Bad debts galore?

A slew of Chinese banks are reporting half year results, and most have reported lower bad debts ratios. Good news? Wait. Due to an explosion of property related loans in the H1, total bad debts had actually gone up.

China has a prudent down-payment policy, in the range of 20% to 60% (!). As such mortgages are actually prime assets of the banks. The weak link is loans to the property developers. Huaxia Bank, listed in Shanghai and known ninja loan maker, reported a 14.5% increase in bad debts to the developers. Citic Bank’s bad debts to property developers were up 10%. China Minsheng Banking Corp., one of the better managed ones (and perhaps more transparent?), actually surged by 78%!

In terms of bad debts ratios, all banks are still within the comfort zone. But with the tightening policies only kicking in mid-April, one has to wonder whether the bad debts situation will deteriorate, perhaps dramatically, in H2.

Battle lines hardened in the Chinese property market

With the CBRC, China’s powerful banking regulator, banning 3rd mortgages and tightening other banking operations like securitization, it seems like the Chinese government, the central government at least, has hardened its resolve in pricking the property bubble.

However, the push back from the property lobby is forceful as well, especially now it seems that government is serious and the tightening measures might last a while. An economist from TsingHua University had calculated earlier on that if the tightening measures last for more than a year, more than 45% of Chinese property companies will encounter solvency problem.

A strong and faithful ally to the property lobby is China’s local governments. Yes, China is not all synchronized and monolithic, and there is indeed internal politics. Many ocal governments absolutely live on land sales. Due to the tightening measures, land sales had been way below budget during the first half of the year. In Hangzhou, a prosperous coastal city, the government sold only 22% of land budged for 2010. Shanghai, China’s money center, sold 29% of its annual plan during the same period.

So in order to secure more revenue, the local governments will definitely push for more loosening, especially now that the economy has weakened. One can only hope that the sane mandarins, who have been calling for “tolerance for a new lower growth rate”, will prevail, but somehow I’m not particularly optimistic.

Is more money coming for the credit junkie?

Even though imports slowed drastically and inflation has busted the 3% target, some people at least can breath a little easier. Yes, I’m talking about the credit junkies, and they are making their cries for more stimulus heard. From Bloomberg:

“Policy makers may have more room to sustain growth if needed,” said Sun Chi, a Hong Kong-based economist at Nomura, who previously worked for the U.S. Treasury in Beijing. “The lending quota could be loosened to sustain ongoing investment projects.”

This is largely based on expectation that inflation is peaking and, dare I say it, the economy is weakening.

On the first factor, I think it’s still too early to call inflation peaking. Food has been a major driver behind inflation this year, with no sign of abating so far. And there has been a persistent rumor lately that China has purchased 600k metric tonnes of rice from Vietnam, mind you, the nation imported only 174k metric tonnes in H1/2010. So this could point to a severe shortage of rice in the market. Is this rumor true? I don’t know. But it’s at least credible enough for a Vietnamese minister to come out to assure his people of food security.

Besides persistent worries on inflation, the asset bubble is another cause of concern for China. Considering that the bank regulator has ordered the banks to consolidate off-balance sheet items on Monday and clamp down on their credit card activities today, plus the PBoC has drained an estimated RMB187bn from the banking system with its open market operations in three weeks, the fix is not coming, at least not yet.

China to ban 3rd mortgages in key cities

The Shanghai and other Asian markets have been choppy lately, mainly on the prospect of the Chinese government backing off from regulating the property market. So much so that property sales doubled last week in Beijing. Some other cities have even racked up price increases.

To prove that it’s indeed serious about pricking the property bubble, the powerful China Banking Regulatory Commission is now banning 3rd mortgages in Beijing, Shanghai, Shenzhen, and Hangzhou all together. Taking out 3rd mortgages in other cities, while still legal for now, will require 60% down payment and almost 200bp over prime rate.

Of course the central government worries about economic slowdown, but failing to regulate the property market risk serious popular discontent. With most full year GDP forecasts still in the 9%+ range, the tightening measures seem to be in place, for now.

As a side note, the 21 Century Business Herald has a follow up story on the stress test that raised so many eyebrows. Assuming a 30% drop in housing prices and 108bp  interest rate hike, the property portfolios of  sample banks would have registered 2.2 percentage point increase in their bad debts, and taking 20% hit to pretax profit.

Yes, painful, and would have been excruciatingly more so with a 60% fall in housing prices, but the system will not collapse. With the hindsight, it seems that the 60% fall stress test was ordered partly as a way to advertise to all speculators that the government is indeed serious and won’t be taken hostage by the property market. However, I expect the economy to slow dramatically in Q4, so it might have to sing a different tune by then.

How bubbly is the Chinese property market?

This is the million dollar question and I’ve decided to give it a try. Where do I start? How about the developers inventory?

The National Bureau of Statistics just announced yesterday that developer’s inventory for residential housing by the end of June at 106mn sqm, or roughly 1.5mn homes assuming an average of 70 sqm (753sf) per home. This amounts to a mere 1.5 months of new home supply on last year’s sales. Now, 2009 was a brisk year. But even if I use 2008 figure, when sales dived 20% due to the financial crisis, it equates to 1.8 months of supply, far from horrendous if you consider that the US new homes supply seldom dip below 4 months even in the best of times.

Why is this focus on new homes supply important? Due to the requirement for 30% down payment for homeowners, the weakest link for a Chinese bank is actually lending to the developers, the conduit in which the bursting of a property bubble may morph into a full-fledged financial crisis.

Of course, the tightening measures on the property market only kicked in mid-April and the data is only from end of June. Given time, it’s definitely plausible that inventory may build up further and prices may plummet (so far it has barely budged). Which is why the Chinese banking regulator is performing a stress test on the assumption of 60% pricing fall in the worst case scenario. But should this be taken as an admission that Chinese property market will indeed collapse? I think not.

According to the National Bureau of Statistics, housing price index rose 14% year-on-year by June this year. Before you scream communist propaganda, I should add that this index is compiled with data from 70 Chinese cities, with huge variance among them. Beijing registered 22% rise during the period, while Sanya of Hainan (think Florida in terms of climate, location, and economy) rocketed by 59%! Private economists, like Stephen Green of Standard Chartered, have also noted the geographical concentration of the housing bubble.

So all in, I think the coming bursting, while painful, will not be catastrophic. The froth is concentrated in a few key cities and the banking system is insulated to a degree by the down payments. The US financial crisis had its root in leverage, rather than the fall of housing prices.