Chinese mortgage strikes: All the questions that you were afraid to ask
The protestors aren't refusing to take possession of the homes. On the contrary, they are saying that deliver the homes, and we will continue paying the mortgages
I take a break from documenting the financial scams in the Pakistani financial sector and write about something completely different. The crisis is similar to that faced by the Indian real estate sector when IL&FS and Dewan Housing defaulted. I wrote about it here —> Amazing rise and spectacular fall of shadow banking in India
What is happening?
The mortgage boycott started in late June with a single China Evergrande Group project in the city of Jingdezhen. That became 28, then 58, then at least 100 developments in more than 50 cities by July 13. As of Sunday, the tally was at least 301 projects in about 91 cities. Capital Economics estimates that construction has been halted on around 13 million apartments in the past year, potentially affecting more than 4 trillion yuan in mortgage debt.
Why are they protesting?
Of course, the concern for the mortgage strikers isn’t the falling value of their investment but whether they will receive what they’ve paid for at all. With a record wave of developer defaults and home sales stuck in a prolonged slump, that’s a tangible fear. It’s hard to blame them for taking such a hardball approach. Beyond the desire to cut their losses or put pressure on property companies to deliver, some buyers may have their own cash-flow problems amid the economic downturn, said David Qu, a Hong Kong-based economist with Bloomberg Economics.
Authorities have repeatedly emphasized the need to deliver homes to buyers, even as record delinquencies brought the real estate sector to its knees. But the majority of boycotted loans are tied to projects from builders that have defaulted, according to data compiled by CLSA, which estimates that Evergrande alone accounted for 35% of the total.
Nomura’s Lu estimates that Chinese developers have delivered only about 60% of the homes they presold from 2013 to 2020. China Evergrande, which has seen protests over halted projects since last year, faces the most boycotts, according to the online tally. More than a dozen other builders are targeted.
Why are developers defaulting?
This is the paradox of this latest rescue measure. The financial distress afflicting the property market is a result of the government’s attempt to impose greater market discipline on developers and arrest the relentless buildup of leverage. Even if the victims may be deserving this time, intervention keeps China locked into a pattern of protecting investors from the consequences of market failure. That’s probably still better than letting their faith in the system implode.
Beijing began instituting a series of curbs on what’s known as shadow financing—lending by entities other than banks or through practices such as selling wealth management products. Among other things, it prevented companies from raising money by offering guaranteed returns to investors. There were also efforts by provincial and city governments to damp real estate speculation. On Hainan, an island in the South China Sea touted by developers as China’s answer to Hawaii, nonlocals were effectively blocked from buying homes before spending two years in the province, and all buyers were barred from reselling a residence within five years of purchasing it.
In March, Beijing signaled it might revive efforts to introduce a national property-tax system, which would reduce local administrations’ reliance on land sales for income. The central and local governments also released some 400 separate regulations on homebuying, including rules preventing people from divorcing just to get around “one house per family” limits, and directed banks to slash mortgage lending and channel money to manufacturers instead. Outstanding mortgages as a share of GDP dropped for the first time in a decade.
The results have been dramatic in the booming coastal cities that previously powered China’s property market. A broker in Shenzhen, who asked to be identified only by his surname, Li, says that inquiries from prospective buyers are down a third from a year ago. “The transaction volume looks pretty ugly, and the only homes sold were either due to the sellers urgently needing cash or worries that prices will drop further,” he says.
In mid-2020, the Government began to squeeze new financing to real estate developers to try to reduce the threat, and asked banks to slow the pace of mortgage lending.
New borrowing metrics introduced for developers proved to be a gamechanger. Called the “three red lines" by state-run media, they aimed to reduce reckless borrowing by setting thresholds for a developer’s liabilities, debt and cash holdings. Annual borrowing would be capped based on how many parameters were met.
In past Chinese housing slumps, this might be the moment when Beijing would step in to put a floor under the market, encouraging banks to lend to push up prices and boost revenue for property developers. But for now, policymakers seem willing to inflict economic pain to alter expectations that real estate prices will always rise. Many homeowners have gotten used to policymakers protecting their investments. “If prices fall, that means the economy is in a downturn, and that’ll put huge pressure on the local government,” says Jenny Wu, a financial worker in Shenzhen who bought an apartment last year. “So it’s impossible that home prices would drop in Tier 1 cities.” (“Tier 1” is shorthand for the megacities of Beijing, Guangzhou, Shanghai, and Shenzhen.)
