NO MONEY DOWN

A growing corner of China’s $2 trillion mortgage market looks a lot like the US subprime bubble

Obsession
China's Transition
Obsession
China's Transition

The US subprime boom that eventually would trigger the 2008 global financial crisis started when lenders pushed outsized home loans on people without the wherewithal to pay them back. These homeowners were often so cash-strapped that they made tiny down payments on their properties. When home prices fell and loans went bad, banks and investors holding the loans, and financial investments build off them had to eat massive losses.

One corner of China’s property market is starting to look very similar. That’s because Chinese home buyers are borrowing huge amounts of money to pay for down payments through the country’s hard-to-track shadow banking system. While international investors have not jumped in to buy these loans as they did in the US, a housing price downturn could slash China’s banks’ profits, and the net worth of millions of Chinese.

Normally, to get a mortgage in China, homebuyers need to put down at least 20% of a home’s value, and more in some big cities. But in recent years, these new players have stepped in, making it possible for someone with no savings at all to take out a mortgage.  It is possible for someone with no savings at all to take out a mortgage in China.  Property developers, real estate agencies, and internet peer-to-peer lenders are active in this highly leveraged market, and they sell the loans as wealth-management products, to millions of individual investors in China.

China’s top leadership is worried. Chongqing mayor Huang Qifan, who is rumored to be premier Li Keqiang’s new top economic adviser, pointed out parallels between China’s situation and the US subprime crisis during the Communist Party’s annual planning meetings earlier this month. “If China allows high leverage in the housing market, it could lead to a financial disaster,” Huang said.

Speaking on the sidelines of Beijing’s annual political meetings earlier this month, Chinese central bank governor Zhou Xiaochuan said borrowing money to cover home down payments are not allowed. Vice governor Pan Gongsheng said regulators are cracking down on developers, agencies, and P2P lenders—but the problem has already grown to many billions of dollars.

Home loans are growing fast

Even as China’s economic growth has slowed, outstanding mortgage loans have continued to grow. Chinese bank-issued home loans rose to 14 trillion yuan ($2.2 trillion) in 2015, 6% faster than the previous year, according to the Chinese central bank (link in Chinese).

In first-tier cities, homes have rarely been a bad investment, especially when compared to the volatile stock market. When China’s stock market tanked in mid-July 2015, investors began to ditch stocks for real estate. Home prices in first-tier cities including Shanghai, Shenzhen, Beijing and Guangzhou have been rising since then. The finance ministry reported property sales tax in January and February rose 20% (link in Chinese) vs. the previous year.

And China’s banks are being encouraged to lend more. On March 1, the bank required reserve ratio was cut 0.5%, releasing an estimated $105 billion into the financial system. In response, Chinese banks have reportedly (link in Chinese) shortened the days it takes to approve new mortgage loans and lowered interest rates. The down-payment ratio was lowered in September 2015 for the first time in five years, after it was hiked to deflate a property bubble.

 China desperately needs the housing market to grow to prop up its slowing economy.  China needs the housing market as a backbone to prop up its slowing economy, and central and local governments have introduced new incentives to fill empty homes in lower tier cities. Even the country’s 270 million migrant workers are being pushed to step in and buy homes to keep the economy strong.

Banks check borrowers’ salaries, assets, education, and credit history to determine who to lend to, but because the mortgage market has a much shorter history in China than in developed countries, predicting where the risks might be not easy. And, as the US proved, lenders can make serious mistakes even in a mortgage market with a long history.

The P2P problem

China’s online “peer to peer” lenders, who raise money from consumers and lend it out to other consumers while taking a cut of their own, made 924 million yuan ($142 million) in down-payment loans in January, more than three times the amount made last July, according to Shanghai-based P2P consulting firm Yingcan Group. The business is less than a year old, but already the total amount of P2P loans made for home down payments stands at 5 billion yuan, Yingcan estimated. (October and February were weaker months because of holidays.)

