China's property market continues to slide. In response, a shift has emerged in how Beijing is dealing with the property slump. The suite of new measures rolled out by authorities over the last couple of months doesn’t aim to reflate the property sector or bail out developers. Rather, it's designed to staunch the fallout from the sector's readjustment, which has gone far beyond what regulators anticipated when they launched their efforts to deleverage real estate in 2020.

Beijing's strategy has three components. First, it's providing funds to ensure that developers have the financial resources to complete unfinished housing. Second, it's trying to ensure that relatively healthy developers – firms that have been unfairly afflicted by contagion – are able to access the credit they need to function normally. And third, authorities at both the central and local levels are doing all they can to boost housing sales by reducing the cost of buying a home.

Ultimately, authorities hope that these measures will establish the foundations of a recovery.

The first two components will boost construction activity above what it would be otherwise – but it will take time for demand for new housing to recover under the third. Meanwhile, many private sector developers will likely have to downsize, restructure, or be taken over. 

Even with Beijing's newly invigorated approach to dealing with the downturn, it's likely that the property sector's adjustment has at least another couple of years to run. Until then, the sector will continue to be a drag on growth, and Beijing's focus will be on limiting the fallout. 

Step 1 – Completing Unfinished Homes

Starting in July, homebuyers at hundreds of unfinished developments across the country threatened to stop mortgage payments until their homes are completed. About 90% of all housing in China is sold off-the-plan, which means homebuyers buy their apartment – and take out a mortgage to do so – between one and three years before taking delivery of their homes.

However, over the past year it's become increasingly difficult for many developers to borrow the funds they need to complete housing they've already sold. Yields in the offshore dollar bond market have spiked, making it prohibitively expensive for developers to replace maturing bonds. Meanwhile, onshore investors have been unwilling to buy new bonds issued by private sector developers. And, despite government encouragement, many banks have been reluctant to lend to developers.

To help ensure that homebuyers receive delivery of their housing, in August Beijing launched a bailout plan. The People's Bank of China (PBoC) will lend up to Rmb200bn to policy banks, which will lend them to local governments, that will then make the funds available to housing projects where construction is behind schedule or stopped entirely. The loans must be backed by collateral provided by the developers.

The program will hopefully put an end to mortgage boycotts, and it will stimulate construction by restarting stalled projects.

However, it will do nothing to resurrect the finances of struggling developers.

Step 2 – Picking Winners

One of the biggest challenges for Beijing is ensuring that relatively healthy private sector developers – that is developers with moderate debt levels who would probably be operating normally were it not for contagion effects – are able to access sufficient credit to stay afloat.

In August, regulators drew up a list of eight relatively healthy private sector developers that are entitled to have their bonds guaranteed by China Bond Insurance Co.

China Bond Insurance is China's first credit enhancement institution and is jointly owned by the National Association of Financial Market Institutional Investors (NAFMII) – the interbank bond market regulator – and several state-owned entities. 

The lucky eight developers are: Longfor, Midea Real Estate, Seazen, Country Garden, CIFI Holdings, Gemdale, Binjiang Group, Sino-Ocean. The first five have already issued bonds backed by guarantees at interest rates well below what had previously been possible.

All eight firms rank among China's 25 biggest developers by sales, a group that also includes 11 state-owned developers which don't need guarantees. If the guarantees prove successful in shoring up the developers' finances, then we expect that guarantees will be extended to smaller private developers.

However, we doubt they will be extended to the six private developers among the top 25 not already offered guarantees – Greentown, Sunac, Jinke, Shimao, Yanlord, Zhongnan Construction.

That begs the question: what is likely to happen to those developers denied state backing for their bonds? We suspect that their financial difficulties may deepen, not least because they'll find it increasingly hard to borrow from banks.

Banks are already picking winners.

Despite central authorities repeatedly exhorting them to increase lending to developers, 25 of China's 59 listed banks – about 40% – reduced their outstanding loans to developers over the first half of the year.

Overall, outstanding loans to developers rose 3.1%, but that was driven almost entirely by lending by large state-owned commercial banks – China's Big Six banks – a group far more responsive to policy instructions than most.

The reduction was in part due to banks disposing of distressed loans to developers. However, many banks said explicitly in their mid-year earnings reports that they are striving to reduce their exposure to developers they deem overly risky. The following comment, from China Merchants Bank, is representative. It said it:

"...focused on high-quality customers and high-quality projects, reduced the proportion of assets of high-leverage and high-debt real estate customers with lower ratings and poor qualifications, strictly investigated the cash flow of real estate enterprises, [and] selected housing projects with capacity to cover their debts and commercial sustainability.”

The PBoC is clearly frustrated that many banks have pared back their lending to developers, thereby contributing to funding pressures. In early October, Bloomberg reported that it told the Big Six banks (ICBC, China Construction Banks, Agricultural Bank of China, Bank of China, Bank of Communications, and China Postal Savings Bank) to increase their property loans by Rmb600bn by year end, which is roughly double their new lending to the sector in the first half of the year.

We expect the majority of those funds to be channeled into firms that the government and banks identify as winners.

That will likely translate into a small handful of private developers becoming increasingly active at local governments' land auctions. It might also eventually translate into higher sales by "winners" as the public's faith in their ability to deliver presold housing is restored. "Losers" will have to look for support elsewhere – and there are no guarantees it will be forthcoming.

Step 3 – Restoring Demand

Measures like bond guarantees are stop-gaps designed to keep developers alive. What really needs to happen is for housing sales to rebound.

Beijing is desperate to stimulate housing demand. Between May and August, the PBoC reduced the floor on first mortgages by 0.5 percentage points to 4.1%, its lowest ever level. Meanwhile, local governments have introduced a range a measures – like homebuyer subsidies, and reducing minimum down payments – in an effort to stimulate buyer interest.

All with little effect. In response, authorities are doubling down.

Starting in the last week of September, Beijing rolled out a suite of new measures designed to reduce the cost of buying a home. On September 29, the PBoC said that cities where the price of newly constructed housing declined between June and August would be able to reduce – and even remove entirely – the floor under mortgage rates for first home loans.

Then on October 1, the central bank lowered the interest rate on funds borrowed from housing provident funds by first time home-buyers by 0.15%. It's the first time the rate has been adjusted since 2015. (Employers and employees are required by law to make mandatory contributions to housing provident funds. People can take out low-cost loans from the funds – which are administered by local authorities – when they buy a home.)

On the same day, the Ministry of Finance and State Taxation Administration said that people who purchase a new home within a year of selling their old home are entitled to tax rebates on the sale. Most large Chinese cities tax capital gains on homes sold within five years of purchase at 20%.

Conclusion

So far, lower borrowing costs haven't been sufficient to revive housing sales. No doubt Beijing's covid-management policies – which continue to suppress consumer sentiment – aren't helping. 

Still, presumably costs will eventually fall to a point that homebuyers are willing to start buying again. We're not at that point yet.

In the meantime, Beijing is trying to mitigate some of the negative – and unexpected – effects of the downturn. It wants to ensure that homeowners get what they've paid for, and that well managed private sector developers are able to emerge from this period intact. That will help boost economic activity above what would be possible if the market was left to fend for itself.

But for now the housing sector will continue to be a drag on growth.