China Property Bubble Could Cause $600 Billion in Bad Debts

  • Price rise of 30% ‘suggests a bubble-like phenomena:’ Pimco
  • DBS sees 4.1 trillion yuan in soured loans on 30% price drop

Experts Warn of China Property Bubble

China watchers are starting to put a price tag on what any collapse in the nation’s red-hot property market could cost banks.

A drop of 30 percent in housing prices could cause 4 percent of total loans worth 4.1 trillion yuan ($615 billion) to sour, according to DBS Vickers Hong Kong Ltd. Commerzbank AG said such a drop could trigger 4 trillion yuan in delinquencies. Pacific Investment Management Co. expects the non-performing loan ratio to peak at 6 percent in the next few years from the current 1.75 percent, amid risks from the property sector.

While bank losses under those scenarios would be a far cry from the $1.3 trillion in the U.S. after the 2008 financial crisis, economists are increasingly anticipating a banking system bailout that could rock the stock market and push up government borrowing costs. Ma Jun, the central bank’s chief economist, said in an interview with China Business Network last month that the property "bubble" needed to be curbed after home prices rose 60 percent in the southern city of Shenzhen in a year. 

“The amount of increase in housing prices in China that we have seen in recent years, especially this year, is concerning,” said Roland Mieth, portfolio manager for emerging markets in Singapore at Pimco, which doesn’t have a real estate NPL estimate. “Those increases in price year on year at 30 percent or more tend to suggest a bubble-like phenomenon.”

Deutsche Bank AG wrote in a Sept. 28 report that property could face a severe correction in 2018 as a bubble is spreading to more cities, while Goldman Sachs Group Inc. wrote on Oct. 4 it saw growing vulnerability after prices "skyrocketed." China’s surge in home prices reminds JPMorgan Asset Management’s chief Asia market strategist Tai Hui of last year’s stock market mania because of spiraling leverage and implicit state support. While a sharp drop isn’t DBS Vickers’ base case, risks will rise if the pace of lending is sustained.

“The property sector is the biggest concern for China’s banking system,” said Shujin Chen, a banking analyst at the brokerage in Hong Kong. “If the property prices decline a lot, it would affect the quality of loans to property developers first because they are the most highly levered. The second-tier impact will be mortgages.”

Chen estimates about 7 percent of loans go to developers and 20 percent to residential mortgages. The median total debt at 144 listed Chinese builders jumped to 8.1 times earnings before interest, taxes, depreciation and amortization, from 4.9 five years ago, data compiled by Bloomberg show. Their total debt has also risen to a record high of 2.8 trillion yuan.

Healthier Households

While the debt of households in China jumped to a record 40.5 percent of the nation’s economic output as of Dec. 31 from 28 percent in 2010, that is still below the 80 percent for the U.S., 85 percent for South Korea and 66 percent for Japan. Goldman wrote it was not too concerned about a "foreclosure crisis" as Chinese homebuyers need 20 to 30 percent downpayments and banks have recourse to property.

“Leverage and lending complexity around the property market is a lot less toxic” than in the U.S. before 2008 because of a relative lack of derivatives, said Pimco’s Mieth.

As delinquencies made banks reluctant to lend to companies, the amount of outstanding mortgages in China jumped 31 percent in the first half, three times more than the increase in overall lending. Loans to households soared to 71 percent of total new lending in August, from 24 percent in January. 

“Chinese banks are extending mortgage loans very aggressively,” said Christine Kuo, a Hong Kong-based senior vice president at Moody’s Investors Service. “Those loans are becoming riskier because housing prices are at a frothy level.”

Read: China’s Bubble Trouble Risks Missing Lessons from Japan’s Crash

Fitch Ratings estimates Chinese banks’ exposure to the sector, including off-balance-sheet lending and corporate loans using real estate collateral, may be as high as 60 percent of total credit.

“Property prices tend to collapse quickly under stress,” said Grace Wu, a Hong Kong-based analyst at Fitch. “When that happens, there are usually very few transactions and it would be difficult to recover the value of collateral such as land and property.”

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