It’s like COVID:
For months Xi has stood firm in reining in over-leveraged Chinese developers, spurring a record wave of defaults that spooked global investors and brought at least 24 leading property companies to the brink of collapse. In the process, more than $80 billion has been wiped from its offshore bond market.
But now ordinary Chinese people are publicly revolting, with rapidly escalating boycotts on mortgage payments spread across at least 301 projects in about 91 cities. These homeowners accuse developers of failing to deliver apartments they’ve already paid for: the value of mortgages that could be affected has swelled to an estimated 2 trillion yuan ($297 billion).
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There are no good options to end it. TSLombard:
China’s slow-motion property crunch has entered a new phase–namely, of “mortgage strikes”.
Buyers are threatening non-payment unless developers complete construction on their paid-for, but not-built apartments. So far, well below 1% of mortgages are impacted; however, it is a worrying trend with potentially large-scale social and financial spillovers. The government response has focused on local governments, banks and SOEs. We think a stronger indication of support will be needed (including liquidity provision for certain projects) and will, in fact, be forthcoming in the coming weeks. The payment strike will hit property sales and funding and further delay the cyclical bottoming of property sales and investment. More widely, monetary policy transmission is further impaired via weaker credit demand and the “national service” (higher NPLs and lending to developers) being performed by banks.
China’s recovery is stalling.
We stay below consensus growth and above consensus stimulus, with a preference for infrastructure-related stocks and bond steepeners. “Stop work, stop payment” is a tactic proposed by a growing number of Chinese home buyers in an attempt to force developers to complete construction of unfinished apartments that have already been paid for. Mortgage holders at 300 stalled projects have collectively issued notices threatening non-payment to the relevant banks, builders and local governments. The home loans in question account for less than 1% of outstanding mortgages, but the “stop payment” movement has grown rapidly in the past few weeks. Based on local brokerage and media reporting, we estimate that activity has stopped on 10% of the total residential floor area under construction. A back-of-the-envelope calculation puts the current total industry construction area at6.9bn square metres, with the total amount of stalled construction at roughly 690mn square metres. Based on a price of 10,000 yuan/square metre, the corresponding asset value of stalled construction is RMB 7trn. Assuming 80% of projects are pre-sold and the average down payment is 40%, there is approximately RMB3.3trn in mortgage loans that could join the “strike”. This represents7% of total outstanding mortgages.
Mortgage strikes carry large social, financial and economic risks that go well beyond a few stalled projects.
Since 2016,pre-sales have been the major source of funding for developers(Chart2). As Chart1 above shows, until recently new starts have significantly outpaced completions. The “three red lines” policy regulated debt financing, but not pre-sale funding, further increasing developers’ reliance on advanced payments. With developers already struggling to generate pre-sales (and normal transactions) the mortgage strikes deal a blow to their finances at a time when bank, bond and equity funding channels are constrained. Potential spillovers from mortgage/developer defaults, falling property prices and sluggish/dwindling investment are well known for cascading from real estate to Chinese growth and social stability,
Beijing and the mortgage holders are clearly playing a high stakes game.
Politicians face the obvious social and macro risks, while deliberately defaulting on a mortgage can have a devastating impact for individual home buyers. Citizens with black marks on their credit records struggle to buy train tickets, let alone find jobs. All sides are incentivized to find a de-escalatory solution, but Beijing faces a tricky balancing act in crafting a plan that limits social and financial stability risks. The emerging approach appears to be to mobilize local governments banks and SOEs to restart construction. In recent days, CBIRC, the banking regulator, has urged banks to lend to qualified real estate projects. A number of local governments have promised to take action, too, with Yunnan, Shaanxi and Hebei already running programmes to restart projects
Markets have reacted positively to the announcements, but measures are only small,piecemeal ones.
Should rhetoric and action prove insufficient to stop default threats spreading, then existing local financial resources will rapidly become insufficient. Beijing would then need to resort to something akin to a mortgage holiday for pre-sale buyers and/or liquidity provision to fund construction either directly to banks or via bond issuance to local governments. All approaches would require banks to perform “national service” (accept higher NPLs, lend to low-quality projects, buy local government debt). We think a stronger indication of support will be needed (including liquidity provision for certain projects) and will, in fact, be forthcoming in the coming days. The longer the delay in providing support, the greater the eventual liquidity injection required.
The macro impact comes, above all, via the hit to property sector sentiment.
Sales, especially pre-sales, remain deeply negative yoy but recovered somewhat last month from the Shanghai lockdown nadir. High-profile “mortgage strikes” and a muddled response will not encourage purchases and will further delay the cyclical bottoming of investment and sales. The incidence will also weigh on credit creation and monetary policy transmission through the impact on banks (higher NPLs and national service) and household (lower demand for mortgages). The degree of impairment depends on how swiftly “mortgage strikes” are resolved. Finally, slower property salesand bank lending will ultimately have a negative impact on the broader recovery.
The backdrop reinforces our market outlook.
For some time now, we have been forecasting below consensus growth and above consensus stimulus. The resurgent Omicron wave, combined with continued property sector stress, supports our view that until the dynamic zero Covid policy ends (Q1/23 is our base case, with a step towards easing being taken after the Party Congress in Q4/22) China growth will be sluggish and highly dependent on stimulus measures. We think the PBoC will remain easy, cutting policy rates (MLF and 7-day repo) by 10 bps and RRRby 50 bps. A supplementary local government bond quota of RMB1-2trn is also likely. The backdrop puts us neutral equities and bonds with a preference for infrastructure-related stocks and bond steepeners. We are negative RMB vs the dollar.