BarroMetrics Views: A Crisis in the Making?
While the Western markets are focusing on the woes of Europe and the US, there is a possible crisis brewing in China that is likely to have far reaching consequences for S-E Asia, Australia and Canada – given that the Chinese have been extensive and expansive buyers of property there.
Greentown has been in the news. Who? Greentown is a trust that lends money to developers. To understand the drama around Greentown, let me provide some context.
When the Chinese Government ostensibly pressured banks to reduce real estate lending in 2010, it gave the green light to Trust Lending (see attached pdf). In summary, trusts operate in this way:
- They lend to a developer for a project
- Take security (usually the real estate) as collateral
- Sell portions of the trust to investors.
But, the investors have a life tenure of one or two years; and the projects take longer than that to complete. So, the Trusts have to find new investors to replace the old ones (Ponzi Scheme? Not quite but close).
Since Trusts were given the green light in 2010, they have provided more than 40% of the borrowing to the large developers, like, Agile, KWG and Poly.
Now here’s the problem. If a project fails, the investors have recourse to the developers’ guarantees. But the developers are low on cash, so the trust investors will probably find themselves saddled with land and empty (and perhaps partially completed properties). The value of the holdings are likely to fall short of what is owed, and the ensuing fire sale will have implications for property values elsewhere.
The Chinese Government is concerned that cash flow problems among the developers will turn to a full blown crisis. Hence, it stepped into the Greentown project (see http://www.xe.com/news/2011/09/22/2172005.htm?c=1&t=).
With this context, let’s turn to Greentown.
Greentown has 6.7 billion renminbi at the end of June 2011. But, it has a liability of 14 billion renminbi to repay by year’s end. That would be OK if sales were happening BUT, sales are dropping, and inventory is rising. On top of this, banks are restricting lending.
All in all a crisis of its own. Now here’s the thing. Many Chinese developers have borrowed locally to buy overseas. If a need for cash arises, we may well see property prices drop in S-E Asia etc as the cash strapped Chinese seek to remain liquid.