China’s property debt red lines need a redraw

HONG KONG, Jan 11 (Reuters Breakingviews) – Beijing’s efforts to cap developers’ leverage are backfiring. The “three red lines” policy on debt ratios has begun aggravating market stress and impairing balance sheets.

Frustrated by the ineffectiveness of efforts to curb speculation by hiking mortgage down payments and similar measures, regulators led by banking chief Guo Shuqing stiffened policy in 2020. They introduced formal caps on three key ratios: debt-to-cash, debt-to-assets, and debt-to-equity. Those on the wrong side of those lines found themselves almost entirely locked out of credit markets. The theory was this would compel developers to cut back on overzealous land purchases that pushed up prices, sell off excess inventory, and issue more equity to get their balance sheets back in line.

The ensuing pain was immediate and acute. Unable to refinance itself, Evergrande (3333.HK), China’s second-biggest developer, began defaulting on some of its $300 billion of liabilities, as did other peers. They also failed to complete pre-sold apartment projects in time, prompting some buyers to halt their mortgage payments.

With developers and worried investors dumping apartments onto the market to raise cash, and the rest of the economy cooling, home prices started falling. Sales volumes contracted 25% last year. Constricted cash flows made it even harder for developers to pay down debts. Indeed, the average net-debt-to-equity ratio at China’s top 80 real estate companies rose to 152% by the second quarter of 2022, nearly double what it was in mid-2020, per analysts from state-owned Chinese Academy of Social Sciences. The number of companies exceeding the cap on the debt-to-cash ratio increased too. In short there are now more property firms on the wrong side of the red lines than when the policy was first rolled out, and even the most financially healthy are struggling.

Beijing is already backing off. Officials have nudged state banks to extend more credit to some developers and facilitate acquisitions. They are also mulling letting companies in good financial condition raise debt by more than the current 15% annual limit, per Bloomberg. However, the three red lines remain in place for now. The sooner they are blurred, moved or erased, the better.

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CONTEXT NEWS

China’s home sales are expected to slip by a median of 8% this year, a Reuters survey showed on Jan. 6, compared to a slump of around 25% in 2022.

The People’s Bank of China said on Jan. 5 that in cities where new homes prices have fallen both month-on-month and year-on-year for three consecutive months, the floor on mortgage rates can be lowered or abolished for first-time home buyers.

Editing by Pete Sweeney and Katrina Hamlin

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