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The escalating crisis for distressed projects has undermined the confidence of hundreds of thousands of homebuyers, leading to mortgage boycotts in more than 90 cities and warnings of broader systemic risks. The big question now is not whether, but how much it will harm the country’s $56 trillion banking system.
In a worst-case scenario, credit rating agency Standard & Poor’s has estimated that 2.4 trillion yuan ($356 billion), or 6.4% of mortgages, are at risk while Deutsche Bank AG warns that at least 7% of home loans are at risk. So far, the listed banks have reported only 2.1 billion yuan of mortgage overdue directly affected by the provinces.
Banks are stuck in the middle, said Qiu Chen, a professor of finance at the University of Hong Kong’s Business School. “If they don’t help developers finish projects, they will end up losing a lot more. If they do, it will surely make the government happy, but they add more to their exposure to delayed real estate projects.”
With headwinds from slowing economic growth, COVID-19 disruptions, and record-high youth unemployment, Beijing is putting financial and social stability at its top. Efforts contemplated so far have included a grace period on mortgage payments and a central bank-backed fund to provide financial support to developers. Either way, banks are expected to play an active role in a coordinated government bailout.
Here are five graphs that explain why the crisis is escalating and undermining financial stability:
Chinese banks’ exposure to the real estate sector is higher than that of any other industry. There were 39 trillion yuan in mortgages outstanding and another 13 trillion yuan in loans to developers at the end of March, according to data from the People’s Bank of China.
Gabriel Wildau, managing director of Teneo Holdings, said in a note this month that the real estate market is the “ultimate foundation” for China’s financial stability.
As authorities move to control risk, lenders with higher exposure could come under more scrutiny. Mortgages made up about 34% of total loans at Postal Savings Bank of China Co and China Construction Bank Corp. At the end of 2021, above the regulatory limit of 32.5% for the largest banks.
About 7% of outstanding mortgage loans could be affected if defaults spread, according to Deutsche Bank analyst Lucia Kwong. She said that this estimate may still be conservative due to limited access to information on incomplete projects.
To limit the fallout, China can tap into excess capital and excess loan provisions at its 10 largest lenders, which together amount to 4.8 trillion yuan, according to a report by Frances Chan and Christy Hong, analysts at Bloomberg Intelligence.
Local banks – commercial lenders in cities and in the countryside – can take on more responsibility than their state counterparts, based on past bailouts and also because of their strong relationships with local governments, even though their capital reserves lag far behind the industry average.
Chinese banks have raised a record amount of capital in the first half of bond sales as they prepare for a possible surge in non-performing loans.
Lenders’ bad loans, which amounted to 2.9 trillion yuan at the end of March, are expected to reach new records and add pressure on the economy, which has been expanding at the slowest pace since the start of the Covid outbreak.
While China’s total debt-to-GDP is expected to rise to a new record high this year, consumers have been reluctant to take on more leverage. This has fueled debate about the risk of China falling into a “balance sheet stagnation”, with households and businesses cutting back on spending and investment.
Disposable income growth is slowing, hurting homebuyers’ ability to service their debt. Weak home prices in China spread to 48 of the 70 major cities in June, up from 20 in January.
S&P Global has forecast home sales to fall by as much as 33% this year amid a mortgage boycott, adding pressure on distressed developers’ liquidity and leading to more defaults. About 28 of the top 100 developers by sales have either defaulted on bonds or negotiated debt extensions with creditors over the past year, according to Teneo.
Real estate investments, which drive demand for goods and services that account for about 20% of the country’s GDP, fell 9.4% in June.
Bank profits are at stake. After recording the fastest expansion of earnings in nearly a decade last year, the country’s lenders face a challenge in 2022 as the government presses them to prop up the economy at the expense of profits.
Citigroup analysts led by Judy Chang estimated in a report released July 19 that a 10 percentage point slowdown in real estate investment growth translates to a 28 basis point increase in total bad loans, which means a 17% drop in their 2022 earnings.
The Hang Seng index of mainland banks is down 12% this month.
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