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Transferring the pain from the levered Chinese property developers to the banks

Transferring the pain from the levered Chinese property developers to the banks

As China reflated its economy in 2015, we saw a massive five-to-six-year tailwind assisting the property boom. Speculation and strong property prices led to over-supply, and the eventual carnage experienced by most highly levered Chinese property developers over the past two years.

The very tailwind that helped housing – a significant sector within the Chinese economy – has now become a headwind. The fact that iron-ore prices are holding up at the current U.S.$130/tonne, given the Chinese real-estate sector typically accounts for significant demand, seems difficult to grasp. The “bulls” point to investment in railways, machine manufacturing, auto output and the renewable energy sector.

In recent news, China indicated it may allow banks to offer unsecured short-term loans to qualified property developers for the first time. As part of a package of new measures to backstop the real estate industry, regulators are considering allowing banks to issue so-called working capital loans with the objective of soothing buyer fears over unfinished homes.

If the support measures are approved, they would represent China’s most forceful attempt yet to plug the funding gap and help deliver millions of uncompleted homes. Investors expect some improvement in the New Year and while many Chinese property developers rallied strongly at the news it is unclear how the more levered companies will repay their creditors, especially their offshore bondholders. 

China’s banking industry is battling shrinking margins and souring loans as authorities have steadily increased pressure on lenders to shore up the economy and the property sector. Outstanding property loans at the end of September fell on a yearly basis for the first time, indicating caution at the banks. Government orders could see negativity associated with the levered property developers transferred to the banking system via shrinking net interest margins and lower profitability.

As China transitions from an investment driven growth model to one based on consumption, structural issues related to employment and debt, deflation, and demographics have seen Morgan Stanley, for example, revise down their 2024-2027 baseline gross domestic product (GDP) forecast by 0.4 per cent to an average annual 3.8 per cent.

And given China accounts for 35 per cent of Australia’s total exports (and an average of 70 per cent of revenue for our big three Iron-ore companies), the enormous “pull-up effect” enjoyed by Australia’s dependence on China over the past two decades could decelerate somewhat.

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Chief Executive Officer of Montgomery Investment Management, David Buckland has over 30 years of industry experience. David is a deeply knowledgeable and highly experienced financial services executive. Prior to joining Montgomery in 2012, David was CEO and Executive Director of Hunter Hall for 11 years, as well as a Director at JP Morgan in Sydney and London for eight years.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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