Those that didn’t have enough cash on hand to cover their liabilities found themselves in a bind. At least 18 defaulted on offshore bonds after the crackdown began. China Evergrande Group once the country’s biggest developer was labeled a defaulter for the first time in December after it missed payments on several bonds.
But many smaller developers also followed Evergrande’s familiar strategy: borrow heavily, build aggressively -- and make buyers pay in full upfront, sometimes before ground is even broken. Until the bottom fell out, nearly nine out of every 10 homes in China were “pre-sold,” according to Hongta Securities Co. Buyer protections commonly used abroad, such as escrow accounts and installment payments, have tended to be weak.
The result is a mirror image of the 2008 subprime fiasco. Back then, in the U.S., it was homebuyers who got in over their heads. This time, in China, it’s builders.
In a deep slump. Combined sales at the top 100 developers halved in the first four months of this year compared with last. Property loan growth slowed to the weakest pace in over two decades at the end of March. Construction fell 14% in 2021 from the previous year, the biggest fall in six years.
What are the three red lines?
In a bid to curtail China’s freewheeling real estate sector, policy makers introduced debt metrics in 2020 that set limits for developers seeking to borrow more. Called the “three red lines” by state-run media, they have become a game-changer for an industry that accounts for about a quarter of economic output. But with more and more real estate companies now sinking into a worrying liquidity crisis, regulators are now tweaking the rules to engineer a soft landing.
Developers wanting to refinance are being assessed against three thresholds:
Their liabilities shouldn’t be more than 70% of assets, excluding advance proceeds from projects sold on contract.
Net debt shouldn’t exceed equity.
Cash must be at least equal to short-term borrowings.
Under the rules, property firms are being categorized based on how many limits they breach and their debt growth is capped accordingly. If a company passes all three, it can increase its debt a maximum of 15% in the next year, according to an August report in the Securities Times and an earlier one by China Central Television in 2020.
One way for distressed developers to raise badly needed cash without borrowing is to sell assets to healthier firms. But the rules made that difficult because potential buyers ran the risk of breaching the metrics by taking on more debt to fund purchases. So in December 2021, regulators were said to have quietly issued guidance that borrowing by property firms used to finance mergers and acquisitions won’t be counted toward the red lines.
Two-thirds of the top 30 Chinese developers crossed at least one red line
Why does the real sector matter?
The real estate industry has an oversized impact on the economy. When related sectors like construction and property services are included, real estate accounts for more than a quarter of Chinese economic output, by some estimates. About 70% of household wealth is stored in the property, along with 30-40% of bank loan books, while land sales account for 30-40% of local government revenues, according to Pantheon Macroeconomics’ Botham.
China’s property market poses unique systemic risks. Once called “the most important sector in the universe,” the real estate industry is now reeling under a clampdown initially aimed at a handful of debt-saddled borrowers like China Evergrande Group. As more firms collapse, pressure is growing on banks that prop up the industry and local governments that rely on land sales for revenue.
How did the real estate sector become so big?
In 1998, when China created a nationwide housing market after tightly restricting private sales for decades, only a third of its people lived in towns and cities. Now almost two-thirds do, increasing the urban population by 480 million.
When the 2008-09 global financial crisis cut demand for Chinese exports, the central government responded with a massive stimulus package that made borrowing easy. Land prices soared, in both coastal megacities and previously sleepy regional centers, and developing housing became a near-certain bet. The key to success was scale, achieved by borrowing with land as collateral. The bigger a developer became, the more it could borrow, and at lower interest rates, a cycle that could continue as long as property prices kept rising.
Supercharged by real estate profits, Evergrande expanded its reach into China’s burgeoning consumer economy. Some ventures, such as theme parks, had at least a faint connection to property development; others, including mineral water and a quixotic attempt to build a world-class soccer club in Guangzhou, had none at all.
