Nomura: Worst not over for Chinese property

Nomura with the note (Tu Ling has been better than most on this):

Despite Beijing’s efforts to alleviate the funding crunch for developers, we expect developers and their construction partners to face some increasing financial challenges in the next couple of months. First, they may need to pay a total of RMB1.1trn in deferred wages to migrant construction workers before 31 January, the end of the Chinese lunar year. Second, local governments have been tightening their grip on presale funds in escrow bank accounts. Third, their maturing offshore dollar bonds will almost double in Q1 and Q2 2022 from Q4 this year. Developers specializing in lower-tier cities will especially
be faced with difficulties, as new home sales there have halved from a year ago. Despite Beijing’s easing measures on the property sector, the PBoC’s RRR cut and the latest 5bp cut of LPR, we believe the worst is yet to come for the economy in general and the property sector in particular.

The lunar calendar and migrant construction workers’ deferred wages

In China, the official fiscal year for all entities is the Gregorian calendar year. In practice, however, the traditional Chinese lunar calendar has a significant impact on debt payment and cash management for corporates and households because it is the long-held tradition in China to pay off all debts, including deferred wages, before the end of each lunar calendar year. The end of the current lunar year is 31 January 2022. Of all types of debt, developers and their construction partners are especially under pressure for repaying deferred wages, because failing to do so could trigger social instability. There are about 52mn migrant workers with average annual pay at around RMB61K. Unlike other sectors, the construction sector pays a majority of migrant workers’ annual compensation right before the end of each lunar year. We estimate that about RMB1.0trn in deferred migrant construction workers’ wages might be at risk of delay, putting a lot of pressure on private developers and their construction partners in the coming month.

Local governments’ tightening grip on escrow bank accounts

In China, presale accounts for nearly 90% of new home sales and more than half of developers’ funding. To ensure developers have enough funds to complete their projects and deliver pre-sold homes, local governments have quite a lot of room to set up detailed rules on supervising developers’ presale funds in local escrow bank accounts. In view of the worsening financial situations of developers, local governments across China have recently tightened their grip on presale funds in fear of diversion to other regions for debt repayment. It’s like a prisoner’s dilemma: though each local government is rational in stepping up its monitoring of presale funds, the collective actions of local governments are equivalent to a credit crunch for the whole property sector.

Offshore bond repayment pressures will rise in Q1

Having experienced the worst dump of developers bonds in offshore markets so far, Chinese developers will face even higher repayment pressure in the coming two quarters in offshore bond markets. We estimate the amount of maturing offshore bonds issued by developers will almost double from USD10.2bn in Q4 2021 to USD19.8bn in Q1 2022 and USD18.5bn in Q2. For the onshore market, we estimate the amount of maturing bonds issued by developers may fall from RMB126bn in Q4 to RMB84bn in Q1 and RMB91bn in Q2, before jumping to RMB138bn in Q3. Assuming the USD/CNY remains at the current level of around 6.4, the total amount of maturing bonds (including both onshore and offshore) issued by developers will increase from RMB191bn in Q4 to RMB210bn in Q1 and RMB209bn in Q2.

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