Founder of Antler Capital

Stanley Tsai, CFA

Thematic (Sector/Industry)

For all the roller coaster rides the sector has taken investors on over the years, the Chinese property developers have been unsettlingly consistent in one regard. The CNY1tn fixed asset investment (FAI) homebuilders coughed up in May continued a two-decades long secular trend that may make or break China's still fragile recovery (Exhibit 1).
The Debt-Fueled Supercycle. The sector has seen its share of excesses and corrections, exemplified by the post-GFC FAI expansion and subsequent retrenchment. Covid might have driven up construction costs, but the enthusiasm of would-be homeowners has shown no signs of abating. Just as the developers are working overtime to deleverage their balance sheets, household debt is piling up and may approach alarming levels over the next five years if mortgage growth doesn't decelerate quickly enough.
The Inventory Drawdown. Behind the headline FAI number is a more nuanced picture of inventory reductions and landbank replenishment. Housing starts slowed in May and dipped below project completions on a 12-month rolling basis. This affords cash-strapped property firms an opportunity to rebuild their cashflows, while deploying cash to projects in hand.
The Insatiable Demand. The 0.5% m/m or 5% y/y rise in home prices last month may appear benign in other settings. In the context of China's already exorbitant base, recent data points are a cause for concern. Among the largest cities across the country, those in the Greater Bay Area stand out as outliers, with valuations skyrocketing in spite of the latest round of lockdowns.
The Aggressive Developers. The increasingly bullish undertones of sell-side notes that have landed on our desks are centered around the inventory drawdown / cashflow rebuild story of the perceived higher-quality names in the space. We are not buyers of that story just yet and our work suggests that many developers have been acquiring land at a more aggressive rate than they had planned at the beginning of the year. Regulators are already keeping a close eye on recent transactions and we think we should too.
<table class="table table-striped">
<tbody>
<tr>
<td style="width: 746px;">Exhibit 1: Monthly Housing FAI | 3M Moving Avg (CNY bn)</td>
</tr>
<tr>
<td style="width: 746px;">
<figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/215/144/original/image_45072834061624549646155.png?1624549646" class="editor-image img-responsive" data-smartkarma-image-id="215144"></figure>
Source: National Bureau of Statistics, Our analysis
</td>
</tr>
</tbody>
</table>
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<a href="https://www.smartkarma.com/insights/china-financials-silver-linings-playbook" target="_blank" data-smartkarma-citation="insights:53013" rel="noopener">China Financials: Silver Linings Playbook</a> </li>
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<a href="https://www.smartkarma.com/insights/glut-and-famine-we-might-see-snow-in-china-this-summer" target="_blank" data-smartkarma-citation="insights:52840" rel="noopener">Glut and Famine: We Might See Snow in China This Summer</a> </li>
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<a href="https://www.smartkarma.com/insights/china-macro-consumers-remain-on-the-sidelines-as-their-home-equity-grows" target="_blank" data-smartkarma-citation="insights:53210" rel="noopener">China Macro: Consumers Remain on the Sidelines, as Their Home Equity Grows</a> </li>
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For all the roller coaster rides the sector has taken investors on over the years, the Chinese property developers have been unsettlingly consistent in one regard. The CNY1tn fixed asset investment (FAI) homebuilders coughed up in May continued a two-decades long secular trend that may make or break China's still fragile recovery (Exhibit 1).
The Debt-Fueled Supercycle. The sector has seen its share of excesses and corrections, exemplified by the post-GFC FAI expansion and subsequent retrenchment. Covid might have driven up construction costs, but the enthusiasm of would-be homeowners has shown no signs of abating. Just as the developers are working overtime to deleverage their balance sheets, household debt is piling up and may approach alarming levels over the next five years if mortgage growth doesn't decelerate quickly enough.
The Inventory Drawdown. Behind the headline FAI number is a more nuanced picture of inventory reductions and landbank replenishment. Housing starts slowed in May and dipped below project completions on a 12-month rolling basis. This affords cash-strapped property firms an opportunity to rebuild their cashflows, while deploying cash to projects in hand.
The Insatiable Demand. The 0.5% m/m or 5% y/y rise in home prices last month may appear benign in other settings. In the context of China's already exorbitant base, recent data points are a cause for concern. Among the largest cities across the country, those in the Greater Bay Area stand out as outliers, with valuations skyrocketing in spite of the latest round of lockdowns.
The Aggressive Developers. The increasingly bullish undertones of sell-side notes that have landed on our desks are centered around the inventory drawdown / cashflow rebuild story of the perceived higher-quality names in the space. We are not buyers of that story just yet and our work suggests that many developers have been acquiring land at a more aggressive rate than they had planned at the beginning of the year. Regulators are already keeping a close eye on recent transactions and we think we should too.



