Analysis - Near-bankrupt Chinese property firm offers lesson in lending risks

By Pete Sweeney

FENGHUA, China (Reuters) - To understand why many of China'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 China's biggest real estate bankruptcies in recent memory.

As China's property bubble shows signs of deflating in some areas - in peripheral neighbourhoods in lower-tier cities - privately held developers like Zhejiang 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 Zhejiang Xingrun is on the verge of bankruptcy with 3.5 billion yuan (339 million pounds) in debt offset with only 3 billion 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.

Chinese home price inflation fell for a second straight 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. Zhejiang Xingrun's investments were in the satellite city of Fenghua within the port municipality of Ningbo in eastern Zhejiang province.

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

To be sure, Zhejiang Xingrun's investments were focused in Ningbo, so the company does not represent a broader threat to stability, Chinese officials and bankers said.

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, Hong Kong-based property analyst with Nomura.

The inventory of unsold property in Ningbo is much longer than the 12-15 months that the Chinese government targets, 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 bailed out 600 companies in 2012 around its capital Hangzhou after property developer Tianyu Construction buckled owing 10 billion yuan, local media reports said.

BORROWING HIGH, SELLING HIGHER?

Fenghua is a low-slung cement city made up of small hills that straddle a river of the same name. The city's economy is largely fuelled by automobile 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 developer Heyuan Real Estate near the city centre, had already sold out in advance at an average of 11,000 yuan per square metre, said a sales agent on the premises, who gave his surname as Lin. This is 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 has 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, chief executive of major mainland property developer Greentown Real Estate .

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 Zhejiang Xingrun had borrowed 2.4 billion yuan from banks.

But the firm'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. Shen and his son are now both under arrest, officials said.

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

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

Xingrun did not respond to calls from Reuters and addresses listed on the company's website in Fenghua did not correspond with operating company office locations.

Analysts say there are plenty of other companies that have borrowed at punitive rates - sometimes as high as 20-30 percent - on the assumption that property prices would rise faster. Some included speculators, such as companies that sold bonds for business purposes only to use the funds to buy real estate.

Analysts are concerned that some of these bonds were in turn bundled into high-yielding wealth management products and sold to individual investors.

"There wouldn't be a problem if prices had kept going up," said the chief finance officer of a mid-sized property developer, with projects mainly in coastal provinces.

In Wenzhou, an export-oriented city on the coast of Zhejiang, property prices have declined month-on-month for 31 straight months thanks in part to the use of property as collateral for business loans.

Many businessmen used real estate holdings as collateral to secure high-interest business loans. When their businesses ran into problems, they had to sell off their properties, adding to inventory and further depressing prices, said Chen Qian, executive chairman of the Wenzhou real estate industry association.

HOLDING THE LINE?

Few believe the government would deliberately engineer a wider decline in property prices. After all, property contributes around 16 percent of China's economic activity.

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 in 2013. That campaign has ended and bank lending rates are back on the decline.

That means that even as Beijing broadcasts its intentions to tolerate more defaults, it is effectively making it cheaper for companies to roll over debt. That may bring temporary reprieve, but also raises the risk of further pressure on the sector if rates rise again.

Investors also suspect Beijing may be preparing to ease up on administrative restrictions on home purchases to further support the sector. Real estate stocks rallied on Wednesday on reports in state media that local governments in Hangzhou and Changsha, in southern Hunan province, may be preparing to loosen restrictions to revive growth.

(Additional reporting by Clare Jim and Umesh Desai in HONG KONG and Gabriel Wildau in WENZHOU; Editing by Neil Fullick)