to go under. It is easy to imagine a politically driven process resulting in the survival of the best-connected borrowers rather than the fittest.
Finally, imposing financial discipline on the Chinese economy through default and credit retrenchment will make it harder to meet Beijing’s growth target of 7.5 per cent for 2014. To strengthen the credibility of their commitment to reform, Chinese leaders need to consider abandoning this artificial objective so that they will have more freedom to implement painful financial restructuring.
Maybe property won’t be the trigger, maybe there won’t be a crash, but it seems the best case scenario is slower growth for quite a while.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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