Exhibit 1: Monthly Housing FAI | 3M Moving Avg (CNY bn)




Source: National Bureau of Statistics, Our analysis




Related Insights


China Financials: Silver Linings Playbook 

Glut and Famine: We Might See Snow in China This Summer 

China Macro: Operation Twist | The Deposit Version 

China Macro: Consumers Remain on the Sidelines, as Their Home Equity Grows 

China Macro: PPI Peaks, while CPI Eases Tightening Fears 

China Macro: Exports Disappoint, but It's Still Early in the Game 


China Properties: Like Clockwork, Real Estate Investments Haven't Skipped a Beat

Macroeconomics

Following consultations with the industry earlier this month, the PBOC has rolled out a new deposit pricing framework, which has the net impact of raising short-term rates while lowering long-term rates for depositors. In our view, this is marginally positive from a macro standpoint, but is far from a major market catalyst.
While policy rates were left untouched, the central bank has tweaked the way deposit rate ceilings are calibrated. The maximum add-ons to base current account, term deposit and negotiable CD rates are 10bp / 50bp / 60bp for SOE banks and 20bp / 75bp / 80bp for the rest of the banking system. This results in a flattening of the deposit rate curve, similar in form to the intended outcome of Operation Twist in the treasury market (Exhibits 1 and 2).
However, the latest move should not be construed as a signal of monetary easing by the PBOC. At the margin, the rate structure reform may encourage some additional consumer spending and corporate investments. But we expect the bulk of the impact to be seen in institutional money flows, with investors such as insurance companies moving away from term deposits to wealth management products and the rates market.
Average deposit rates were already very close to the ceiling prior to the change. And we believe the smaller banks may take the opportunity to raise short-term rates to attract retail money from the G-SIBs and each other. This may lead to further divergence in funding costs between the national and regional players, although we take some comfort from the fact that long-term rates are set to fall, minimizing the potential for irrational pricing that is locked in for two to three years.
Loan prime rates (LPRs) have held steady at 3.85% and 4.65% for one-year and five-year tenors. We continue to see little room for China's LPRs to change in the rest of 2021. Having said that, the runaway housing market seems increasingly more than a tail risk and may trigger a surprise lending rate hike on the long end if price appreciations show no signs of abating in 2H21.
<table class="table table-striped">
<tbody>
<tr>
<td style="width: 352.333px;">Exhibit 1: SOE Banks | Deposit Rate Ceiling (%)</td>
<td style="width: 352.333px;">Exhibit 2: Non-SOE Banks | Deposit Rate Ceiling (%)</td>
</tr>
<tr>
<td style="width: 352.333px;">
<figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/214/570/original/image_44634500891624334029988.png?1624334029" class="editor-image img-responsive" data-smartkarma-image-id="214570"></figure>
Source: PBOC, Our analysis
</td>
<td style="width: 352.333px;">
<figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/214/572/original/image_517531219111624334079589.png?1624334079" class="editor-image img-responsive" data-smartkarma-image-id="214572"></figure>
Source: PBOC, Our analysis
</td>
</tr>
</tbody>
</table>
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</ul>

