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Real estate crisis jeopardises China’s economic rebound

A turbulent year in China’s real estate sector has created unease in the domestic market. Kimberley Long reports on how the banking sector has been shielded from the worst of the crisis, but wider problems for the economy remain. 
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Real estate crisis jeopardises China’s economic rebound

China’s property sector hit international headlines during 2021 for all the wrong reasons. Evergrande, China’s second largest property developer, missed multiple debt payments. A Global 500 company, Evergrande employs 200,000 staff and in 2020 the company had a total asset value of Rmb2.3tn ($342.58bn). 

While primarily a property developer, the company has expanded across industry sectors, including operating 15 amusement parks across China and owning Guangzhou football club and an associated football school. It is believed these wide-ranging concerns, and the level of debt needed to support all areas of the company’s operations, are what led towards the financial problems. 

The first warning signs that the company was in trouble were seen from September 2021, when the company missed a deadline on an $83.5m interest payment due on some of its dollar-denominated bonds. The company just missed defaulting by making the payment at the end of its 30-day grace period. 

But this was just the beginning of wider issues. During December 2021, the company missed repaying interest on approximately $1.2bn of international loans. Following this, Fitch declared the company to be in default. Evergrande has been labelled the most indebted company in the world, to the sum of $300bn, and has a range of payments due on the interest and the principal of offshore debt on an almost monthly basis through to December 2022. 

The company entered into a restructuring process with local government officials, with the preliminary plans to be announced before the end of July 2022. The move is needed after the company stated in a filing to the Hong Kong Stock Exchange that “there is no guarantee that the group will have sufficient funds to continue to perform its financial obligations”.

While the involvement of the Chinese authorities was reassuring to local bondholders, this was not the case for international investors, who were not guaranteed support. 

These problems are not limited to just Evergrande and its stakeholders. The impact ricocheted down the supply chain, with suppliers including construction companies to estate agents and furniture companies being left without payment for work. Interior design company Jangho Group was one of the hardest hit, with a credit impairment loss of Rmb1.68bn linked to Evergrande and its subsidiary companies at the end of 2021. Some suppliers have begun legal action in order to recoup their finances. There are concerns about the impact this could have on the property sector and the potential for contagion across the economy. 

Having a strong real estate sector is a big concern for the Chinese government as it represents around 30% of China’s gross domestic product, and as such it has stepped in to stop a wider fallout. While the Evergrande crisis may not turn into the economic catastrophe some had feared, it did bring to the surface the issues which are playing out across the property sector.

Real estate purchases 

The Evergrande crisis brought China’s property sector to international attention, but the country has been experiencing several issues across the sector. The pandemic has slowed demand for home purchases, with sporadic lockdowns suppressing consumer appetite. 

In a note published in May 2022, Fitch stated that funding had been constrained due to subdued property sales within the weakened economy and falling property prices. “We forecast China’s property sales to fall by 25% to 30% in 2022,” the note added. “This is likely to further compromise internal funding and, in turn, limit access to external funding from banks, non-bank financing and bonds issuance, especially for financially vulnerable developers.”

According to the National Bureau of Statistics of China (NBSC), sales of new properties fell by 47% in April 2022 year-on-year. The price of property in 70 cities fell for the eighth consecutive month. 

Measures have been implemented to support the market. The People’s Bank of China (PBOC) moved to cut the five-year loan prime rate (LPR) by 15 basis points (bps) to 4.45% during May 2022. It was the second time the rate had been reduced in a year and was the largest reduction on record. The LPR is used as a benchmark rate for banks to lend to customers and the five-year maturity period is a reference for mortgage lending. The PBOC also lowered the benchmark lending rate by 20bps for first-time buyers in May 2022, but Fitch believes this will only narrowly improve market sentiment. 

Chan Kung, founder of China-based think tank Anbound, believes there is real danger brewing. “The balance of real estate loans is Rmb52tn, which can be understood as a risk exposure to China, because China’s real estate industry is still in a restricted state. This is a huge number, and creating problems for the government,” he says. “The number is already high, and may be increasing. Unless the policy-makers change their attitude towards the real estate industry, we think this risk will grow.” 

The problems in the real estate space are hitting across the economy and may worsen without intervention. Elaine Xu, director of financial institutions at Fitch Ratings, says: “We see lingering weaknesses in the property market, which challenges overall economic growth.

“There has been some targeted loosening, such as reducing the amounts needed for down payments and relaxing home restriction policies in several cities, but we still see buyer confidence and home transaction volumes at low levels. For Chinese banks, the non-performing loan (NPL) ratio for property development loans has increased from around 1.7% at end-2020 to around 2.7% at end-2021. So far this seems manageable, with overall sector exposure to property development loans at less than 10% of loans.” 

