Goldman with a sensible analysis. Likewise, I do not think that this is a game changer for Chinese property. Chinese authorities do not want to change course. This is a decline management tool for the greatest ponzi ever.
Reports of China real estate fund to alleviate construction delays. In mid July, news emerged that homebuyers in China have suspended mortgage payments on a number of pre-sold property projects due to construction delays. The root of the problem is tight financing conditions faced by the developers, including weak pre-sales and difficult credit conditions. As noted in our Asia Credit Trader, the need for a policy response to address the mortgage issues is high, as recent events highlight the uncertainties across the property and financial sectors, which could dent confidence further. On 25 July, Reuters reported that policymakers are planning to launch a real estate fund to help alleviate the financing pressures on developers.
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According to the report, the size of the fund would initially be set at RMB 80bn, with the China Construction Bank (CCB) contributing RMB 50bn, but with the proceeds coming from the People’s Bank of China’s relending facility. It was reported that, if the model works, other banks will follow suit with a target to raise up to RMB 200bn to RMB 300bn.
A step in the right direction, and more steps may be needed. If this new fund goes ahead, we would view it as a first step in the right direction to stabilize homebuyers sentiment. To us, a key aspect to this plan is cash being set aside to provide tangible assistance to ease construction funding gaps, and is not reliant on window guidance or regulatory policy adjustments. That said, the initial RMB 80bn is relatively small compared with the total amount of property sector credit currently outstanding. For example, our China property team earlier estimated the outstanding mortgages relating to projects affected by mortgage payment suspension is around RMB 400bn, and a maximum of RMB 2tn to RMB 2.4tn of mortgages could be at risk based on their analysis of project backlogs. These suggest that more steps may be needed, should RMB 80bn not be sufficient. Our China banks team believes that other banks may join at a later stage, and per the report, this could bring the total fund size to RMB 200bn to 300bn. Furthermore, our China banks team believes the funds could be levered up, and assuming 3x leverage, the financing available to property developers could be RMB 600bn to RMB 900bn (and even higher if leverage ratio goes above 3x).
Keeping systemic risk concerns in check without creating moral hazard. Details on how such a fund would operate is currently unclear. For example, the Reuters report mentioned that the proceeds could be used to fund the purchases of unfinished projects and to complete their construction, though we believe other paths are possible, including providing direct funding for developers or to finance mergers and acquisition activities for the stronger developers. That said, if the media report is correct, the fund could help to alleviate some funding pressures for the developers and to stabilize sentiment amongst consumers and homebuyers. These would help to keep systemic concerns in check, without requiring government bailouts of the stressed developers. Our China banks team noted that having CCB provide the funding rather than a policy bank (like China Development Bank) reduces moral hazard issues. They view CCB as a commercial bank, and believe it could reduce any negative impact of government guarantees by carrying out appropriate due diligence and risk pricing towards the stressed property credits compared with a policy bank.
Credit differentiation will continue. Based on the reported details, we would not expect this potential fund to provide sufficient support to many of the stressed credits within the China property sector, except for some of their viable projects that need funding for completion. Our China banks team estimates that, at the end of 2021, there was RMB 19tn of property credit in China, excluding mortgages, and the reported size of the fund is unlikely to provide sufficient credit support across the entire sector. To us, this means that the differentiation between the stronger and weaker developers will continue, and one way to illustrate this is the divergences in the recovery in property sales.
Exhibit 1plots the aggregate monthly sales for 3 types of developers that haveoffshore bonds outstanding – State-Owned Enterprises (SOEs), Privately-Owned Enterprises (POEs) that have defaulted or conducted bond exchanges, and POEs that have not defaulted nor conducted bond exchanges. The aggregate sales are rebased to100% at June 2021, and we note that for SOEs, June 2022 sales was 98% of June2021 sales level, suggesting that sales have mostly recovered. However, for POEs that have not defaulted nor conducted bond exchanges, aggregate June 2022 sales was only 62% of June 2021 sales, and for POEs that have defaulted or conducted bond exchanges, this fell further to 24%. Note that the June 2022 sales from SOEs accounted for only 33% of the total sales, suggesting it could be a challenge for SOEs to provide sufficient support across the entire property sector:
Maintaining our forecast of 45% default rate for China Property HY in FY22. In our most recent Asia Credit Trader, we raised our forecast for China Property HY default rate to 45% in FY22. The news regarding the set up of this new fund do not alter that, given our expectation the fund is unlikely to provide sufficient support to stressed developers. The YTD China Property HY default rate has reached 28.7% (Exhibit 2), and is not far from our previous FY22 forecast of 31.6%. We arrive at our default estimation by assuming that, for any issuers that have conducted bond exchange or maturity extension transactions, only the bonds that have been exchanged or extended are included in our default calculation. If we assume all outstanding bonds from issuers that have conducted bond exchanges or maturity extensions to be in default, this would bring our YTD default rate to 42.8%. As such, we believe a FY22 forecast of 45% is a better reflection of the default risks.
Muddle through a possibility, and stay up in quality. The path for China Property HYwill likely be very much dependent on policy actions. Stronger policy support that boosts property sales (e.g. a larger than expected real estate fund with central government support, scaling up shantytown redevelopment projects etc) could be a catalyst for the sector to rebound; conversely, stabilization of homebuyers sentiment with a gradual recovery would likely lead to a long path towards restructuring of the stressed credits. Tous, the continued stresses in the property sector coupled with the uncertainties related to COVID measures suggest a murkier outlook for China. Could we see a “muddle through” scenario, which we define as credit worries staying elevated, but without systemic concerns emerging, with growth positive but at low levels? We believe it is possible, and that is not necessarily a positive outcome for the HY credit markets, withl ingering uncertainties negatively affecting investor sentiment. As such, we maintain the view that for investors considering China property HY exposure, they should only consider the best developers (i.e. including IG rated names), and we see relative value in their lower dollar priced longer duration bonds.
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.
He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.
