Or at least they’re worried about what it will look like in the second half of this year, when we might start running into a funding “crisis”.
That’s what Andrew Collier of Orient Capital Research is suggesting, with our emphasis:
Based on our interviews, we believe the property sector will face a liquidity crisis when the peak of debts come due in the second half of 2017 and beginning of 2018. According to the Centaline Group, China’s property developers raised Rmb1.14trn in 2016 through privately raised company bonds, corporate bonds, medium term notes and related sources. This was a 26% increase YoY, for the first time breaking Rmb1trn. However, both domestic and foreign financing channels have been blocked since last October due to tightening regulations on capital raising, along with a strong U.S. dollar As a result, property developers are confronting a significant increase in the cost of financing that could cause them to reach crisis levels in the near future. We estimate Rmb544 billion in corporate bonds alone will come due in 2H 2017 and early in 2018.
As was widely reported, there was indeed a chill cast over Chinese property funding in the third quarter of 2016 as regulators looked to cool an overheating market. “All the relevant [national] regulators and government departments have intervened to curb developers’ financing,” said Jonas Short at NSBO, a policy research group, to the FT. “It’s an example of the concerted action that you get when [Beijing] is convinced something must be done.” More so, from the same FT report in November:
Corporate bond sales by real estate developers have come to a complete halt this month while their issuance of trust products fell by a quarter in October compared with September. Trust products bundle corporate loans and other assets that are sold on to a variety of investors including bank depositors.
Now, before going on, do please remember that China’s property market is effectively the foundation of the country’s economy. As Citi said before, “property-related tax revenues and land sales proceeds jointly account for 42% of local governments’ direct income (fiscal revenues + local government funds). The property market, in short, has become the critical income source for local governments. This is the key reason why we believe a property market collapse could be ill afforded by central/local governments, though they do hope for a cooling of the property market.”
Then there’s the normal industry involved in the… industry: construction and real estate made up a fifth of real gross domestic product growth in the first half of 2016, according to China International Capital Corporation (via the FT). There’s also the very real issue of banks investing in property bonds and/or investing in shadow banking products (WMPs) which are in turn invested in property bonds.
You get the picture: it’s an important sector that they won’t want to see crash even if credit growth can’t keep going forever. China is, as has been widely explained, very probably pushing against its debt-capacity limits.
Remember too then, that what the regulators have tightened can by the same regulators be loosened.
So, yeah, the PBoC etc are clearly worried about over-investment into the bubbling property sector but it’s very very unlikely that they will keep credit so tight that they allow a crisis. While allowing some defaults to instil some sense of credit risk is part of the plan, anything that endangers financial stability is not.
All the more so since the shadow market — which is another funding avenue for the property developers — would not look pretty if those defaults were to cascade. An illustrative example from Michael Pettis’s latest newsletter:
The market “inefficiency” that allows WMP investors to earn higher yields than they would on bank deposits, while believing that they are taking no greater credit, maturity or liquidity risk, is simply calculated obfuscation. We will only know once the WMP markets faces its first major test whether WMP investors were the ones who were able to “arbitrage” this inefficiency, because banks were forced to absorb the credit and liquidity risks, or banks were the ones who benefitted from the “arbitrage” as they walk away from WMP, and forced investors to absorb the credit and liquidity risk…
While most market participants understand the credit risk distortions implied by WMP, they may be less clear about the liquidity risk distortions. By regularly buying and selling corporate bonds the SPIVs create liquidity in Chinese corporate bond markets as a function of the expansion of the WMP market. This liquidity creation can be highly self-reinforcing, however, and investors should be aware of the risk of liquidity gapping, i.e. a sudden sharp contraction in trading volume and market liquidity.
Gapping risk is exacerbated by the fact that while a lot of WMPs are backed by the very simple form of securitization described above, an increasing number of WMPs may be backed by more complex securitizations. Among them are those in which the SPIV invests in the stubs of other SPIVs, thus leveraging up products that are already levered, and in which there is a structural mechanism that links WMP redemptions far more directly than the normal contagion mechanisms.
So how will this particular liquidity worry turn out?
As Collier says: “PBOC, could, however, intervene on a case-by-case basis, particularly when the developer or project is sufficiently large to cause economic distress in a politically important location.” Which seems about right.
