China’s real-estate sector has been in turmoil since the momentous default of property developer Evergrande in 2021, which left behind a staggering Rmb2.4 trillion hole.
The situation worsened in the second half of this year, with default risks spreading to top-tier companies such as Country Garden and even state-backed organizations like Vanke.
Banks, now thrust into the role of rescuers, are grappling with the implications of the crisis. Will their efforts end up transferring toxic assets and default risk from developers to banks, positioning the latter in the line of fire?
Rewind to last November. Regulators urged commercial banks to maintain stable financing for developers to ensure housing delivery. This occurred even as banks had been actively decreasing their exposure to developers to control their exposure to the sector.
Banks publicly trumpeted their support for the policy, with a number announcing strategic partnerships with real-estate firms, committing to credit grants ranging from tens of billions to hundreds of billions of yuan. According to the China Index Academy, around 60 banks provided an astonishing Rmb4 trillion ($570 billion) to nearly 100 developers during this period.
However, the reality tells a different story. Few of these credit grants materialized. Indeed, had the Rmb300 billion credit grant for Country Garden been fully implemented, the company might have avoided default.
this liquidity crunch is not linked to asset quality, operations or management. Rather, it’s a test of faith in state backing for the sector
A renowned economist close to China’s policymaking circle sums up the situation: “If commercial banks strictly adhere to the central bank’s directives, they absorb the losses into their balance sheets. The central bank won’t shoulder that burden for them.”
Given this backdrop, the latest round of bank-shouldered rescue plans – widely reported last week but not yet officially confirmed – will likely go ahead. These plans include a whitelist of 50 developers eligible for financing. Furthermore, in a significant first, banks are poised to provide unsecured short-term loans to qualified developers.
However, as Morgan Stanley highlighted in a recent report, these plans may not be mandatory and instead depend on implementation at each bank.
Taking a step back, even if these measures were enforced, analysts do not see an increased risk of default.
“It seems that the policy decision is that these ‘whitelist’ developers will not default,” one China expert tells Euromoney. “And perhaps the government has already realized that if the housing market does not recover, they will eventually need to clean up the banks’ bad assets. The Chinese government needs its banks more than anything else. They serve as conduit for policy transmission.”
The local government’s bailout of the regional Shengjing Bank offers a hint of a potential rescue chain: local governments back their banks, and in turn, the central government is willing to support local governments. This interplay was evident in the unexpected issuance of Rmb1 trillion in bonds to local governments last month.
Accumulating risks
Yet, a low possibility of default does not imply a smooth ride for Chinese banks, a misconception highlighted by a recent comment at China’s National People’s Congress. Published among various suggestions, it was proposed that financial sector has “a lot of room” to sacrifice profits to bolster the real economy.
This view diverges from reality. A Goldman Sachs report dated November 7 shows an average third-quarter profit growth of zero among the Chinese banks covered. This is in stark contrast to the 7% growth recorded the previous quarter and 13% growth in the same quarter last year. The report headlines a “parallel downward shift” – a decline quarter-over-quarter and year-over-year.
Even this flat growth was hard won, as many banks have reduced their provisions to boost profits, at a time when they are accumulating risks.
The persistent slump in housing transactions has led to a drop in banks’ mortgage loan assets. These are generally their highest quality assets, with an average non-performing loan (NPL) ratio of under 0.5%, according to the People’s Bank of China – markedly better than the overall 1.71% banking NPL ratio. As a result, banks have been compelled to shift to higher-risk lending, such as that to the manufacturing sector.
Liquidity crunch
The Chinese property crisis is more a liquidity issue than an insolvency problem. The recent default risks faced by top-tier developers such as Country Garden and Vanke underscore that this liquidity crunch is not linked to asset quality, operations or management. Rather, it’s a test of faith in state backing for the sector.
The initial slump in the property market led to liquidity issues for all developers. When this happened, state-owned organizations continued to enjoy strong bank support, while private developers were largely abandoned by the sector.
This has led to a vicious cycle for private developers, where the liquidity crunch has impacted project completion, which in turn undermines market confidence.
Privately owned developers have, therefore, almost disappeared from land acquisitions. The top 100 private real-estate firms in China maintained an annual land investment around Rmb2 trillion until 2020, which subsequently fell to Rmb1.7 trillion in 2021. By 2022, this had plummeted to Rmb250 billion, a year-on-year decrease of 88%, as per local research firm CRIC.
The government’s recent explicit emphasis on “treating private and state-owned developers equally” is an encouraging development. It remains to be seen how much the banks act on it.
