China's shadow banking firms slashed lending to property developers in the first half of this year, closing off a crucial funding avenue just as the housing market cools, potentially spelling trouble for the sector and the broader economy.
Trust companies, which pool money from rich people and companies to make high-interest loans and are part of the China's vast and opaque shadow banking system, were a ready source of cash during the housing boom, particularly for smaller developers that had trouble borrowing from banks.
But in the first half of this year, trusts lent real estate firms 39 percent less than in the previous six months, according to trust research company Use Trust based in Nanchang. At the same time, the average interest on 48.3 billion yuan ($7.78 billion) in loans made through wealth management products climbed 16 basis points to 9.67 percent.
That bodes ill for Chinese developers who must repay nearly 600 billion yuan ($96.83 billion) worth of trust loans next year, according to brokerage firm Jefferies.
"Default risk is heightening because trusts rely heavily on house prices rising," said Xie Ya Xuan, an economist at China Merchants Securities' Research and Development Center in Shenzhen.
Trust firms, under greater scrutiny from regulators worried about rapid growth of shadow banking, are both finding it harder to raise money themselves and growing wary of lending to developers, particularly smaller ones, while the market cools.
New home prices in China fell in June for the third straight month, private sector surveys show, as some developers cut prices to spur sales, with many expected to offer steeper cuts as they scramble to meet 2014 sales targets.
That could squeeze developers with trust loans coming due in the next 12 to 18 months as a supply glut clouds the outlook for the property sector.
With its 15 percent share of China's economy and direct impact on 40 other sectors, many economists identify a property market downturn as the main risk to Beijing's 7.5 percent growth target for this year.
Tightening credit conditions make it tougher for developers to refinance and roll over their trust loans.