2014-06-20

Real Estate Trust Problem Stretches into 2015; Too Early To Say No Crisis

China Property Failures Seen as $33 Billion in Trusts Due
Chinese property trusts face record repayments next year as the real-estate market cools, fueling 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 203.5 billion yuan ($32.7 billion) in 2015, according to Use Trust, a Chinese research firm. That’s almost double the 109 billion yuan due this year. New issuance of the products slumped to 40.7 billion yuan this quarter, 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 $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.

Forget potentially. They are already having cash flow difficulties and projects are already underwater. This week there was research that estimates Hangzhou May Have 40 Plus Housing Projects Underwater. More than half of the firms in trouble bought land in 2013. It is very similar the end of the housing bubble in the United States: the worst of the subprime excesses came at the end of the bubble and those were also the first mortgages to go bust. Here the problem is with developers.

In almost every optimistic article on China that I read, the focus is on a single data point. Manufacturing PMI is picking up. Positive. There are lots of home buyers out there. Positive. The debts of copper traders isn't very large. Not a big negative. Manufacturing is somewhat independent due to China's export sector, which is tied to foreign economic conditions. In contrast, the housing bubble, copper scandal, trust defaults, credit guarantee/microfinance defaults and local government reliance on land finance are all a result of the credit bubble.

China's property market may not be as bad as it looks
The first fall in Chinese home prices in two years has crystallised worries of a messy end to a housing boom, but some analysts say fears of an imminent collapse similar to that in the United States after the sub-prime crisis are overblown.
Fair enough. What's the reason for that?
But high downpayments, low household debt, some government support - and expectations of more to come - have some experts forecasting the downturn will be short lived, with prices expected to recover as economic growth steadies in the second half of the year.
In America, subprime mortgages fueled home purchases by marginal home buyers. In China, subprime loans fueled home construction by marginal developers. In America, there were lots of home purchased by people who could not afford them. In China, lots of homes were built by developers who cannot afford not to sell them. This is the same credit crisis expressed in two different systems, the consumer friendly U.S. and investment friendly China.
"If you look at China from the balance sheet point of view, the only balance sheet that has not been destroyed is the household balance sheet," said Bo Zhuang, an economist at Trusted Sources, a U.K.-based investment consultant.

"It is the most healthy balance sheet at the moment."
A great reason to be bullish on the Chinese consumer, especially when home prices come down and substantially increase disposable income.
Experts disagree about the extent of housing oversupply in China, but agree that slower property investment would be a drag on the economy. A sharp drop in home prices would destroy household wealth, undermining confidence and spending.
Slower investment would be a boon to China because it would stop wasting precious capital on bad investments. Lower home prices would unleash a wave of spending because lower home prices will raise disposable incomes.

The biggest problem is a misallocation of resources, said Ting Lu, an economist at Bank of America-Merrill Lynch.

With only about one-third of the 1.3 billion population living in urban centres, too many homes that will never be filled have been built in small cities. That would likely see a sharp spike in bankruptcies among small developers, Lu said, but would not cause "a big crash".

Wages in China are still growing faster than house prices, with average incomes in cities and rural areas climbing 10-12 percent last year, on par or faster than a 10 percent rise in property prices.

"This is a cyclical correction," said Rosealea Yao, an economist at Gavekal Dragonomics. "We see no signs of imminent collapse."
Rising wages are the best shot China has to avoid a major housing slump.

Even if only small developers go bust, that will hit the trust sector and credit will tighten again. It will ripple out and take down the microcredit lenders, the copper/steel/iron ore rehypothecators, and all other borrowers who put leveraged money into real estate. Glass, cement and other suppliers will not get paid. There's a reason why, when the housing market made a short-term top in 2011, all manner of factory bosses hit the road in Wenzhou, in order to flee their unpayable debts. They are all connected.

In FT's Into the shadows: risky business, global threat was this chart.

If developed economies with more efficient capital allocation systems had crises after smaller debt buildups, I have to think China is on thin ice now. Still, it's near impossible to predict whether a crisis will happen because it is a non-linear event. In order to have a crisis, a tipping point must by crossed, but the tipping point is a moving target based on the intersection of a number of variables, including psychology. What I do know is that there has been a huge buildup of debt and much of it was wasted in bad investments. The link between borrower and lender often goes in two directions, which is why coal bosses are now dumping real estate. If the real estate market slows further, there will be more bosses who will "lose contact" and disappear, leaving huge debts behind.

A major crisis is not inevitable, but there is fertile ground for one. It might only take one domino to knock all the rest down, and there are a lot of dominoes.



No comments:

Post a Comment