8th May 2015 18:00 HKT
Chiecon first to report in English on a report out today from Netease news which shows that facing the prospect of running out of funds, small and mid-sized property developers are raising funds for projects under the guise of local P2P (peer to peer) networks, misleading unsuspecting and often elderly investors. In doing so, real estate firms are creating local ponzi schemes, and increasing hidden contagion risk.
Chinese media over the past year has reported on numerous online P2P collapses, yet the offline P2P market is just as messy. Low barriers to entry mean illegal enterprises can easily enter the market, causing losses for the investors and borrowers.
One founder of a P2P platform told Netease news that with traditional fundraising channels unable to meet cash flow requirements, its now common to see smaller sized property developers enter the offline P2P market.
According to a net finance industry insider, the offline P2P market consists of four segments: personal micro loans, personal mortgage loans, corporate loans, and real estate loans. Of these, loans to real estate present the greatest risk.
The worrying aspect is that many small property developers are themselves establishing wealth management companies in order to start up offline P2P businesses. One worker who interviewed for a job in the business was clearly told by the boss that most offline P2P networks cooperate with property developers, and that eventually, the money ends up in real estate.
An industry source who wishes to remain anonymous explained: “Since late 2013, small property developers have found it increasingly hard to obtain bank loans, and with the cost of private equity considered too high, instead decided to set up their own P2P platforms. But individual investor funds, which they thought were being lent to other individuals, were in fact being directed to a real estate company’s own building projects”.
The same source added that a common feature of these wealth products are one to two year maturities, but it is unlikely a developer will be able to sell enough housing units to cover repayment of principal and interest to the investors within that period.
So if these P2P loans were being signed from 2014 onwards, this implies many loans will be due this year. In a depressed property market, can the property developers meet these repayment demands, or will this trigger defaults?
How it works
The biggest difference with the online P2P platforms, is that online, investors and borrowers can directly match up with each other.
But offline, the company acts as an intermediary, lending out the funds to borrowers, then transferring the loan repayment rights to investors. The investor and borrower never meet, and the P2P company is supposed to vet the borrowers and in some cases provide gurantees.
So in this offline P2P model its easy for the real estate companies to hide from the investor the funds ultimate destination, effectively fundraising illegally under the banner of the P2P platform.
And the reason private investors would risk their cash lending offline? High interest rates, sometimes 10% higher than usual returns of 5-6% on bank wealth management products.
The source also explains how many of the investors are usually the elderly, targeted on the streets near the P2P company offices, using questionable sales tactics. The Netease Finance team also went to see for themselves, and noticed the P2P sales team would ignore the younger crowd, and approach only the elderly investors.
A person familiar with the offline P2P industry explained that if an investor doesn’t seem convinced, the salesman will invite them to the conpany’s office, sit them down with tea, offer small gifts, and obtain the investor’s contact details. Later the investor, along with others, will be invited to an investment senimar.
According to analysts the reason for targeting the elderly is “not only because they represent a large market, but also because they lack basic investment knowledge, which increases the overall risk”.
The same person familiar with the sales tactics used explained that “at the investment seminars the company will line up speakers who present to the investors, as well as inviting previous investors up onto the stage to help with the sales pitch”.
Investors are then warned about the dangers of net finance, and if their funds are not enough, are encouraged to remortgage their house with the bank, enabling the investor to pocket the interest rate difference.
Offline P2P firms especially like to target those families who have been relocated by the government, as often they hold a few properties which can then be remortgaged to raise funds for investment.
This is quite scary, because if the company fails to repay the loans, there’s nothing the investors can do to get their money back.
Another risk raised by experts is that due to the lack of transparency, companies can setup new platforms, continue to take in new funds, and use them to repay old loans. Thus creating local ponzi schemes, which can only continue as long as the property market keeps moving.
Finally P2P experts warn of the greater problem of hidden contagion risks, as property developers in trouble might pass on these risks to the end property buyers, creating a new bubble. If a local property market were to collapse, the P2P ponzi schemes would collapse, which would create a wave of defaults, causing social instability.
Sounding familiar? A few years back a similar situation of property based private lending emerged in Wenzhou, only to suddenly collapse, taking the property market down with it.
Where are the regulators?
Critics argue that offline P2P lending, even if for legitimate purposes, is no different from a bank taking deposits and lending out. According to available data, in 2014 the ten largest offline P2P companies handled loans in excess of 100 billion yuan, but in general these large and legit companies utilise technology and mature risk management systems.
With respect net finance, the government has been vocal about allowing innovation whilst controlling risks. Early this year, the China Banking Regulatory Commission (CBRC) initiated structural reform, including carving out a department responsible for net finance.
But in terms of regulating the offline P2P market, the regulators have been less enthusiastic. The reason experts point out, is because in reality its too difficult to supervise
Whilst its old news that Chinese property developers are facing a slowing market, and finding it tougher to raise funds, recent data from the National Bureau of Statistics (NBS) highlights the diverging trend of stabilising month on month home prices in first tier cities, whilst second and third tier cities continue to struggle with chronic oversupply.
Consequently its the small and medium sized property developers experiencing the steepest drop in revenues, and with less capital available to purchase new land, must resort to loans.
The only problem is that at the governments request, state banks have been slowly turning off the credit tap, especially if it means authorising loans to the smaller, and deemed riskier, property developers.
As per a previous chiecon post, property inventories are still high, and in many smaller cities, the rate of oversupply is still increasing. In other words the developers are unable to sell off units at a quick enough pace to repay their liabilities.
Another reason for shrinking fundraising channels is the allure of the stockmarket.
Over the past few years, real estate developers were able to rely on private investors lending money to shadow banking wealth management products (WMPs). On a visit to Shenzhen’s finance expo last year, I asked many of the companies where their products were being invested. In almost every case the answer was property.
But now data from the China Trust Association shows funds are switching to securities based WMPs. And then there’s the swelling assets under management at asset management firms, mainly being ploughed into the stockmarket.
Recent data from the Peoples Bank of China (PBOC) shows that the government’s squeezing of shadow banking has proven effective, with bank bills, entrusted loans and trust loans now a small fraction of total lending, when compared with a year ago.
Since small property developers face tight liquidity from banks and now even from shadow banks, they’ve decided to take matters into their own hands and set up their own P2P platforms.
Only a healthy rebound this year in the property market, or continued government policy support and a change in the tax system, will save the smaller developers.
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And over a year later… Bloomberg, 22/09/2016 – Beware the Chinese Property Companies That Look Like Shadow Banks