It didn’t take long for analysts, particularly outside the country, to predict that Chinese developers in general, and Evergrande in particular, were building up far too much debt. As early as 2012, some argued that Evergrande would soon buckle under the weight of its leverage.
But the day of reckoning never seemed to arrive. The increasing sophistication and profitability of Chinese companies meant more of their workers could afford new homes. Evergrande even weathered a steep drop in home sales in 2015, when a glut of unwanted apartments drove average prices down by as much as 6% year on year. Evergrande’s Hui became China’s second-richest man, behind only Alibaba’s Jack Ma.
This resilience was partly a function of government policy, including the renewal of stimulus measures that helped prices recover. But policymakers in Beijing were haunted by the fragilities the 2015 slump exposed. At the end of 2016, the ruling party’s Politburo unveiled a new slogan “Houses are for living in, not for speculation.” One policymaker complained the following year that the economy was being “kidnapped” by the housing sector.
Local and regional authorities, which rely on sales of public land for a hefty chunk of their revenue, encouraged more development, which also helped meet the central government’s ambitious annual targets for economic growth, which often hit double digits. Debt piled up as builders rushed to meet demand. Annual sales of dollar-denominated offshore bonds -- meaning those sold mainly to foreign investors -- surged from $675 million in 2009 to $64.7 billion in 2020, leading to a swelling interest burden. Developers had some $207 billion in dollar-denominated bonds outstanding as of late last year, accounting for about one-quarter of the total from all Chinese borrowers. Additional, opaque liabilities make it hard to assess true credit risks.
Is it a banking crisis?
Not yet.
China’s outstanding mortgages stood at 38.3 trillion yuan at the end of 2021, according to the People’s Bank of China.
Affected loans amount to less than 0.01% of outstanding residential mortgages at most Chinese banks, according to Fitch Ratings. As much as 2 trillion yuan ($297 billion) of advances could be impacted, Bloomberg News reported GF Securities Co. as saying. That’s the total balance of the loans; the amount that could be withheld will be smaller.
Other estimates of the impact are less dire. Should every buyer default, that would lead to a 388 billion-yuan increase in nonperforming loans, Jefferies’s Chen said. Banks say the impact is much lower still. Lenders have detailed about 2.11 billion yuan of loans at risk from the protests, according to a tally of banks that have disclosed their exposure.
Is it a political crisis?
Not yet. But it has the potential to become one.
The protest is all the more remarkable because Chinese families rarely abandon mortgages and banks are legally entitled to demand full repayment, according to Chang at DBS. Still, consumers may be hoping that collective action will force a resolution, especially as Beijing seeks to limit social unrest ahead of the Communist Party Congress in October. “This is a political protest,” Diana Choyleva, chief economist at Enodo Economics, said in an interview on Bloomberg Television. “It’s not going to be a banking crisis; they are not there. But it is a crisis potentially of confidence—and one that the Chinese Communist Party fears tremendously.”
Authorities face a dilemma, according to Chen at Jefferies. Easing lending rules to favor homebuyers may encourage additional delinquencies, but social stability remains the priority for the government. “Our base case is for the government to step in and untie the Gordian knot,” Chang at DBS said.
“If thousands of homeowners believe that their largest asset is in trouble, they could protest as individuals across China, creating a ‘systemic’ political crisis,” said Andrew Collier, a managing director at Orient Capital Research Inc.
City dwellers tend to have roughly 80% of their assets tied up in housing.
The national numbers may mask starker declines in some pockets. In some economically weaker cities, the slump has been so sharp that at least two dozen local authorities have restricted minimum prices. A property industry association in Zhangjiajie, a relatively small city in mountainous central China, warned developers in late November not to push prices “off the cliff.” Home sales in northern China are likely to trail the more affluent south, Nomura Holdings Inc. economists say.
One small developer is struggling to entice homebuyers in so-called tier-three cities, even after offering 20% discounts, an executive said, asking not to be identified. Even at a top-10 builder of upmarket homes, some prospective buyers concerned about its ability to deliver on time have delayed purchases and demanded proof of its financial status, according to a person familiar with the matter.
To entice buyers in cities where large price cuts are banned, some developers are offering free parking lots and home appliances instead, local media have reported.
Can the protests have a broader impact?
