Developer's collapse highlights property sector risk

The insolvency of a property developer in east China's Zhejiang Province has shed light on the risk in China's formerly red-hot real estate sector.

Due to the slowing economy, tightened lending and market expectation of a moderation, China's home prices have seen smaller gains in large cities recently. But in some smaller cities, the housing market has cooled considerably, with sales tumbling and prices stagnant or declining.

The cooling took its toll on the Zhejiang Xingrun Real Estate Co. based in the city of Fenghua as it failed to pay off a total of 3.5 billion yuan (565 million U.S. dollars) in debts.

Xingrun owed the debts to 17 banks, two micro-credit companies, 99 individuals as well as some contractors, said Chen Yonghui, deputy director of the general office of the Fenghua municipal government and member of a government group formed to help settle the debt issue.

From late last year, Xingrun started to see defaults as its capital chain broke, said Chen. "Latest investigation showed that Xingrun has become insolvent with liabilities exceeding assets."

The company's owner and legal representative have been arrested and put under criminal investigation for alleged illegal absorption of public funds.

Defying tightened bank lending, Xingrun turned to private loans to help maintain normal operation, but high lending costs and property market cooling made defaults unavoidable, Chen said.

According to the official, the group is in talks with creditors to seek solutions but may ultimately need to go through bankruptcy liquidation.

Xingrun has attracted widespread media coverage as it could become the country's first real estate developer to go bust this year. Also, many are closely watching to see if the government will bail it out or allow it to go bankrupt.

Experts say its collapse has highlighted the risks for real estate developers, particularly smaller ones in the third- and fourth-tier cities, where a cooling market is starting to bite.

After years of housing curbs, many third- and fourth-tier cities have seen declining transaction volumes and some have even showed signs of excess supply, said Cheng Weiming, chief analyst with kfw001.com, a real estate information service website.

The China Index Academy, a property market research institute, said in a research note that the excess supply of new homes in smaller cities came as local authorities sold more land to cash in on the property boom; meanwhile fewer people are willing to migrate there.

In Wenzhou, another city in Zhejiang, the property bubble started to deflate last year and many local residents have rushed to sell their homes, with some even abandoning apartments to banks. The situation has sparked worries over a property market crash and huge potential risks for banks.

Since the beginning of the year, some property developers in bigger cities, like Beijing, Hangzhou and Guangzhou, have also been offering apartments with discounts, in a promotional bid to attract buyers and retrieve funds.

"Compared to other sectors, the bankruptcy of property developers could have wider impacts and therefore should be more carefully handled," said Cheng. "The local authorities should help defuse risks to avoid similar cases from occurring."

Most Chinese real estate companies borrowed massively to capitalize on the property boom. But the developers, particularly smaller ones, could now be susceptible to defaults as the market slows and banks stop offering lifelines.

Moody's Investors Service said the collapse of Zhejiang Xingrun Real Estate Co. is an isolated incident, but does highlight the vulnerability of small, highly leveraged developers with weak sales execution ability and high refinancing needs.

"In this environment, we believe financiers and investors will become more selective and favor borrowers with relatively strong credit, thereby further pressuring the liquidity of financially weak developers," said Moody's Assistant Vice President and Analyst Franco Leung.

Developers with weak sales and financial discipline will need to manage their balance sheets by selling assets, or risk being taken over or filing for bankruptcy, said the credit rating firm.

Moody's added that China's housing demand growth in the next 12 to 18 months will soften compared to 2013, and developers will need to balance their sales against their land purchases and development of new projects.