Unfinished homes in Shanghai on July 27. Photo: Bloomberg
The View
by Nicholas Spiro
The View
by Nicholas Spiro

China’s banks are trapped between a property crisis and a sluggish economy

  • With mortgage boycotts signalling a loss of confidence in China’s property sector, banks are under pressure to help developers deliver on promised homes
  • However, the quality of the collateral that secures loans to developers is a broader concern, even as the economy struggles to reboot under strict zero-Covid measures

Fears about China Evergrande Group, the world’s most indebted property developer, spiralling into default now seem a distant memory.

The months-long financial drama that culminated in the company being labelled a defaulter in December 2021 unleashed a wave of distress that has spread to some of China’s largest and most creditworthy developers.
While defaults in the nation’s offshore dollar-denominated debt market rose to US$14 billion last year, they have reached a staggering US$37.3 billion this year, data from Bloomberg shows. New house prices in 70 cities have fallen for 11 straight months, while sales among the top 100 developers have contracted on an annual basis for 12 successive months.
In a sign of the severity of the loss of confidence in China’s property market, tens of thousands of borrowers have halted mortgage payments on housing projects that sit unfinished. According to Nomura, developers only delivered 60 per cent of the flats they pre-sold between 2013 and 2020. Not only is the presales model – which dominates the residential market – broken, the threat of social instability and a sharper deterioration in asset quality in the banking sector has become more acute.
Blocks of flats under construction in Haiyan in China’s Zhejiang province on February 25. Photo: Bloomberg

In a report published on August 18, S&P Global Ratings said the mortgage boycotts are “not only a social stability risk. Should the strikes become widespread, they could undermine financial stability, particularly if they cause a sharp decline in home prices.”

The property crisis is escalating just as Beijing doggedly pursues its uncompromising zero-tolerance approach to the Covid-19 virus, imposing citywide lockdowns that undermine the effectiveness of measures to stimulate the economy.

China’s downturn leaves the country’s banks stuck between a rock and a hard place. The mortgage strikes have prompted a more forceful policy response. Banks are being leaned on by the government to provide the bulk of the funding to jump-start and complete stalled residential projects.
Yet, while helping restore confidence in the real estate market is in banks’ interest – the number of distressed developers targeted by the strikes could rise significantly, increasing the hit to banks’ mortgage books – lenders have been reducing their exposure to the sector, especially since Beijing launched measures in 2020 to rein in developers’ debt.

In early 2019, lending to housebuilders was growing 20 per cent year on year. This dropped to less than 5 per cent by December 2020, data from Moody’s Investors Service shows. What is more, corporate loans to the property sector were the main source of new non-performing loans last year, with smaller regional banks facing much higher credit risks than their nationwide peers.

Homebuyers at the sales centre for a residential project in Chongqing in March 2019. Photo: Zheng Yangpeng

Poor corporate governance and risk controls, coupled with less diversified loan books, make regional banks more prone to lending to vulnerable developers, particularly in smaller cities where most of the unfinished developments are located.

However, the broader concern for the financial sector as a whole is the quality of the collateral that secures loans to developers. Although the stock of mortgage lending affected by the boycotts can be absorbed by banks – a manageable 6.4 per cent of mortgage loan books would be at risk in a worst-case scenario, S&P estimates – a steeper decline in home values would eat into collateral buffers against potential credit losses.

Indeed, part of the reason the government hurriedly mobilised capital to complete the stalled projects is because of the growing threat to land values, the critical underpinning for the collateral. “When there’s a real threat to the valuation of land and housing, the government steps in”, said Nicholas Zhu, senior credit officer at Moody’s in Beijing.

Mounting tension between the government’s efforts to curb leverage and speculation in the real estate industry, and the more forceful measures over the past few months to avert a protracted crisis, is reflected in the share prices of Chinese banks. Since mid-July, they have been moving sideways, lacking direction in a highly uncertain economic environment.


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The problem is that Beijing’s policy response is not addressing the root cause of the property sector’s woes. In a blog post published on August 24, Michael Pettis, a senior fellow at the Carnegie Endowment, said the support measures wrongly treated problems in the industry as a liquidity issue, instead of addressing underlying solvency problems. By shifting liabilities onto the balance sheets of local governments and larger banks, China’s financial system continued to be “underpinned by moral hazard”.

Property-related risks in the banking sector are exacerbated by increasing pressure on lenders’ net interest margins, signs of a “liquidity trap” as households and businesses are reluctant to borrow and, crucially, the economic damage and uncertainty wrought by the government’s “dynamic zero-Covid” policy.

It’s time to go from zero-Covid to zero Covid restrictions

Not only are draconian growth-sapping lockdowns stymieing efforts to stabilise China’s economy and markets, they are contributing to the severe loss of confidence among homebuyers, creditors and investors. Harry Hu, a senior director at S&P in Hong Kong, said the zero-Covid policy posed a bigger threat to banks than the turmoil in the property market because it “had a compounding effect on everything”.

The longer China’s policy-induced economic downturn persists, the bigger the risk that long-standing vulnerabilities in the banking sector come under much sharper scrutiny.

Nicholas Spiro is a partner at Lauressa Advisory