1. Slow the real estate market
The boycotts over project delays also pose a risk to the broader housing market by keeping potential homebuyers on the sidelines. The market had seen signs of stabilizing in recent months, with some analysts calling for a turnaround in the second half of the year. Output in the real estate industry, a key economic contributor, contracted 7% in the second quarter from a year ago, the National Bureau of Statistics said Saturday. It remained the biggest drag on the world’s second-largest economy among all sectors, and performed worse than the first quarter of 2022.
In February 2022, they even tried to keep the party going by dropping downpayment rates.
Banks in several Chinese cities have cut mortgage down payments for some homebuyers, in a move that may boost flagging housing demand, local media reported.
In Heze, a city of 8.8 million in Shandong province which was first reported to make the change, Bank of China Ltd., Agricultural Bank of China Ltd., Industrial & Commercial Bank of China Ltd. and China Construction Bank Corp. lowered the down payment ratio for first-time homebuyers to 20% from 30%, China News Service-backed Economic View and Shanghai-based Cailian reported on Thursday evening.
Some banks in the southwestern metropolis of Chongqing and the southeastern city of Ganzhou also lowered the down payment ratio by the same amount, Shanghai Securities News reported Friday, citing property agents.
Chinese authorities have been racing to arrest a worsening slowdown in the property sector that is hurting growth in the world’s second-largest economy. Home sales have been falling since July, exacerbating a cash crunch among developers.
“A change in the down payment threshold will have a big impact on homebuyers,” said Chen Wenjing, associate research director at China Index Holdings. “More smaller cities may follow suit, especially tier-3 and tier-4 ones that are seeing a heavy slowdown.”
2. Suppliers refusing to repay bank loans
Some suppliers to Chinese real estate developers are refusing to repay bank loans because of unpaid bills owed to them, a sign that the loan boycott that started with homebuyers is starting to spread.
Hundreds of contractors to the property industry complained that they can no longer afford to pay their own bills because developers including China Evergrande Group still owe them money, Caixin reported, citing a statement it received from a supplier Tuesday.
One group of small businesses and suppliers circulated a letter online saying they will stop repaying debts after Evergrande’s cash crisis left them out of pocket.
“We decided to stop paying all loans and arrears, and advise our peers to decline any requests to be paid on credit or commercial bill,” the group said in the letter dated July 15, which was sent to the developer’s Hubei office. “Evergrande should be held responsible for any consequence that follows because of the chain reaction of the supply-chain crisis.”
3. Risk to the social contract
The wider behavioral consequences of the homebuyers’ revolt can only be guessed at. Property is by far the most important store of wealth for most Chinese owners and is central to the unwritten social contract that the Communist Party will guarantee ever-rising living standards in return for acquiescence to its rule. In the past, homeowners who bought in the earlier batches of a new project have been known to turn up and trash the sales office after the developer cuts prices for later tranches.
From 2011:
However, furious protests by existing homeowners against price-cuts on new developments show that the road to real estate equilibrium is a rocky one. For every aspiring home buyer in China thwarted by a speculative property bubble that has seen house prices in key cities jump nearly 10-fold in 10 years, an existing homeowner is anxious to see the biggest investment they’re likely to ever make keep rising. Anxiety built to anger in Shanghai on Oct. 22 after Longfor Properties cut prices on the latest phase of a housing development to revive stalling sales at the site. A mob of about 300 people smashed up the development’s sales and demonstration centre, according to local media reports. All had bought homes in earlier phases of the project at prices as much as 30 percent above current selling levels - levels which Longfor insists just reflect market conditions.
Does the protest mean the buyers walking away from their mortgages?
No.
The country has long been assumed to be immune from the type of self-feeding mortgage spiral that drove the US subprime crisis. When you’re a fruit picker loaned 50 times your salary to buy a $750,000 house with no money down, it’s little trouble to walk away if the market turns south. The Chinese property market is a very different animal, with first-time buyers required to front 30% of the purchase price, at least until regulations were relaxed earlier this year.