Following consultations with the industry earlier this month, the PBOC has rolled out a new deposit pricing framework, which has the net impact of raising short-term rates while lowering long-term rates for depositors. In our view, this is marginally positive from a macro standpoint, but is far from a major market catalyst.
While policy rates were left untouched, the central bank has tweaked the way deposit rate ceilings are calibrated. The maximum add-ons to base current account, term deposit and negotiable CD rates are 10bp / 50bp / 60bp for SOE banks and 20bp / 75bp / 80bp for the rest of the banking system. This results in a flattening of the deposit rate curve, similar in form to the intended outcome of Operation Twist in the treasury market (Exhibits 1 and 2).
However, the latest move should not be construed as a signal of monetary easing by the PBOC. At the margin, the rate structure reform may encourage some additional consumer spending and corporate investments. But we expect the bulk of the impact to be seen in institutional money flows, with investors such as insurance companies moving away from term deposits to wealth management products and the rates market.
Average deposit rates were already very close to the ceiling prior to the change. And we believe the smaller banks may take the opportunity to raise short-term rates to attract retail money from the G-SIBs and each other. This may lead to further divergence in funding costs between the national and regional players, although we take some comfort from the fact that long-term rates are set to fall, minimizing the potential for irrational pricing that is locked in for two to three years.
Loan prime rates (LPRs) have held steady at 3.85% and 4.65% for one-year and five-year tenors. We continue to see little room for China's LPRs to change in the rest of 2021. Having said that, the runaway housing market seems increasingly more than a tail risk and may trigger a surprise lending rate hike on the long end if price appreciations show no signs of abating in 2H21.



Exhibit 1: SOE Banks | Deposit Rate Ceiling (%)
Exhibit 2: Non-SOE Banks | Deposit Rate Ceiling (%)




Source: PBOC, Our analysis



Source: PBOC, Our analysis




Related Insights

China Financials: Silver Linings Playbook

Glut and Famine: We Might See Snow in China This Summer 

China Macro: Consumers Remain on the Sidelines, as Their Home Equity Grows


China Macro: PPI Peaks, while CPI Eases Tightening Fears 

China Macro: Exports Disappoint, but It's Still Early in the Game 


China Macro: Operation Twist | The Deposit Version

In our view, the latest macro numbers are a bit light. Consensus is building around a gradual adjustment in home prices, but we still seem to be quite a ways away from the peak. What has us worried though is the cautious consumer, who remains timid in a benign inflationary environment.
Industrial production (IP) has pulled its share of the weight, but momentum may be waning. Headline IP growth was 8.8% y/y for the month of May, down from 9.8% a month earlier. Key items are tracking reasonably well. We believe monthly IP growth will settle in at the 6% y/y level in 3Q21, adjusted for the blip in 2020. The wildcard seems to be export strength going forward. We are marginally more optimistic than most on that front.
Infrastructure investments were weaker than expected last month. However, there is no reason to be alarmed. The public project pipeline is heavily weighted towards 2H21. And local governments have a CNY4.27tn war chest to spend, to be funded by a recently approved bond issuance quota. On the other hand, we were somewhat taken aback by how well property investments held up, despite tighter financing conditions.
Buoyant housing prices have not made homeowners loosen their pockets. Consumer confidence appears to be fragile. Retail sales growth ticked up only modestly last month. And the weak trend was evident in both rural and urban areas. The hospitality industry is not out of the woods yet. The situation in southern China certainly isn't helping.
We believe credit growth will largely determine how the economy will fare in the second half of the year. As we pointed out in our insight <a href="https://www.smartkarma.com/insights/glut-and-famine-we-might-see-snow-in-china-this-summer" target="_blank" data-smartkarma-citation="insights:52840" rel="noopener">Glut and Famine: We Might See Snow in China This Summer</a>, China's Credit Impulse is now sinking into negative territory. And the PBOC's hands are tied. If this sounds familiar, it may be because we are right back where we were before the pandemic, with concerns over China's debt problems back in the spotlight.
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<li>
<a href="https://www.smartkarma.com/insights/glut-and-famine-we-might-see-snow-in-china-this-summer" target="_blank" data-smartkarma-citation="insights:52840" rel="noopener">Glut and Famine: We Might See Snow in China This Summer</a> </li>
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<a href="https://www.smartkarma.com/insights/glut-and-famine-china-s-monetary-conditions-a-notch-tighter-in-may" target="_blank" data-smartkarma-citation="insights:51799" rel="noopener">Glut and Famine: China's Monetary Conditions a Notch Tighter in May</a> </li>
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In our view, the latest macro numbers are a bit light. Consensus is building around a gradual adjustment in home prices, but we still seem to be quite a ways away from the peak. What has us worried though is the cautious consumer, who remains timid in a benign inflationary environment.
Industrial production (IP) has pulled its share of the weight, but momentum may be waning. Headline IP growth was 8.8% y/y for the month of May, down from 9.8% a month earlier. Key items are tracking reasonably well. We believe monthly IP growth will settle in at the 6% y/y level in 3Q21, adjusted for the blip in 2020. The wildcard seems to be export strength going forward. We are marginally more optimistic than most on that front.
Infrastructure investments were weaker than expected last month. However, there is no reason to be alarmed. The public project pipeline is heavily weighted towards 2H21. And local governments have a CNY4.27tn war chest to spend, to be funded by a recently approved bond issuance quota. On the other hand, we were somewhat taken aback by how well property investments held up, despite tighter financing conditions.
Buoyant housing prices have not made homeowners loosen their pockets. Consumer confidence appears to be fragile. Retail sales growth ticked up only modestly last month. And the weak trend was evident in both rural and urban areas. The hospitality industry is not out of the woods yet. The situation in southern China certainly isn't helping.
We believe credit growth will largely determine how the economy will fare in the second half of the year. As we pointed out in our insight Glut and Famine: We Might See Snow in China This Summer, China's Credit Impulse is now sinking into negative territory. And the PBOC's hands are tied. If this sounds familiar, it may be because we are right back where we were before the pandemic, with concerns over China's debt problems back in the spotlight.
Related Insights