Developer defaults 

While Evergrande’s problems made the headlines, there are other Chinese developers who are struggling. Tianjin-based Sunac China Holdings was in talks with shareholders during June 2022 to extend payments on Rmb2.3bn of debt, which was imminently due for repayment. By settling the extension, the property developer was able to avoid domestic default. Developers Fantasia and Sinic Holdings defaulted during October 2021, after being unable to pay off bonds worth $206m and $246m, respectively. 

Nicholas Zhu, vice-president and senior credit officer at Moody’s Investors Service, believes this is only the start. “More developer defaults are likely, including distressed exchanges. However, the impact on banks is mitigated by loan collateral,” he says. 

The structure of bank lending is likely to shield them from the worst effects of the declining market. China Minsheng Bank, China Zheshang Bank and Shanghai Pudong Development Bank all gave Evergrande more time to repay its debts. As stated by China Minsheng Bank, most of the loans had land, properties or projects under construction held against the loans as collateral. Hangzhou-based China Zheshang Bank stated Evergrande’s borrowing amounted to Rmb3.8bn, but that it held “sufficient collateral”. In a statement posted on the Shanghai Stock Exchange, the bank said: “The overall risk is controllable. The risk situation … will not have a significant impact.” 

Mr Zhu says this fits with the general structure of bank lending to property companies. “Banks generally lend to the project companies of the property development companies working on specific sites or projects. The project-level legal entities borrow from banks collateralised through the claim on the land and the value of the construction project. The impact of a default on a project-level company on the headquarters of a developer is limited if the value of the site is not affected,” he explains.

Because of this setup, the risk to banks is less than to other parties. “There is a difference between a bank’s secured exposure and bond holders’ unsecured exposure to distressed developers,” Mr Zhu adds. “We see a lack of direct contamination of the exposures that the banks have at the project level from the distress of developers’ unsecured bond obligations. What the banks have exposure to [with regards to the] distressed developers will either be categorised as an NPL or as a stage-three exposure, which means it will be fully provisioned.” 

In a note dated April 2022, Fitch stated: “In addition to the continued resolution of bad debts, banks’ moderate direct exposure to property development (at around 7% of total lending) helped to cushion the impact on their overall NPL ratios. There may also have been recognition issues, especially for smaller banks.” 

Risk to banks 

While the risk from property development may not be severe, there is the ongoing concern around NPLs and the falling value of real estate outside of the major cities. Home prices in 70 large and medium-sized cities continued to drop through to May 2022, according to the NBSC. There was a 0.1% decline in the prices of new homes in 31 second-tier cities, while in 35 third-tier cities it fell 0.3% month-on-month. 

In a bid to stimulate purchases, authorities have loosened the rules around owning multiple properties. Hangzhou has introduced rules to allow families with three children to buy more than one home, in a move that it hoped will also act as an incentive to increase the birth rate. Some have also introduced smaller down-payment requirements to encourage more new buyers. 

Unless values plummet, Mr Zhu says the banks will be in good shape. “Is there any risk to the banks? There is, but by a different nature. It is hedging on the collateral value,” he notes.

“Should that collapse by up to 30%, the banks will find themselves undercollateralised. That’s the main risk to bank real estate lending exposure. How likely is this to happen? There is a clear policy indicator that the government will not allow this. It is in their interest to ensure construction continues and the housing value stabilises.

Mr Zhu continues: “Even if the value softens by 5% to 10%, it will be manageable, but a higher double-digit decline of housing prices will cause a shock to bank creditworthiness. We do not think this scenario is likely, given the recent policy measures to stabilise the real estate sector.” 

Ms Xu adds that Fitch believes banks should be protected as long as the issues seen so far are contained. “Our rating assessment considers some property stress, and the banks’ viability ratings have sufficient headroom to absorb potential deterioration in the property market, provided there are no material spill-overs into other segments which may pressure economic growth over a longer period. Their issuer default ratings remain driven by Fitch’s expectations of varying levels of government support,” she says.

There is optimism that the issues within the property sector will remain there. Harry Hu, senior director at S&P Global Ratings, says: “The property crackdown has been quite harsh over the last year. We always believe the pressure within the sector is high, but we don’t think that will turn out to be a systemic issue beyond the property sector. Last year we expected around a third of property developers to be in financial trouble, but when we saw the end of year financials it was around 40%. Despite this, the banks get buttress from the property collateral. At a national level, the average decline in price is around 5%, but some smaller cities have seen greater volatility.” 

The level of regulation in place has helped to protect the banks. Yu Lingqu, vice-director of the department of financial development and state-owned assets, and state-owned enterprise research at think-tank China Development Institute, says: “China’s real estate market has been under regulation in recent years. The banking industry and real economy haven’t been impacted by those real estate companies that came into crisis.” 

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Kimberley Long is the Asia editor at The Banker. She joined from Euromoney, where she spent four years as transaction services editor. She has a BA in English Language and Literature from the University of Liverpool, and an MA in Print Journalism from the University of Sheffield. Between degrees she spent a year teaching English in Japan as part of the JET Programme.
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