When homeowners are laying out that much of their wealth to obtain a loan, it takes something catastrophic to get them to give up. In Hong Kong, which had similarly onerous down-payment rules prior to the Asian financial crisis, mortgage defaults stayed low even as home prices slumped by more than 60% starting in late 1997, with the delinquency rate peaking at 1.43% in 2001. In China’s second-tier cities, where the mortgage boycotts have been concentrated, prices of newly built homes are showing nothing like that scale of decline, though the trend is clearly negative.
How do mortgages work in China?
While consumers in many countries need to put down deposits to secure a housing unit before it’s built, they generally don’t make mortgage payments until they take possession. In China, loan payments start with that initial deposit, and can go on for years when projects are delayed. That hoard of presale cash helped developers feed the housing boom in the past decade, allowing them to start new projects before old ones were finished. In essence, the builders were borrowing from the homebuyers themselves, except they owed them housing instead of cash.
What is the state doing?
The central bank is “dodging between support for the property industry and isolated acts of pain to curtail the property bubble,” he added. “It’s a dangerous dance.”
Chinese policymakers face a dilemma in dealing with the problem, according to Chen at Jefferies. On one hand, easing lending rules to favor homebuyers waiting for their properties to be completed may encourage more delinquencies. On the other, social stability remains the top priority for the government. Avoiding a deeper property crisis that sends shockwaves across markets and banks is a political necessity ahead of this year’s Communist Party Congress.
Any move to tighten mortgage lending would put further pressure on already weak home sales as potential buyers balk at higher borrowing costs and longer loan approvals. The outlook for sales -- which some say recently bottomed -- is also being dimmed by a resurgence in Covid cases and potential restrictions.
1. Asking state banks to lend more to developers
China’s bank and property stocks rose after regulators sought to defuse a growing consumer boycott of mortgage payments by urging banks to increase lending to developers so they can complete unfinished housing projects.
The guidance from the China Banking and Insurance Regulatory Commission was issued in response to the boycotts and is aimed at expediting the delivery of homes to buyers, a newspaper published by the watchdog reported Sunday, citing an unidentified senior official at the agency.
“In a worst-case scenario, the issue could trigger systemic financial risk and social instability, given housing’s role as a bedrock of the broader financial system,” Gabriel Wildau, a managing director at global business advisory firm Teneo, wrote in a note July 15. “But our base case is that regulators will succeed in containing the crisis by strong-arming state-owned banks into supporting troubled developers so that they can complete stalled projects.”
The China Banking and Insurance News meanwhile reported Sunday said that regulators had urged banks to support mergers and acquisitions by developers to help stabilize the real estate market. Banks were also asked to improve communications with home buyers and to protect their legal rights, the report said.
2. Grace period for mortgage payors
China may allow homeowners to temporarily halt mortgage payments on stalled property projects without incurring penalties, people familiar with the matter said, as authorities race to prevent a crisis of confidence in the housing market from upending the world’s second-largest economy.
Under a yet-to-be-finalized proposal from financial regulators, hundreds of thousands of buyers of stalled homes would be allowed to pause mortgage payments with no impact on their credit scores, the people said, asking not to be identified discussing a private matter. The plan is part of a broader push to stabilize the property market that includes urging local governments and banks to plug some of the funding shortages at developers, the people said.
3. Exploring a fund option
Regulators have also asked China Construction Bank Corp., the nation’s largest mortgage lender, to explore a pilot program to set up a fund with selected local governments to purchase projects under construction that have yet to find buyers, with the aim of converting them into apartments for long-term rentals, a person familiar with the matter said. China Construction Bank didn’t immediately respond to a request for comment.
A real estate relief fund to help troubled developers in the city is being jointly set up by Zhengzhou Real Estate Group Co., a state-backed developer, and Henan Asset Management Co., a provincial bad-debt manager that specializes in distressed assets, according to a Tuesday statement.
The fund—whose size wasn’t disclosed—would help revive construction at some uncompleted projects, and conduct asset disposal, restructuring and other activities, the statement said. It didn’t say when the fund would be set up and where its money would come from.
4. Local governments may have to step in
Local governments are likely to be asked to step in and provide support, through taking minority stakes in projects and raising funds through special-purpose bonds, according to Travis Lundy, an Asia markets veteran and independent analyst on the investor research platform Smartkarma, who has studied Chinese property companies in depth.
