How wealth products helped inflate China real estate

Alarm bells are ringing in China as people in search of high yields keep investing their savings in wealth-management products (WMPs).A history of bailouts had many of them believing that WMPs are implicitly guaranteed by the issuing bank or the state. So when Chinese developers started to offer similar WMPs at even better terms, wealthy Chinese snapped them up as well. Now that some of the country’s largest property firms are struggling to repay their debts, investors are discovering they are not risk free. The prospect of big losses could jolt the world’s second-largest economy. 1. WHAT ARE WMPs? They are investments initially marketed by the wealth-management units of banks as a tool to attract funds. Like mortgage-backed securities were in the US, they are building blocks of a shadow-banking system that exists largely off balance sheets of their issuers - mostly banks. They typically offer a fixed rate of return of 3 to 5 per cent over a short period, usually less than six months, compared with 1.5 per cent for one-year bank deposits. The WMPs invest in everything from bonds to property and can be exposed to struggling industries like mining. The banks can keep them off their balance sheets provided the products are not principal-guaranteed, which most are not, but they are still subject to regulatory scrutiny. 2. WHAT ARE THE RISKS? In offering WMPs, banks and other lenders can partially sidestep lending restrictions and capital requirements. They also can hand over the products to non-banks to manage in return for a predetermined interest rate. Lenders may face a liquidity crunch if investors turn cold on the products. Some WMPs have invested in each other, meaning one soured product could infect others. 3. HOW DID DEVELOPERS GET INVOLVED? Almost all major private developers turned to offering WMPs as a way to raise capital after the government, worried about a growing debt bomb, tightened access to traditional bank loans for them at the end of 2020. (Guo Shuqing, the head of the banking regulator, a year ago called real estate “the biggest grey rhino” for China’s financial stability - referring to a large yet overlooked threat.) They were sold not only to wealthy individuals but also to their homebuyers and even their own employees, touting returns above 6 per cent. Unlike those offered by banks, the WMPs issued by developers are unregulated.  4. HOW’D THAT GO? Initially the developers that joined the craze were able to use cash from property sales to pay their WMP investors. Then liquidity dried up and property sales slumped this year amid a debt crisis surrounding China Evergrande Group, one of the biggest developers. As of Nov 10, at least 50 billion yuan (US$8 billion) of WMPs linked to developers including Evergrande and Kaisa Group Holdings have missed payments or had their payment terms revised. Some investors took to the streets to demand repayment, sparking fears of social unrest.

How wealth products helped inflate China real estate

Alarm bells are ringing in China as people in search of high yields keep investing their savings in wealth-management products (WMPs).

A history of bailouts had many of them believing that WMPs are implicitly guaranteed by the issuing bank or the state. So when Chinese developers started to offer similar WMPs at even better terms, wealthy Chinese snapped them up as well.

Now that some of the country’s largest property firms are struggling to repay their debts, investors are discovering they are not risk free. The prospect of big losses could jolt the world’s second-largest economy.

1. WHAT ARE WMPs?

They are investments initially marketed by the wealth-management units of banks as a tool to attract funds. Like mortgage-backed securities were in the US, they are building blocks of a shadow-banking system that exists largely off balance sheets of their issuers - mostly banks.

They typically offer a fixed rate of return of 3 to 5 per cent over a short period, usually less than six months, compared with 1.5 per cent for one-year bank deposits.

The WMPs invest in everything from bonds to property and can be exposed to struggling industries like mining. The banks can keep them off their balance sheets provided the products are not principal-guaranteed, which most are not, but they are still subject to regulatory scrutiny.

2. WHAT ARE THE RISKS?

In offering WMPs, banks and other lenders can partially sidestep lending restrictions and capital requirements. They also can hand over the products to non-banks to manage in return for a predetermined interest rate.

Lenders may face a liquidity crunch if investors turn cold on the products. Some WMPs have invested in each other, meaning one soured product could infect others.

3. HOW DID DEVELOPERS GET INVOLVED?

Almost all major private developers turned to offering WMPs as a way to raise capital after the government, worried about a growing debt bomb, tightened access to traditional bank loans for them at the end of 2020. (Guo Shuqing, the head of the banking regulator, a year ago called real estate “the biggest grey rhino” for China’s financial stability - referring to a large yet overlooked threat.)

They were sold not only to wealthy individuals but also to their homebuyers and even their own employees, touting returns above 6 per cent. Unlike those offered by banks, the WMPs issued by developers are unregulated. 

4. HOW’D THAT GO?

Initially the developers that joined the craze were able to use cash from property sales to pay their WMP investors. Then liquidity dried up and property sales slumped this year amid a debt crisis surrounding China Evergrande Group, one of the biggest developers.

As of Nov 10, at least 50 billion yuan (US$8 billion) of WMPs linked to developers including Evergrande and Kaisa Group Holdings have missed payments or had their payment terms revised. Some investors took to the streets to demand repayment, sparking fears of social unrest.