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.

The property lobby is having the upper hand…for now

Despite global weakness, Shanghai actually went up 2.1% today. This is NOT an indication of faith in the global recovery, or any recovery, but rather an expectation of loosening of governmental controls over the property market.

Due to popular backlashes against runaway housing prices, Chinese government launched a series of cooling measures in April, causing a sharp drop in turnover (Shanghai saw a fall of over 75% in turnover) but the impact on prices has been marginal so far. To date, the developers have refused to cut prices, buttressed by record profits last year. However, the war of attrition is gradually starting to bite, and an association representing the developers has plead with the central government in an open letter to loosen the controls.

Despite repeated government responses of “No”, you can’t blame the public for trusting the developers more, as previous cooling measures all ended in sharp policy reversal in the face of economic slowdown. However, I think the government will hold out for longer this time, at least for one more quarter.

1. Chinese slowdown will not be apparent until end of Q3. There’s still a wee bit of time.
2. Popular discontent with extra-orbital housing prices is threatening the CCP’s legitimacy. Contrary to western conception, even an authoritarian government has to deal with popular opinion if it wants to stay in power.
3. Housing policy is believed to be part of the portfolio of Li Keqiang, slated to the China’s next premier. Failing in a key policy initiative will become a major stumbling block on his personal route to power.

As such, I believe housing policy will remain unchanged (i.e. tight money, anti-speculation) till the end of Q3. Since I expect rapid deterioration of the Chinese economy in Q4, the government might be forced to revert its stance then.

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.