Conclusion
It is not that buyers are defaulting on their mortgages and don't want their homes. Quite the contrary, buyers are asking the developers to deliver their homes.
The people held signs and chanted: “Construction stops and mortgage stops! Deliver homes and get repaid!” The project in question was developed by Greenland Holdings Corp., a state-backed developer that has been struggling with liquidity issues. It presold apartments last year and had committed to deliver them by the end of 2022, but the home buyers said construction has stalled for the last nine months.
The banking regulator arranged for several individuals to meet with representatives of four large state-owned banks, according to a person who attended the meeting. The home buyers asked to suspend their mortgage payments until their homes were delivered, and the bank representatives said they would relay the requests back to their companies, the person said. The China Banking and Insurance Commission didn’t respond to a request for comment.
This is a scenario similar to the crisis faced by India when IL&FS defaulted followed by Dewan Housing. The difference here is that there weren't many collective protests against the developers in India. Even if there had been protests, it wouldn't have been an issue as India is a democracy and a lot of protests do happen. China immediately cracks down on protests and doesn't want the protests to deliver on the population's demands because if they learn that protests lead to meeting their demands, they will start protesting asking for more rights.
With a quarter of Chinese GDP coming from real estate and 80% of the buyer's wealth tied into real estate, there is a potential that these protests spiral out of control and threaten the social contract.
The real problem lies with the developers, as they have overextended themselves and are now short of liquidity. There is a possibility that many developers will go bankrupt and leave projects stranded. Mortgage strikes are just a manifestation of the developer’s liquidity crisis. It is news because real estate is a large portion of Chinese GDP and protests are relatively rare in China.
What is inexplicable here?
What I don't understand is how Chinese financing works. As per the reports, Chinese buyers make a 30% down payment and take out a mortgage for the balance and start paying the mortgage even before the house is delivered to them. Usually, when you take out a mortgage, the bank pays the builder and registers a charge or lien on the house. There is no house here as the developer hasn't built it yet.
From the coverage, we know that the builders have taken the money from the purchasers that they paid as a down payment and used them to buy more land or start other projects. Assuming the buyer paid 30% of the house price as a down payment. The question is: did the bank also pay the remaining 70% to the builder up front to the builder such that the builder has 100% of the sales price received without say putting a shovel in the ground? Why else are the banks charging interest to the purchaser on the mortgage, and there is talk of providing temporary relief to the purchaser where the purchaser only pays the interest? If that is the case, this raises serious questions about the construction financing model of Chinese banks. How can the Chinese banks extend the 70% financing to the developers in a lump sum and not have project monitors and cost consultants in place to monitor the construction progress?
Further Reading
As mentioned earlier, the crisis is similar to that faced by the Indian real estate sector when IL&FS and Dewan Housing defaulted. I wrote about it here —> Amazing rise and spectacular fall of shadow banking in India
References
1. China Mortgage Boycott Reveals Real Estate Market Uncertainty - Bloomberg
2. China's Response to Mortgage Boycotts Perpetuates a Market Paradox - Bloomberg
3. China City Is First to Cut Mortgage Down Payments, Media Say - Bloomberg]()
4. China Real Estate: Regulator Asks Banks to Fund Housing Projects - Bloomberg
5. China Weighs Mortgage Grace Period to Appease Angry Homebuyers - Bloomberg
6. China City Is First to Cut Mortgage Down Payments, Media Say - Bloomberg
7. China Mortgage Boycott: Xi Jinping Faces Revolt From Homebuyers Seeking Justice - Bloomberg
8. China Real Estate Market: Authorities Convene Banks on Mortgage Payment Boycott - Bloomberg
9. How China's Property Developers Sunac (1918), Evergrande (3333) Got Into - Bloomberg
10. What China’s Three Red Lines Mean for Property Firms: QuickTake - Bloomberg
11. Evergrande Restructuring Puts Bondholders at Beijing’s Mercy - Bloomberg
12. China’s Evergrande Debt Crisis Is Stress Test No One Wanted - Bloomberg
13. It's Not Just China Homebuyers. Now Property Suppliers Are Boycotting Loans. yahoo.com
14. China Faces Growing Pressure to Address Mortgage Protests - WSJ