Can Chinese banks weather a very weak real estate market?

Although Chinese banks fended off the declining profitability with lower loan write-off and provisioning in Q1 2022, there is no guarantee that the trend is sustainable. In the second report of?Natixis China Banking Monitor Series 2022, we aim to answer the million-dollar question of whether it will threaten asset quality in Chinese banks.

The non-performing loan (NPL) ratio of Chinese banks fell from 1.84% in 2019 to 1.73% in 2021. But the real estate NPL ratio climbed from 0.7% to 2.3%. It shows the overall asset quality has improved but with growing credit risks in the real estate sector. With a high bond with repayment pressure ratio, China’s bond market also shows property developers, especially the private firms, are at the core of credit risks.

With regulatory pressure and risk aversion behavior, the growth of corporate loans to developers has decelerated. However, the share of real estate in corporate loans only fell from 11.8% in 2019 to 11.3% in 2021. If the room for reducing exposure is limited, real estate will remain a key determinant in the asset quality of Chinese banks, which is affected by home demand and the funding of developers.?

While the property market may be affected by lockdowns, it is also true that there is no significant sign of a rebound in property sales and mortgage loan growth even after the relaxation of regulations. But of course, it may take time to see the effect of the 15-basis point cut in the 5-year loan prime rate (LPR). Regarding the funding, the sharp decline in pre-sales remains a challenge for developers. Bakers need flour to make bread as if developers need land to build houses, but the share of land purchases by state-owned firms has grown from 40% before 2019 to 74% so far in 2022. It shows private firms find it difficult to maintain their business model of high leverage and quick turnover.

Even though China has relaxed regulations, it depends on if developers, investors and households think the changes are short-term or a reversal of policies. For now, the rebound in real estate investment is limited. Investors still view 40% of real estate firms in the market as negative. Only 17.9% of households think of home purchase in the next three months in Q1 2022, lower than 20.7% in 2019.

All in all, China's banking sector should be able to absorb the poorer asset quality related to real estate as it only forms 4.5% of total assets, but the question is how costly it can be. The overall credit risk is rising in real estate, especially with the widening credit polarization among property developers. Still, there is no direct correlation between real estate exposure and the related NPL ratio. It means the potential loss will diverge among banks depending on their risk profiles. We expect the government to roll out measures to help developers consolidate and restructure, but it is also certain that Chinese banks will need to shoulder the burden with its profitability.

Full report is available for Natixis clients.