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SCMP Reporter

Era of huge profits from mortgage business over
Sichuan resident Pu Jianwen was  on hold for  20 minutes  before he got through a bank hotline for information on preferential mortgages.
When he arrived at a Chengdu branch last Friday with the pile of required documents, he found himself among a small crowd  just as eager to enjoy a 30 per cent discount to their mortgage loans.
But that was not all.
'I was told to wait. The branch had not received  instructions from its headquarters in Beijing on how to proceed with the preferential policy. And I have to pass their scrutiny,'  Mr Pu said.
The waiting game comes as mainland banks  face the reality of adjusting to lower mortgage rates after a continuous period of economic boom.
Since 2002, they have been raising mortgage rates whenever the People's Bank of China lifted benchmark rates. The central bank raised rates nine times before the  cuts began in September last year to  pump-prime a slowing economy.
The  rate for loans over five years, a benchmark for commercial mortgage loans, has been trimmed  1.89 percentage points to 5.94 per cent after the five rate cuts last year.
On top of the contracted margins, banks face an unprecedented challenge - they will grant a 30 per cent discount not only to qualified new borrowers but also to existing mortgage holders  from  this year.
The preferential rate  was lowered from 0.85 times  the benchmark rate to 0.7 times on October 27 last year.
Although  the central bank did not specify whether the policy applies to existing mortgage holders,  smaller lenders  such as China Everbright Bank and China Minsheng Banking Corp  extended the policy to existing borrowers in November.
It remains uncertain whether the measure can bolster the property sector, which saw  light transactions over most of  last year. However,  it appears increasingly clear that banks will have to bid farewell to exceptionally high profits from the low-risk mortgage business.
'Banks definitely dislike making the adjustment to existing loans. A new policy applying to old borrowers is not a practice seen in many other countries. It can reduce bank revenue by tens of billions of yuan,'  said Yi Xianrong, a researcher with the Chinese Academy of Social Sciences.
At the end of 2007, outstanding individual mortgage loans stood at 3.3 trillion yuan (HK$4.08 trillion), or about 10 per cent of  yuan loans.
The country's banking regulator estimated an increase to 3.6 trillion yuan  at the end of last year. But banks had set up thresholds, making the discount only accessible to an estimated 10 per cent of  mortgage loans,  Mr Yi said.
Under the guidelines set by several banks,   qualified borrowers should  have no payment defaults, no contract violation record and have previously enjoyed a 15 per cent discount on the mortgage for  a  first apartment  smaller than 140 square metres.
The country's biggest lender, Industrial and Commercial Bank of China,  has not announced  its parameters, but Bank of China and China Construction Bank Corp officials said it was up to their branches to decide which clients would get the preferential rate.
Still some branches of the two banks said they were awaiting instructions from headquarters.
'Some big banks are still  biding their time on the new lending rule. They have been reluctant to see  net interest margins shrink substantially from 0.8055 at the end of 2007 to 0.558 at the end of last year, reflecting the five rate cuts last year and the 30 per cent discount,'  Mr Yi said.
He calculated the net interest margin, the key  profit contributor to mainland banks,  by subtracting the rate for deposits of more than five years from  that for loans of more than five years.
However,  Samuel Chen, a bank analyst at JP Morgan, said the  margin contraction should be smaller than Mr Yi's calculation.
'The financing from the long-term deposit only accounts for  2 to 3 per cent of mortgage loans. Quite a lot of  funding came from shorter-term deposits. So the net interest margin would not have contracted by so much,'  Mr Chen said.
He said banks' net interest margin was expected to shrink  6 to 9 basis points if 10 per cent of  existing mortgage loans get the 30 per cent discount, denting billions of yuan of lenders' profits.
'The profit reduction is unlikely to be a blow to big banks such as  ICBC which reported 82.3 billion yuan in net profit in 2007. However, the policy ended the unreasonably high profits banks used to make from the low-risk mortgage business,' Mr Chen said.
'In the past few years, banks have been enjoying 400-500 basis point interest margins from mortgage loans, while it is about  100 points in other countries.
'China's rates are unreasonable because they are ministered by the government, instead of determined by the market.'
With the preferential rate for loans over five years at 4.158 per cent and financing cost at lower than 2 per cent, mortgage loans are still good business, according to Mr Chen.
For small lenders, the earlier they put in place the preferential policy, the greater the opportunity to grab market share.
Lu Zhengwei, an economist with  Industrial Bank, said: 'Small lenders are targeting quality clients from big banks. Mortgage business is just a starting point. Later on, they can offer wealth management and other financial services.'
A bigger pool of clients  was crucial when demand for mortgage loans was slipping amid the economic downturn, Mr Lu said.
Outstanding individual mortgage loans rose 10.6 per cent at the end of November. The growth was 25.8 percentage points slower than the previous year,  according to the central bank.
The non-performing loan ratio in the business has been below  1 per cent for years. It was 0.7 per cent in Shanghai at the end of October, a low level though up 0.04 percentage point from  a month earlier, the Shanghai banking regulator said.
'The sluggish property market is a big concern for banks. I think people have formed the expectation that property prices will fall further this year, which will make  it hard for the sector to have an early turnaround, and  sentiment can't be reversed simply by the loan discount policy,' Mr Lu said.
A 30 per cent fall in mainland property prices could trigger serious loan defaults, ravaging banks and even devastating the  economy.
According to a study conducted by the Shanghai bureau of the China Banking Regulatory Commission, the average bank non-performing loan ratio in Shanghai banks could soar to 4.73 per cent from just over 1 per cent in November, if property prices fell about 30 per cent,  bureau head Yan Qingmin said. 'If the decline is no bigger than 30 per cent, banks can still afford it. Otherwise, the whole banking sector and the whole Chinese economy won't be able to bear the impact.'
Economists generally forecast a 10 to 30 per cent decline in property prices this year, without ruling out the possibility of worse scenarios.
Mortgage loans and lending to developers account for more than  17 per cent of  loans granted by mainland banks.
The number rises to 65 per cent if  loans using property as collateral are included, according to the  banking regulator.



Banks face challenge of lower loan rates