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Trust busting

27 September 2011 By John Foley

A favourite financing wheeze of Chinese property developers is starting to show cracks. Regulators have sounded the alarm over Greentown, a real estate company in the picturesque city of Hangzhou, which used trust companies to funnel debt to new projects. Many others have done the same. But trusts, which provide short-term financing secured on illiquid collateral like land and half-built apartments, are inherently vulnerable to a crisis of liquidity and confidence.

Trusts filled a funding gap left when banks, responding to official worries about bubble-some asset prices, pulled back from real estate lending last year. Trusts have provided more than 40 percent of the last year’s new borrowings for big developers like Agile, KWG and Poly, according to Credit Suisse. Typically they lend to a project, take equity as collateral, and sell on slices to investors. But the structures are designed to be repaid after a year or two. Since many projects take longer than that to finish, many trusts often need to find new investors to pay back old ones.

If a project flops, investors often enjoy protection in the form of a guarantee from the developer. But delays or outright failure threaten the solidity of the guarantees. With developers low on cash, trust investors could find themselves forced to take ownership of collateral like land and empty properties. The proceeds of selling those in a hurry might fall short of what investors are owed, and push down the market elsewhere. Nasty feedback loops could be created.

The chances that developers experience a serious cash crunch are rising. Greentown had 6.7 billion yuan of cash on its balance sheet at the end of June, but 14 billion yuan of debt repayable within a year. Housing transaction volumes have dropped sharply, year on year, and inventory is rising.

Meanwhile, banks are delaying delivery of mortgage loans to meet rules on credit tightening. This could strain developers’ cash flows even after they have agreed sales.

Trusts have spread rapidly to become a critical source of funding for property companies. Authorities are aware of the problem, but may not have the tools to deal with it. If a crisis of confidence sees even healthy developers unable to refinance their trusts, the resulting unravelling could be very messy.


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