HONG KONG (S&P Global Ratings) July 26, 2022--A boycott on mortgage payments in China signals sliding confidence among homebuyers. S&P Global Ratings now expects national property sales will fall 28%-33% this year in the country, almost double the drop of our prior forecast, as people lose faith many developers can complete presold units. This could further squeeze the liquidity of distressed developers, leading to more defaults.
The strikes pick at China developers' reliance on presales. Developers typically ask buyers to pay for residences before they are completed. Such presales account for the bulk of developers' cash inflow.
Homebuyers have withheld payments on mortgages spanning hundreds of residential projects in China, on the view some distressed developers don't have the means to complete the homes. This boycott on payments could easily spread to other developers, in our view.
The real estate sector makes up about 25% of GDP, including direct and indirect effects such as developers' suppliers used in construction, and banks. Our bottom-up analysis shows the country's banks could rack up almost Chinese renminbi (RMB) 1 trillion in at-risk mortgage loans by recent homebuyers boycotts in mortgage payment associated with stalled residential projects (see "China's Mortgage Strike Puts Almost RMB1 Trillion In Bank Loans At Risk," July 26, 2022).
"We continue to expect an 'L-shape' recovery for property sales, bottoming out at RMB12 trillion to RMB13 trillion in 2022, with any recovery likely delayed till early next year," said S&P Global Ratings credit analyst Esther Liu.
This will certainly hit developer liquidity. Presales proceeds are often upstreamed for debt repayment as long as they meet regulatory requirements. This can serve as a funding means of last resort while most other refinancing channels are shut.
Regulators have subsequently eased many of these measures, signalling on March 16 that policy tightening had bottomed. However, as some distressed developers such as Evergrande have run out of funds to complete homes, the sector is now contending with homebuyers' waning confidence. People have doubts about developers' ability to continue as a going concern. Buyers may also have questions about their own financial standing, as a weak economy means that some are contending with the possibility of job loss or a pay cut.
This further restricts developers' liquidity, hitting the confidence of investors and banks to lend to property firms. Suppliers and services firms would also be less inclined to support distressed developers on the promise of payment down the line.
Buyers are also losing confidence that property as an asset class will continue to appreciate, in our view, with home prices set to fall 6%-7% this year. We assume almost of all this decline happened in the first half and that prices will stabilize from here.
While developers want to sell more units, they also understand further price cuts would hit already-weak buyers' confidence. Price floor policies introduced by local governments will also stop home prices from dropping significantly.
Property Crisis Set To Ensnare Higher Rated Developers
We anticipate the boycott on mortgage payments could presage a liquidity crunch for property firms higher up the ratings spectrum. So far most of the strain has focused on firms within the 'B' ratings category. But we now see greater possibility the crisis may entangle higher rated entities that have so far largely retained their liquidity and funding lines.
"Many firms have already lost access to bank loans and debt raised in both onshore and offshore capital markets. Contracted sales have served as many developers' funding channel, or repayment source of last resort--as long as they meet regulatory requirements. If they now lose presales, because people decline to buy homes from weaker developers, or banks decline to provide mortgages, the firms could quickly tip into distress," said S&P Global Ratings credit analyst Lawrence Lu.
China rules on presales aim to trap funds at the project level. The goal is to ensure funds are available to carry the homes through the whole building process. However, developers have always found loopholes to extract money from these projects to buy new land or pay down debt. This is particularly true in lower-tier cities, where rules on escrowing are relatively loose, giving firms more leeway to use presales to bolster their liquidity. If developers lose this source of sales, their liquidity risks will grow.
We anticipate there could be a vicious cycle in which weak contracted sales hit cash flow, leading to more defaults. This may shut more developers out of capital markets, with homebuyers staying away from projects developed by entities known to be in financial difficulty.
Likewise, there may also be a flight to quality. Higher rated, state-owned developers or privately owned developers that have been able to tap onshore capital markets would retain more capacity to do presales, in our view. Buyers would likely continue to buy homes from stronger developers on a contracted basis, on the assumption they won't run out of money, and will deliver the homes they promised.
The mortgage strikes mark a significant deterioration in China's property downturn. It is a highly visible and concrete statement of no-confidence in some of the country's biggest developers. While we anticipate regulators will shortly attempt to address the issue, it is very difficult to restore sentiment by fiat. This makes the next leg of the downturn tricky, and risky, for developers.
Writing: Jasper Moiseiwitsch
Related Research
- China's Defaulted Developers Are Running Out Of Time To Exchange And Extend, July 17, 2022
- China's City-Led Property Voucher Plan Won't Replicate Sales Boom Of 2015, July 6, 2022
- China Signals Policy Support For Select Private Developers, June 1, 2022
- China's Property Downcycle Won't End With Policy Easing, April 7, 2022
- Auditor Resignations Flag Governance Risk For China Developers, Feb. 16, 2022
- As The Escrow Flies: China Developers Navigate Convoluted Rules On Presales, Jan. 20, 2022
This report does not constitute a rating action.
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| Primary Credit Analyst: | Esther Liu, Hong Kong + 852 2533 3556; esther.liu@spglobal.com |
| Secondary Contact: | Lawrence Lu, CFA, Hong Kong + 85225333517; lawrence.lu@spglobal.com |
| Research Assistant: | Ivy Yi, Hong Kong |
| Media Contacts: | Ning Ma, Hong Kong (852) 2912-3029; ning.ma@spglobal.com |
| Michelle Lei, Beijing + 86 10 6569 2961; michelle.lei@spglobal.com |
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