Chinese banks' exposure to the real estate sector is expected to decline further on top of already sharp falls in recent years.

Lenders have shifted their focus away from real estate amid ongoing challenges to the property market even as government and financial authorities move to encourage lending to the sector.

Aggregate real estate exposure as a percentage of total loans declined to 25.9% in 2023 from 32.3% in 2020, according to S&P Global Market Intelligence data. The aggregate value of loans, meanwhile, has virtually flatlined since 2021 — an indication that the once-booming industry has turned tepid.

"The exposure as percentage of total loans is likely to continue to fall," Ming Tan, Asia-Pacific director of Financial Institution Ratings at S&P Global Ratings, said in an email.

Ratings expects property development loan growth to pick up to 3% from 1.5% in 2023, and then to rise to 5% in 2026. It is still, however, expected to lag overall system loan growth of 9% on average over this period, Tan said.

This means lenders will likely look to other sectors of the economy to pick up the slack and make up for potential lost revenue.

Growth of the world's second-biggest economy slowed in the second quarter. China's GDP expanded 4.7% year over year in the April-to-June quarter, compared with 5.3% year over year in the first three months of 2024, mainly as the drag from the real estate sector hurt construction and household consumption, according to the National Bureau of Statistics of China. The manufacturing sector performed well in the second quarter, helped by a recovery in exports, which fed into the GDP expansion.

Loans to the infrastructure and manufacturing sectors, especially high tech, maintained double-digit year-over-year growth in the first quarter of 2024, according to the KPMG China Banking Survey Report 2024, dated June 13.

Industrial and Commercial Bank of China Ltd. (ICBC), Bank of China Ltd. and China Construction Bank Corp. — three of what are collectively known as the country's "Big Four" banks — were among the 10 China-headquartered lenders with the highest real estate exposure as of year-end 2023, according to Market Intelligence data. That ranged from 31.42% for Bank of China to 27.99% for ICBC.

ICBC, China Construction Bank and Bank of China did not respond to Market Intelligence's requests for an interview.

Hankou Bank Co. Ltd. had the highest exposure to the property sector, accounting for 32.42% of its loan book, the data shows.

Government support

Chinese authorities have announced several measures to support the property sector, including disclosing a whitelist of development projects to which banks were encouraged to lend. Additionally, the People's Bank of China (PBOC) in May cut down payment requirements for first-time homebuyers by 5 percentage points to 15% and removed a lower limit on mortgage rates.

On July 22, the PBOC announced a series of interest rate cuts, according to separate statements on the central bank's website. The one-year loan prime rate, a benchmark for corporate lending, was lowered by 0.1 percentage point to 3.35%, while the five-year rate, which influences mortgage pricing, was reduced by the same margin to a record low of 3.85%. The central bank also cut the seven-day reverse repurchase agreement rate to 1.7% from 1.8%.

The moves were to "strengthen countercyclical adjustments to better support the real economy," the PBOC said.

This mix of policy actions suggested the PBOC was "faced with a dilemma," Nomura analysts said. "It needs to stimulate a sluggish economy that is suffering from the housing crisis but also needs to fulfil its mandate of a 'powerful currency' and project an image of robust long-term fundamentals," Nomura said in a July 22 note.

Signs of recovery

"Given the narrowing declines in property sales and property investment, and signs of recovery in secondhand property sales, we believe the policy is gradually playing out, especially if the property prices can stabilize in coming months," Iris Tan, senior equity analyst at Morningstar, told Market Intelligence via email.

The government and the central bank remain cautious as they seek to avoid another bout of excessive speculation in the industry that caused a bubble in the years leading up to the COVID-19 pandemic. The nationwide investment in property development grew 9.5%, 9.9% and 7.0% in 2018, 2019 and 2020, respectively, before declining to 4.4% in 2021, according to the National Bureau of Statistics. In the first six months of 2024, investment in property development contracted by 10.1%.

The government is focused on meeting its target economic growth of 5% in 2024 after it bettered a similar goal in 2023 when GDP expanded 5.2%.

Battling bad loans

The challenges in the property sector are laid bare when looking at lenders' nonperforming loan (NPL) ratios. Bad loans from the real estate sector were higher than overall nonperforming assets across most of the banks in the Market Intelligence sample.

For example, Huishang Bank Corp. Ltd., headquartered in the eastern province of Anhui, had an NPL ratio for 7.33% on its real estate loan book as of Dec. 31, 2023, compared with 1.26% overall. At Bank of Hangzhou Co. Ltd., NPLs accounted for 6.36% of the real estate loan portfolio and 0.76% of total loans.

China Construction Bank had an NPL ratio of 5.64% for its real estate loan book, compared with its overall NPL ratio of 1.37%.

This trend of elevated NPL ratios looks set to stay given the lag of NPL formation in addition to stricter asset classification rules, said Ratings' Tan. The rules — issued by the PBOC and implemented since mid-2023, with a grace period till end-2025 — widen the assets that must be officially reported as nonperforming, according to Ratings.

At the end of the first quarter of 2024, the aggregate NPL ratio of China's commercial banks was 1.59%, unchanged from the end of the prior quarter and 3 basis points lower than a year ago, according to the National Financial Regulatory Administration. The financial sector regulator did not disclose the aggregate NPL ratio for the real estate segment.

Mixed bag

The recent measures to support the property sector can help improve developers' cash flows and relieve NPL pressures, Hu Shen, senior research analyst at Hong Kong-based brokerage CLSA, said in an email. However, lower down payment requirements can weaken the protection for lenders, Shen said.

"If banks are required to lend to high-risk whitelist projects, it means the banking system will absorb the losses of unfinished homes," Shen said.

The Ministry of Housing and Urban-Rural Development disclosed Feb. 21 that 5,349 home development projects across 214 cities are on the whitelist. These are projects that would get priority in obtaining bank financing, provided they do not compromise banks' loan approval and risk control procedures.

The "latest measures to boost the property market could move the needle on homebuyer confidence," according to a May 21 report by Ratings. This is because "they widen access to financing and signal a political willingness to stabilize conditions in the market."

In a separate May 27 report, Ratings said that while the relaxation of down payment requirements will temporarily increase demand for mortgages, it could stress some banks if housing prices continue to fall.

"We expect property prices to decline about 14% over 2024–2025 in tier-three cities," Ratings said, which could "plausibly" push first-time homebuyers into negative equity.

Property sales would fall by about 15% year over year in 2024 to a range of 9.5 trillion to 10 trillion yuan, down nearly half from the peak of 18 trillion yuan in 2021, according to a June 20 report by Ratings. This projected decline is greater than Ratings' previous forecast of 5%.

The support measures will not be enough to return the growth in home mortgages to a level above overall credit growth in the foreseeable future, Lin Jinlu, chief banking analyst at Beijing-based Dongxing Securities, wrote in a June 4 note. The report cited economic conditions and unstable household incomes as reasons for the expected muted growth in mortgages.

Overall asset quality indicators in the banking sector remain stable, Lin wrote. However, Lin noted that some small and medium-sized financial institutions will be under pressure from NPLs.

An index that measures the health of the real estate sector in the world's second-largest economy continues to decline. The Real Estate Climate Index, which is reported by the National Bureau of Statistics, hit its all-time low of 92.01 in May. The index had touched a record high of 102.01 in September 2018.

As of July 22, US$1 was equivalent to 7.27 Chinese yuan.