Chinese Developer’s Default Will Speed Up Industry Consolidation

The credit environment for Chinese small developers is rapidly deteriorating. The default of Chinese developer Zhejiang Xingrun Real Estate Co. may signal difficult times ahead for small developers in China, says Standard & Poor’s Ratings Services.

Zhejiang Xingrun does not have enough cash to repay RMB3.5 billion ($567 million) in debt from more than 15 banks, including some large Chinese banks.

The default is due to the company’s weak sales and high debt, as well as the detention of its controlling shareholder because of suspected criminal activities.

"We believe this is merely one example of many distressed small developers in China," says Standard & Poor’s credit analyst Bei Fu. "The companies have been struggling daily for survival. Most of these companies only own one or a few projects."

Many unlisted small Chinese developers have limited access to the capital markets. Bank borrowing used to be their sole financing lifeline.

Over the past three to four years, as Chinese banks raise their risk management standards, getting bank loans have become more difficult for these developers, even at higher interest rates.

Large Chinese developers are able to borrow at 6% to 9% from Chinese banks for construction. The small developers sometimes have to pay 20% interest. The availability of such loans are also limited and refinancing is difficult for the small developers.

Therefore, small developers turned to trust financing as an alternative to bank borrowing. According to China Trustee Association, over 10% of new trust loans in 2013 were extended to the property sector. The majority of that went to small developers who didn’t have other viable funding channels. The cost of trust financing is usually higher than bank borrowings.

S&P believes the recent trust product default and the first onshore Chinese corporate bond default of Shanghai Chaori Solar Energy Science & Technology would mean more limited funding at a higher cost for the weaker companies.

This, combined with tough operating conditions for small developers, could lead to more defaults in 2014 and beyond.

S&P believes consolidation in the Chinese property sector will
accelerate this year. The strong players are often listed companies and some have access to offshore capital markets. They may snap up the ailing smaller peers.

The Chinese property sector has been growing exponentially over the years. A total of RMB8.14 trillion ($1.31 trillion) was transacted in 2013, up from RMB2.41 trillion ($354 billion) five years ago.

"The sector’s profit margin used to be so strong that small developers could justify 15% to 20% in financing cost. But that is behind us now. The sector’s profit margin has been declining for the past several years as price hikes lagged cost increases," Fu adds.

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