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Only China's Government Can Revive Property Confidence

China's property downturn has turned into a crisis of confidence that only the government can fix. S&P Global Ratings believes the sector needs Chinese renminbi (RMB) 700 billion-RMB800 billion to ensure distressed developers can finish presold homes. In our downside scenario, that number could rise as high as RMB1.8 trillion-RMB2 trillion.

If falling sales tip more developers into distressed territory, things will get worse. The distressed firms will halt construction on more presold homes, hitting buyers' confidence further. Our rough estimate is that about 2 million unfinished homes presold by Chinese developers are now in limbo. This has shattered confidence in this market.

In our view, only the state can marshal the volume of cash needed to address this problem. Delivering these homes to buyers is essential to normalizing China's property sector, in our opinion.

We assume further that fixing the property downturn is important to the economy and social stability, two major objectives of the government. A sustained downcycle risks becoming a systemic issue that hits the confidence of consumers and investors across assets and sectors. For the property market to return to health, in our view, the government faces one large problem: How to ensure that presold homes are completed and delivered to buyers.

To that end, the central government is close to launching a RMB200 billion fund that helps get unfinished projects finished. The Chinese news site Caixin reported in late August that the Ministry of Housing and Urban-Rural Development, the Ministry of Finance, and the People's Bank of China are close to establishing the fund, which will be used to complete stalled property projects.

The initial fund size is not enough to solve this issue. The government would be effectively putting RMB200 billion toward a RMB700 billion-RMB800 billion problem. However, the support is a good start and symbolically significant. It signals to buyers and investors that the state is willing to commit serious capital on the matter.

Chart 1

image

Who Will Pay?

With the fund initially capitalized at RMB200 billion but likely needing much more, the obvious question is: who will fund the gap? This will be a political decision. Governments at the local and central level will negotiate the precise burden they will ultimately bear. The process will inevitably involve local government funding vehicles, policy banks, state-owned asset managers, and commercial banks, we assume.

The problem cannot be resolved without involvement of the center, in our view. It signals to the market a greater seriousness of intent to stop the downward spiral in confidence, in particular property buyers. Nevertheless, the rescue would increase the debt burden of the borrowers--governments, financial institutions, and state-owned enterprises--at a time of dimming growth prospects.

Bond investors and other creditors of the distressed developers could also be worse off. Their claims will likely be subordinated to the new capital that will come with terms that prioritize repayment to the government.

Sinking Sales

The country's property downturn is worsening. According to China Real Estate Information Corp., an industry body, contracted sales by the top 100 China property developers were down by about one-third in August, year on year. This puts developers' liquidity at risk.

Presales are a critical source of capital in normal times. They have become even more important during the downturn, with capital market channels largely shut to the developers. Entities are looking at presales as their last viable source of liquidity.

The problem, of course, is that buyers are skeptical. Prospective homeowners question whether developers will deliver their residence. This skepticism has been exacerbated by the widespread strike on mortgage payments on hundreds of stalled projects that kicked off over the summer.

We estimate distressed developers have halted construction on about 20% of their unfinished projects. In our downside scenario, half of such projects could be stalled (see "China Property Sales Set To Drop By A Third As Mortgage Strikes Break Out," and "China's Mortgage Strike Puts Almost RMB1 Trillion In Bank Loans At Risk" published on RatingsDirect on July 26, 2022).

Chart 2

image

Meanwhile, the decline in new-home sales is hitting the economy. In June, we cut our China GDP growth forecast for 2022 to 3.3%, from a prior forecast of 4.2%, citing COVID lockdowns and the property downturn (see "Economic Outlook Asia-Pacific Q3 2022: Overcoming Obstacles," June 27, 2022). China's real estate sector typically drives about one-quarter of national GDP, including direct and indirect effects such as the suppliers used in construction, and banks.

Whatever It Takes?

The property downturn has become a critical policy problem, and this has pushed the state response from the local level to the center. The RMB200 billion fund is a case in point. This would be Beijing's first significant act of support for the property sector in this downturn. This cash will likely be distributed via policy banks to local government-owned banks and asset managers, to be invested in stalled property projects--to ensure buyers get their homes.

