From Bricks To Banks: China's Real Estate Nightmare Sends Shockwaves Through Banking

Since the COVID-19 pandemic, China has been reeling from the worsening real estate crisis, which has spilled over to the nation's banking sector. 

The crisis began with Chinese real estate developer Evergrande Group filing for bankruptcy in August, triggering a property crisis in the second-largest economy worldwide. 

What Happened? 

China's property woes began when Evergrande Group, the world's most indebted property developer, defaulted on its interest obligations of $260 million on dollar-denominated debt in December 2021. While the government stepped in to mitigate the crisis, the contagion rolled over into the broader property sector, as China's Country Garden Holdings Co. Ltd. failed to pay interest on its dollar-denominated bond in October. Country Gardens, which is the largest private property developer in China, extended its repayment deadline on onshore bonds by nearly three years in September. 

Evergrande Founder and Chairman Hui Ka Yan was one of China's richest men in the mid-1990s. But his booming real estate company was financed heavily by debt, causing it to borrow funds from employees in 2016, according to an article published by Reuters. 

Evergrande's properties were sold as a "speculative investment, not sold as a place to live," according to Anne Stevenson-Yang, managing principal at U.S.-based J Capital Research. "So obviously the confidence game will only work as long as people keep buying."

With consumer confidence waning, Evergrande incurred a loss of $4.53 billion in the first half of 2023. The once behemoth's net losses for the last two years combined amounted to nearly $81 billion. The company is facing over 2,200 lawsuits and filed for Chapter 15 bankruptcy protection in the U.S. in August. 

Evergrande stock was suspended from trading on the Stock Exchange of Hong Kong for 17 months. However, it lost 79% — $2.2 billion — of its value intraday after the stock resumed trading on Aug. 28. 

"If not handled properly, risks in the housing sector are likely to trigger systemic risks — that is why prompt steps must be taken to address them," China Vice Premier Liu He said during the World Economic Forum.

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Banking Sector Worries Rising 

China's biggest real estate lenders financed their growth by borrowing from the largest banks as well as trust companies, also known as shadow banks, at exorbitant interest rates, putting pressure on the nation's banking sector amid the property crisis. 

Approximately 40% of all bank loans are invested in property, resulting in increased tensions regarding the banking sector's health. According to the National Administration of Financial Regulation, approximately 3.2 trillion yuan in loans held by commercial banks in China are underperforming. 

"If China fails to order the banks to write off bad loans in the property market, interest costs will continue to chip away at the economy, while too much capital will continue to be wasted on investments with no value," said Andrew Collier, founder and managing director of Hong Kong-based research firm Orient Capital Research.

A bear market could also descend on the Chinese and Hong Kong stock markets as the crisis worsens, as the banking stocks account for nearly 10% of China's total stock market. Hywin Holdings Ltd., a Chinese shadow bank listed on the Nasdaq Stock Market, lost 60% in just three days as concerns regarding debt defaults grew worldwide. 

Experts have drawn similarities between China's ongoing real estate crisis and the U.S. subprime crisis in 2008, during which U.S. banks collectively lost over $700 billion. China's losses are expected to be greater, with Kyle Bass, founder and CEO of Hayman Capital Management, predicting the nation's losses to top $4 trillion.

“We think that [China’s] real estate losses are $4 trillion at least. And the local government financing vehicle market, we don’t even know where the bottom to that market is,” Bass said. “To have a properly functioning capital market, you have to understand the banking system, and their banking system is in freefall right now.”

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