Yingcan tracks down the P2P loans identified as for home purchases on the websites of the some 2,000 Chinese P2P lenders. The real figure could be much higher, because loans for things like “interior decoration” or “daily spending,” may also being used for down payments, Yu Baicheng, vice managing director at Yingcan, told Quartz.

By March 17, all 20 P2P lenders that offered loans for home down payments had halted the service, in response to a government investigation, Yu said. But it’s impossible to tell whether loans they’re making for other reasons are going toward down payments.

Many of those P2P lenders are also real estate agents, so they’re incentivized to make loans to sell homes. Many P2P lenders are also real estate agents, so they’re eager to make down payment loans.  

Beijing-based agency Lianjia, for instance, lent out 13.8 billion yuan through P2P products in 2015, including 300 million yuan for home down payments, company head Zuo Hui told China Business News (link in Chinese) this month. Lianjia has stopped making home down-payment loans, but it still offers loans based on a home’s equity for other purposes, including home decoration, car purchases, and business operations, according to its website.

P2P loans typically mature in three to six months, and cover up to half of the down payment on a home, at a monthly interest rate of 0.6% to 2%, Yu said. Second-time home buyers can use their first homes as collateral for mortgage loans, while new homebuyers get practically unsecured loans. Investors who put their money into products linked to these P2P loans usually get an annual return of 8% to 10% , and the platforms pocket the difference, he said.

Zero down payment?

Another worrying trend is the zero down-payment home purchase. In some cases, property developers will cover 100% of a down payment, with no collateral, for a home buyer who promises to pay back the loan in a year.  In some cases, property developers will cover 100% of a down payment.  Annual interest rates are steep—15% on average, Yan Yuejin, research director at Shanghai’s E-house China R&D Institute, which analyzes China’s housing market, told Quartz.

Yan said the phenomenon is particularly dangerous because these buyers often are speculators. They inflate housing prices, and often bypass restrictions and taxes on buying more than one home, sometimes by faking a divorce or signing an underground contract with developers using a different name, Yan said.

A Shanghai-based real estate agent, who asked not to be named, told Quartz her brokerage saw a rise in home buyers lending for down payments by five times since the end of 2015. This month, one third of her clients have asked for down-payment loans.

They’re speculators, who “buy new homes before selling the old ones” amid a price surge, she said. Housing prices in the southeastern suburb of Shanghai, where her company is located, jumped 30% since the end of 2015. Such loans cover from 30% to 100% of their down payments, with an monthly interest of 1.1% to 1.3% and the old home as collateral, she said.

“Most will pay back in two or three months,” she said, after they sold off their original property. The agency doesn’t offer the financing service upfront, but are happy to when clients ask, as it is in a legal “grey area” she said. “Otherwise they will turn to small loan companies,” for the financing, she said.

How big is the problem?

Verifiable nationwide statistics are hard to come by, but judging from specific city-wide figures and market experts’ experience, low- and no-down-payment mortgages are a significant chunk of the market.

Yan estimated 5% of Chinese home buyers have borrowed money to make home down payments—and that doesn’t count “zero down payment” loans from developers.In Shanghai alone, at least 10 new properties, or nearly 10% of the total each month, offer zero-down payments, Yan said.

An incomplete report on March 9 from the Shenzhen government shows 30 local businesses—including P2P lenders and lending firms—hold outstanding loans for home down payments of 2.5 to 3 billion yuan (link in Chinese). New home prices in Shenzhen surged 58% in March from a year ago.

In a crucial difference between the US market, these zero-down-payment loans have not yet been turned into securities, E-house’s Yan said. Still, he said, “the risks will become more obvious as the home prices keep rising.”

If the US’s experience is any guide, a housing boom fueled by easy lending and low-down-payment loans is a shaky proposition. China’s lenders and investors may find themselves with a genuine subprime crisis, with Chinese characteristics.

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