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More Chinese Developers Nearing Bond Defaults As Evergrande Contagion Spreads

Apartment buildings under construction in the Eastern China city of Anyang in 2015

So far, it appears that the debt-induced collapse of Evergrande Group will indeed drag down a significant portion of China's real estate market.

About two-fifths of Chinese development companies are at risk of defaulting on bonds sold to international investors, according to research from Japanese financial services firm Nomura Holdings reported by The Wall Street Journal. Less than a year after President Xi Jinping instituted measures to curb overleveraging among the country's private developers, many of those companies appear unlikely to meet all their debt payment obligations, which lowers investors' outlook for the sector and compounds the liquidity crunch.

Overall, the Chinese real estate market accounts for about $5 trillion in debt, which is more than the annual output of the entire Chinese economy, WSJ reports. The wave of bad news has reduced confidence in the sector among homebuyers in China, as well, with September home sales among the 100 largest Chinese developers down 36% year-over-year, and 44% among the 10 largest.

With payment deadlines on some of Evergrande's bonds having come and gone without any word on whether the company fulfilled its obligations, Fantasia Holdings Group missed a loan payment of its own last week. Now developers Modern Land and Xinyuan Real Estate, both of which have a presence in the U.S., have asked for extensions and other forms of assistance from bondholders to avoid defaults of their own, Bloomberg reports.

The current state of affairs has prompted a sell-off in the Chinese junk bond market over the weekend, with China dollar junk bond yields reaching a decade-high 16.9%, Bloomberg reports. With banks directed by the government to cut spending on loans to real estate, the primary funding path remaining to real estate companies is home sales, which are also in decline.

A common practice among Chinese developers to raise funds for completing projects is pre-selling units in those projects, which is treated by analysts as an interest-free liability, much like when contractors and suppliers perform work for the developers ahead of being paid. Such agreements made up the largest funding source for Chinese developers last year, according to official government statistics reported by the WSJ.

Both of those transactions have been given the highest priority by the Chinese government to ensure payment, but until the current instability resolves, fewer pre-sales and supplier deals will be possible, the WSJ reports. The cascading effects of funding source after funding source drying up for developers have resulted in analysts cutting their outlook for China's overall economic growth for this year and next.