In China’s Shadow Banking the WMPs Are Just Beginning of Problem [ANALYSIS]

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companies owned by local governments; this travels to lenders and then to micro-credit companies, and finally to real estate developers. We do not have sufficient evidence of this, but will continue to track developments in the sector.

Longfor Properties Co., Ltd.

We visited Chongqing Bamboo Grove, a residential site in the New North Area of the city that is being developed by Beijing-headquartered Longfor Properties. Our first impression on reaching the site, located 41km (40-50 minutes by car) from central Chongqing is that it was quite remote. The total site measures 500,000sqm, with housing to cover 400,000sqm. The massive development will consist of 900 single-family houses, covering three quarters of the area, and 2,700 low-rise condo
units, for a total of 3,600 housing units planned. Sales will be conducted in two phases: 1,300 units by the end of 2014 and the remaining 2,300 by the end of 2016. The developer began to receive applications in April 2012 and completely sold out the first phase in May 2013. The average selling price is CNY9,000/sqm, which looks expensive for a location so distant from the city center. The single-family homes average 300sqm each, while the low-rise condo units have a floor area of 60-280sqm. The first phase has been heavily weighted towards the family homes, with 600 sold (and 700 condo units). The company’s success in selling the final properties by May this year underlines the strength of demand for housing in Chongqing.

According to the company representative, many of the buyers in phase one have been government officials, company managers, and college professors, with annual incomes of between several hundred thousand and several tens of million yuan. These are probably only reported incomes: the three groups mentioned are well known for having substantial side incomes. Under normal circumstances, only a company director or accounting manager would command an income in the tens of million yuan bracket. A senior government official would be paid in the millions of yuan. The project has sold so well for reasons including (1) the area’s designation as a special zone by the central government in October 2011, (2) its location within the second expressway ring road, where future development is set to be concentrated, (3) the prospect that Chongqing’s further development will be to the north of Jiangbei district (due to physical limitations to the south), and (4) a good natural environment. The special zone designation is on a par with Pudong in Shanghai and Binhai in Tianjin, meaning it is set to qualify for large reductions in customs duties and VAT (17%). Some 30 R&D institutes and tech companies have already decided to establish a presence in the zone, including precision equipment manufacturers, the Chinese Academy of Sciences, the GPS Technology Center, and China Mobile.

The residential development we visited is 15 minutes by car from the center of the zone. A station is due to be built on an extension of the monorail line from central Chongqing in the near future. The government aims for the region to generate GDP of CNY1trn by 2020, double Chongqing’s current level. Longfor estimates that 70% of purchasers in phase one of the project already own a home elsewhere in the city, with the remaining 30% from elsewhere. About 10% of all buyers purchased two or more properties, and virtually all already owned a property somewhere. Our impression is that Chongqing’s property boom is in no danger of an imminent slowdown.

Our impressions

Below, we note our insights from the ground during our recent visit to China.

July 1: Beijing

Shadow Financing Is Spreading In China

So-called “wealth management products (WMPs)” have been gaining attention in China. Amid concerns that loans extended via these products could become irrecoverable, the rise from mid-May in the Shanghai interbank offered rate (SHIBOR) has highlighted the deteriorating cash flow of stock-issuing banks (regional banks other than the four major state-owned banks). This does not appear to have stopped the spread of “shadow banking”, however, which involves financial products that fall outside the supervision of the Chinese authorities. Recently, there has been a sharp increase in the number of financial products on sale over the counter at securities companies, advertised under the somewhat odd name of “asset management plans”. The balance of these products amounts to CNY1-2trn. Considering that WMPs are estimated to have tripled in size in one year, depositors’ funds and loans that have flowed out of WMPs could be diverted to these asset management plans. We are yet to fully understand the nature of these products, but according to a mega bank headquartered in Beijing they are clearly high-risk. On the heels of WMPs, we think asset management plans are the next shadow banking product that deserves close monitoring. In our view, their emergence suggests that shadow financing is spreading in China.

July 2: Chongqing

Chongqing is China’s Most Populated City

Chongqing is China’s most populated city. This is the only city in China exempted from regulations that stipulate the number of properties a person can buy. As long as they pay entirely in cash, anyone can buy as many properties as they like in the city. We have been coming to Chongqing for more than five years, including a visit six months ago. The city does not seem to know when to call it a day on real estate development. The 30-minute car journey from the airport into town is long enough to gain the impression that Chongqing has continued to attract speculative investment from other regions since new property regulations were introduced in 2010. We saw more signs today of the micro-financing business that is one aspect of China’s shadow banking system. As with yesterday, our impression is that much of China’s financial system carries on under the surface, but signs of how the system works behind closed doors are finally starting to emerge.

July 3: Chongqing

Today we continued yesterday’s visit of one of Chongqing’s real estate development zones. The site we visited is the Chongqing Bamboo Grove housing development of Beijing-based Longfor Properties. It is part of Chongqing’s new special economic zone. Located 41km from the city center, 3,600 homes with a total floor space of 400,000m2 are under construction. The project’s first stage, which includes 1,300 homes and is expected to be ready at the end of 2014, sold out in May. According to a real estate agent, almost all of the buyers already own other houses, 10% of buyers have purchased at least two properties in the same development, and 70% already own a house in Chongqing. This is a recent symbol of the real estate boom in Chongqing that has resulted from the lack of restrictions on home ownership, as long as properties are paid for in cash. The price of CNY9,000 per sqm seems fairly high, considering the development is 40-50 minutes drive along a motorway from the city center.

July 4: Nanjing

After a day of visiting companies in Nanjing, we travelled to Wuxi. Just before arriving at the hotel, we noticed a business selling WMPs and went inside to ask for an explanation of the products available. The business was typical of those set up to cater to China’s wealthy consumers, with not only pamphlets on WMPs, but also display cases containing gold and jewelry. The WMPs advertised involved investing in gold, offering a guaranteed yield of 13-25% a year, with a minimum investment requirement of between CNY300,000 and CNY5mn. According to the sales representative, the products have a guaranteed yield of 13-15% (the explanation about the investment capital was unclear), the products are available to Japanese people (they had already taken investments from Taiwanese people), and other branches have various products available with guaranteed yield of 9-12%, involving investment in social infrastructure, real estate, and small to medium-sized company bonds (it was unclear exactly what the latter referred to). This conversation was a complete surprise to us, as it showed that despite the government introducing

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