China’s mortgage risk

So far, property sector debt woes have primarily concerned developer defaults. This is different from property crises in other countries, which involved homeowner defaults and foreclosures. 

"Since China has seldom experienced major adjustments to property prices, negative equity could catch households and policymakers off guard”.

There is a risk now that developer defaults could also spill over to the mortgage book. As borrowers for new projects start making payments before a project is completed, unfinished projects will be at risk.

Banking Stability

Recently there has been a wave of early repayment of existing mortgages as the interest rates of old mortgages rose. Borrowers have been motivated to reduce their leveraging using whatever cash they have on hand or sourcing other forms of low-cost funding.

To support the property market, authorities have eased mortgage rules:

• Local authorities can lower the down payment ratio to 20 per cent, from the national requirement of 30 per cent, to meet local conditions.
• Mortgage interest rates can deviate from the national benchmark of “Five-year Loan Prime rate + 60 basis points”.
• Buyers who have had a mortgage before but have no existing mortgage can be deemed first home buyers. 

China's personal mortgages and loans to developers

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The buffer

A high down-payment requirement has been safeguarding China’s banking stability, as it has buffered lenders against falling property prices. Other countries, like Canada, allow down payments for first home buyers as low as 5 per cent.

Our analysis indicates that mortgages drawn in 2021 have the lowest value-to-loan ratio, ie the buffer. They owe banks CNY4.8 trillion. But the mark-to-market value of the original amount was CNY4.7 trillion. Since they began with 30 per cent down payments, the total property value remains 42 per cent higher than the outstanding loan.

It also means if China’s property prices drop 30 per cent from the 2022 level (a fall from CNY6.7 trillion to CNY4.7 trillion) this cohort, which represents 12 per cent of the value of the mortgage book, will experience negative equity. If property prices drop by half, total negative equity will rise to CNY19.8 trillion, covering 51 per cent of China’s total mortgage portfolio.

Beware of free fall

China’s authorities used to have a ban on price cuts for new developments which was intended to avoid triggering a major revaluation of real estate. On 20 August, however, an official newspaper of the Ministry of Housing and Rural-Urban Development opined that local governments should allow developers to cut prices to relieve their cash flow problems.

Recently Zhuhai’s local authority endorsed a price cut of a property project from its original listing price of CNY26k/m2 to CNY19k/m2, down 27 per cent within two years. The pace of the fall is fast. If other cities follow, China’s property prices will come under severe downward pressure.

Massive and rapid property price corrections are not unknown. During Japan’s “Lost Decade,” Tokyo’s new apartment prices fell by 30 per cent in two years after the bubble burst. And a property collapse in Hong Kong saw a 30 per cent correction in four months from October 1997 to January 1998 resulting in massive negative equity.

Sharp property price corrections in Tokyo and Hong Kong

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Such rapid price adjustments shock household expectations, dampen buyer appetites and result in a negative spiral. The secondary market will also be affected, in the worst cases triggering “fire sales” by owners as we’ve observed in other property crises. Such herd behaviour is not new in China’s property and stock market. 

Property price indices of Japan and China

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Revaluation of real estate obviously concerns banking stability as land and real estate are major forms of collateral. Since China has seldom experienced major adjustments to property prices, negative equity could catch households and policymakers off guard. Property sector woes have spread to shadow banking. Any snowball effect from this could be a black swan event.

Raymond Yeung is Chief Economist of Greater China at ANZ Institutional