Chinese banks could face $350 billion in property crisis losses

(Bloomberg) — China’s banks face $350 billion in mortgage loan losses in a worst-case scenario, as confidence sinks in the country’s housing market and authorities struggle to contain the deepening turmoil.

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A spiraling crisis of stalled projects has dented the confidence of hundreds of thousands of homebuyers, prompting mortgage boycotts in more than 90 cities and warnings of wider systemic risks. The big question now is not if, but how much, the nation’s $56 trillion banking system will be hit.

In a worst-case scenario, S&P Global Ratings estimated that 2.4 trillion yuan ($356 billion), or 6.4% of mortgages, were at risk, while Deutsche Bank AG warned that at least 7% of mortgages at risk. So far, listed banks have reported just 2.1 billion yuan in overdue mortgages directly affected by the boycotts.

“Banks are caught in the middle,” said Zhiwu Chen, an economics professor at the University of Hong Kong Business School. “If they don’t help the developers complete the projects, they would end up losing a lot more. If they do, that would of course make the government happy, but they add more to their exposure to delayed real estate projects.”

Already buffeted by headwinds from slowing economic growth, Covid disruptions and high youth unemployment, Beijing is placing financial and social stability at the top of its priorities. Efforts envisaged so far have included a grace period for 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 charts that show why the crisis could escalate and undermine financial stability:

Chinese banks’ exposure to real estate exceeds that of any other industry. There were 39 trillion yuan of outstanding mortgage loans and another 13 trillion yuan of loans to developers at the end of March, according to data from the People’s Bank of China.

The real estate market is “the absolute foundation” for financial stability in China, Teneo Holdings Chief Executive Gabriel Wildau said in a note this month.

As authorities move to control risks, highly exposed lenders could come under greater scrutiny. Housing loans accounted for 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 cap of 32.5% for the largest banks.

About 7% of outstanding mortgages could be affected if defaults spread, according to Deutsche Bank analyst Lucia Kwong. That estimate may still be conservative given limited access to information on unfinished projects, he said.

To limit the fallout, China could draw on excess capital and loan provisions at its 10 biggest lenders, which total 4.8 trillion yuan, according to a report by Bloomberg Intelligence analysts Francis Chan and Kristy Hung.

Local banks — urban and rural commercial lenders — could shoulder more liability than their state counterparts, based on past bailouts and also because of their stronger ties to local governments, although their capital reserves they fall far short of the industry average.

Chinese banks have raised a record amount of capital in the first half of the year from bond sales as they brace for a possible rise in bad loans.

Bad loans to lenders, which stood at 2.9 trillion yuan at the end of March, are set to hit new records and put further pressure on an economy that is expanding at its slowest pace since the start of the Covid epidemic.

While China’s total debt-to-GDP ratio is forecast to hit a new record this year, consumers have been reluctant to take on more leverage. This has sparked a debate about the risk of China falling into a “balance sheet recession”, with households and companies cutting back on spending and investment.

Growth in disposable income is slowing, further hurting homebuyers’ ability to service their debt. The weakening of China’s house prices had spread to 48 of 70 major cities in June, up from 20 in January.

S&P Global predicts home sales could fall as much as 33% this year amid the mortgage boycott, further squeezing troubled developers’ liquidity and leading to more foreclosures. About 28 of the top 100 developers by sales have either defaulted on bonds or negotiated debt extensions with creditors in the past year, according to Teneo.

Real estate investment, which drives demand for goods and services that account for about 20 percent of the country’s gross domestic product, plunged 9.4 percent in June.

Bank profits are at stake. After posting the fastest profit growth in almost a decade last year, the country’s lenders face a tough 2022 as the government pressures them to prop up the economy at the expense of profits.

A 10 percentage point slowdown in real estate investment growth translates into a 28 basis point increase in total bad loans, meaning a 17% drop in their earnings in 2022, Citigroup analysts led by Judy Zhang estimated in a July 19 report .

The Hang Seng index of mainland banks plunged 12% this month.

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