The RMB200 billion fund adds to a recent wave of initiatives coming from governments and regulators to lift the property sector. Local governments such as Zhengzhou in Henan province and Nanning in Guangxi province have worked with their state-owned enterprises (SOEs) to roll out funds to support the real estate industry. The funds are all aimed at bringing stalled projects to completion. According to Caixin, Henan SOEs have injected about RMB10 billion into the funds, and Guangxi SOEs have contributed RMB3 billion. Based on media reports, other cities in Zhejiang, Hubei, and Shaanxi provinces may follow suit.

China's economic slowdown and sliding land sales are hitting the finances of local governments (see "China Slowdown Forces A Rethink For Local And Regional Governments," Aug. 9, 2022). They would, as such, resist pledging too much of their own capital to bail out a project, in our view. Instead, local governments may provide policy incentives, such as lower taxes or special approvals, if the governments believed a failed project would put social stability at risk. Local governments are also liaising with developers, homebuyers, banks, and the courts, to push developments through quickly.

China's distressed asset manager companies may also help to resolve distressed property development projects. However, they are likely to be more selective and commercial in nature (see "Real Estate Funds, A First Aid To China's Property Slump," Aug. 18, 2022).

Table 1

Insurance On Onshore Bonds Is Designed To Pull In Investors
Onshore instruments insured by the China Bond Insurance Co. Ltd. in the year to date

Longfor Group Holdings Ltd.

Midea Group Co. Ltd.

Seazen Group Ltd.

Country Garden Holdings Co. Ltd.*

CIFI Holdings (Group) Co. Ltd.§

Bond type MTN MTN MTN MTN MTN
Announcement date Aug. 26 Sept. 7 Sept. 13 Sept. 9 N.A.
Amount RMB1.5 billion RMB1 billion RMB1 billion RMB1.5 billion RMB1 billion-RMB1.5 billion
Maturity 3 years 3 years 3 years 3 years 3 years
Coupon 3.30% 3.33% 3.28% 3%-4.3% 3%-4.5%
Guarantor CBICL CBICL CBICL CBICL CBICL
Credit-protected amount Full principal and interest Full principal and interest Full principal and interest Full principal and interest Full principal and interest
Credit-protected tenor Full tenor Full tenor Full tenor Full tenor Full tenor
*Issuance based on company announcements and media reports §Issuance based on media reports without an announcement from the company. MTN--Medium-term note. RMB--Renminbi. N.A.--Not available. CBICL--China Bond Insurance Co. Ltd. Source: Company announcements, REDD Intelligence.

Golden Months Are Looking Less Lustrous

We will likely see lackluster property sales in September and October this year. These months have historically been the peak sales season for China property (the so-called "Golden Months"). The lowering of loan prime rate to an all-time low in August may not immediately stimulate homebuyers' demand. It will take time for their confidence to come back.

During May to June this year, the government has shown initial signs to support the liquidity of select privately owned enterprise developers (see "China Signals Policy Support For Select Private Developers," June 1, 2022). The state has recently ramped up such support (see table 1).

The government's support measures such as the offer of default insurance on some property bonds in May to June had indeed turned around sentiment somewhat. The mortgage strike that spread over the summer reversed that. It refocused people's attention on the mass of unfinished residences, and the distressed state of many Chinese developers.

This underscores how unpredictable and uncontrollable sentiment can be. The downturn has now hit a point where the government may feel the need to establish a definitive turning point. It could be the only way to definitively turn around the faltering confidence of homebuyers and investors for this sector.

The best indicator of the government's resolve has yet to come, in our opinion. The 20th National Congress of the Chinese Communist Party to be held in October should reveal how far the government is willing to go to save the sector.

Writer: Jasper Moiseiwitsch

Digital designer: Evy Cheung

Related Research

This report does not constitute a rating action.

Primary Credit Analyst:Edward Chan, CFA, FRM, Hong Kong + 852 2533 3539;
edward.chan@spglobal.com
Secondary Contacts:Lawrence Lu, CFA, Hong Kong + 85225333517;
lawrence.lu@spglobal.com
Harry Hu, CFA, Hong Kong + 852 2533 3571;
harry.hu@spglobal.com
Susan Chu, Hong Kong (852) 2912-3055;
susan.chu@spglobal.com
Iris Cheng, Hong Kong +852 25333578;
iris.cheng@spglobal.com
Research Assistant:Venus Lau, Hong Kong

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