Boycott
*Investors now need to worry about the boycott of mortgage payments on stalled projects; and *Excessive developer short-term leverage on illiquid long-term assets must be addressed.
It’s no secret that mainland China’s property sector troubles led by China Evergrande Group (2888.HK) [“Evergrande”] are wreaking havoc on the economy and causing systemic financial issues. Coupled with the extreme COVID-19 lockdowns, investors now have to worry about an escalating and broad-based boycott of mortgage payments on stalled development projects.
In our “Cipher In the Snow” note dated February 22, 2022, we discussed how difficult it would be for Evergrande to convince the world’s savviest real estate investors/buyers (with inflation raging) to finance the completion of their stalled home construction. If a property investor has already prepaid housing completion deposits on stalled home construction projects (USD 7.9 bn in aggregate), as is the practice in mainland China, housing completion deposits on stalled home construction projects, those projects in a buyers’ mind are likely considered a lost investment – especially with a one year plus of a stop construction over a lack of corporate funds. Will a disappointed buyer throw good money after bad, understanding that his final completion payment collectively will NOT come close to what it will cost Evergrande to cover its 600,000-housing construction completion goal (50% of pre-sold homes) – on top of other property developers rushing to do the same?
According to China Real Estate Information Corp. (“CREI”), homeowners of stalled projects have now stopped making their mortgage payments on at least 200 projects in over 50 cities. The more the news of the boycott spreads locally, the greater the likelihood that these figures will balloon and the greater the systemic threat to the financial system. Confidence that these stalled projects will be completed has eroded, as real estate developer illiquidity has intensified along with the number of developer defaults. According to reports, as much as CNY 2 tn (USD 29.7 bn) or 4.3% of total mainland Chinese mortgages could tactically default – which seems quite low given the magnitude of this real estate crisis. The property sector has been getting steadily worse with pricing, sales, and housing starts all weak.
With the silly season upon us, the China Securities Regulatory Commission (“CSRC”) asked its state-owned (“SOE”) banks to disclose the degree of their mortgage exposure in an effort to allay investor concerns. No surprise, and like good little lap dogs and in coordinated fashion, sixteen banks disclosed that a total of only CNY 2.8 bn (USD 414 mn) or 0.11% of mortgages were those related to the boycott.
Understanding the oversized impact that the real estate sector has on the economy (70% of household wealth attributed to property; 40% of bank borrowings; and land sales at 40% of local government revenues), mainland Chinese authorities have held emergency meetings with banks to discuss a potential acceleration of the mortgage boycotts. Some results of the emergency meetings: a) the Ministry of Housing (“MOH”) suggested that it will penalize developers who cause social incidents over failed project deliveries; and b) the CBIRC has stated that it is encouraging stepped up co-ordination with the PBOC and the MOH to help local governments complete pending real estate developments.
While better late than never, the crux of the problem - excessive developer short-term leverage on illiquid long-term assets – has never been addressed. Meanwhile, the latest issue of national tactical defaults will further exacerbate the weakness in property prices, slow sales, and destroy whatever positive cash flow that remained at real estate developers as this crisis drags on without solution now for over a year. No doubt, the mainland Chinese banks will be left holding the bag on this one. Couple the mortgage boycott, with another financial sector strain seen in Henan province (see our “In the Red” note dated July 13, 2022) where four local banks have frozen CNY 40 bn (USD 5.6 bn) in high-rate online customer (400,000 accounts) deposits and the mainland Chinese military tanks on the street in Shandong province protecting the banks – one of which (Bank of China [3988.HK]) who’ve recently declared these frozen deposits as “investment products” that they can’t be withdrawn – and we are starting see that a real barn burner is now on the government’s hands.