Smaller firms hit as bubble deflates

To understand why many of the mainland's small property developers are struggling, look no further than Zhejiang Xingrun Real Estate. The once little-known regional developer is now on the brink of becoming one of the nation's biggest real estate bankruptcies in recent memory.

As the property bubble shows signs of deflating in some areas - in peripheral neighbourhoods in lower-tier cities - privately held developers such as Xingrun are falling by the wayside, victims of a toxic combination of unjustified optimism about the property market and sky-high interest rates.

Government officials said last month Xingrun was on the verge of bankruptcy with 3.5 billion yuan (HK$4.4 billion) in debt offset with only three billion yuan in assets. The news heightened concerns a slowdown in the property market and the economy was adding to the risks in the financial system following the first default on a domestic bond.

Home price inflation fell for a second consecutive month in February, following government policy curbs aimed at cooling what has been a red-hot market. Some markets saw outright price declines, in particular Ningbo.

Xingrun's investments were in the satellite city of Fenghua within the port municipality of Ningbo, in Zhejiang province.

"It's not just Ningbo, it's Hangzhou, and Nanjing has a problem too. Even Beijing," said Zhang Yongmin, a director of the Centre for Global Finance at Nottingham University's Ningbo campus. "Real estate has a problem; it's overbuilt. And on the policy side, the government is implementing controls, so banks are very cautious."

Xingrun's investments were focused in Ningbo, so the company does not represent a broader threat to stability.

But many of the problems faced by the company are symptomatic of the pressures on many other similarly sized developers, which Fitch Ratings cited as oversupply in smaller cities and significantly slower growth rates and profit margins.

"If you are focused in only one or two cities and your land bank is in the middle of nowhere, it can be a worrying situation," said Agnes Wong, a Hong Kong-based property analyst with Nomura.

The inventory of unsold property in Ningbo was much longer than the 12 to 15 months that the government targeted, said Fitch analyst Andy Chang. "We're watching closely companies exposed to cities with oversupply of housing."

Illustrating the potential fallout from a corporate collapse, the Zhejiang provincial government in 2012 bailed out 600 companies near its capital Hangzhou after Tianyu Construction buckled, owing 10 billion yuan, media reports said.

Fenghua is a cement city made up of small hills that straddle a river of the same name. The city's economy is largely fuelled by car component manufacturing and tourism.

Residents say property prices, while not growing as they once did, are stable.

One townhouse development called Jindi Yinzuo, under construction by Heyuan Real Estate near the city centre, had already sold out in advance at an average of 11,000 yuan per square metre, about a third of the price for similar properties in Shanghai.

Other property developers said that while Xingrun produced big and popular developments when it started up in 2000, more recently it had paid too much for land, in particular for developments of suburban villas.

"We also have property in Fenghua close to Xingrun's property; but they bought it for 10 million yuan, and we paid 3.2 million," said Shou Bainian, the chief executive of Greentown Real Estate, a leading developer.

Xingrun not only bought high, it also borrowed at high interest rates to finance the purchases.

"They borrowed from loan sharks," said Shou, citing comments from government officials. "So once the credit supply dried up, they got into trouble."

The deputy propaganda chief of the Communist Party in Fenghua, Xu Mengting, said Xingrun had borrowed 2.4 billion yuan from banks.

But the company's owner, Shen Caixing, and his son had raised a further 700 million yuan from individual lenders at high rates, including some employees at government-related institutions, which officials said was illegal.

As lending rates outpaced property price appreciation, Xingrun's finances began to bleed.

Shen and his son are now under arrest, officials said.

"We believe that the Xingrun insolvency is an individual case. Other Fenghua developers aren't in this situation," the deputy propaganda chief said.

Analysts say there are plenty of other companies that have borrowed at punitive rates hoping that property prices would rise faster. Some included speculators, such as those that sold bonds for business purposes only to use the funds to buy real estate.

Analysts are concerned these bonds were bundled into high-yielding wealth management products and sold to investors.

Much of the financial pain in the housing market is the indirect result of a campaign against shadow banking and informal lending waged by the central bank through short-term money market rates last year. That campaign has ended and bank lending rates are back on the decline.