Glut and Famine: We Might See Snow in China This Summer 

China Macro: PPI Peaks, while CPI Eases Tightening Fears 

China Macro: Exports Disappoint, but It's Still Early in the Game 

Glut and Famine: China's Monetary Conditions a Notch Tighter in May 


China Macro: Consumers Remain on the Sidelines, as Their Home Equity Grows

Monthly Newsletter | Jun 2021
Total social financing (TSF) data for May reinforce our view that China's credit impulse is set to dive deeper into negative territory. This may put a lid on the commodities rally in the coming months and we expect the PPI to edge down in 2H21.
Net TSF flow fell 40% y/y. Adjusting for the blip in 2020, the CAGR for May would have been a less alarming +6% y/y. Beijing has done its part by greenlighting CNY4.27tn of local government bond issuance in the remainder of the year. But we fear credit growth in the private sector may remain subdued.
Headline loan growth was in line with our expectation. That said, corporate loan originations might have been buoyed by the unwinding of off-balance sheet activities and delayed bond sales. Meanwhile, new mortgages have continued to fall, but perhaps still not fast enough to rein in the runaway property market.
Deposit growth saw a sharp rebound from last month, mainly from non-sticky sources. New deposits from households and corporates were close to zero. Fiscal deposits, non-bank financial institutions and the interbank made up for the difference. 
Looking ahead, we see limited room for significant monetary maneuvers by the PBOC in either direction. In our view, any incremental policy shifts will likely be targeted at small businesses and real estate. Our base case is for the loan prime rates to hold steady at 3.85% and 4.65% for one-year and five-year tenors, respectively. However, we would begin to price in an increasing probability of a rate hike on the long end as a last resort to deal with the property bubble.
<table class="table table-striped">
<tbody>
<tr>
<td style="width: 100%;">Exhibit 1: China TSF-based Credit Impulse (%)</td>
</tr>
<tr>
<td style="width: 100%;">
<figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/212/524/original/image_72331103621623410270234.png?1623410270" class="editor-image img-responsive" data-smartkarma-image-id="212524"></figure>
Note: Index value = 12M change in new system credit / Nominal GDP
Source: PBOC, National Bureau of Statistics, Our analysis

</td>
</tr>
</tbody>
</table>
Related Insights
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<li>
<a href="https://www.smartkarma.com/insights/china-macro-ppi-peaks-while-cpi-eases-tightening-fears" target="_blank" data-smartkarma-citation="insights:52778" rel="noopener">China Macro: PPI Peaks, while CPI Eases Tightening Fears</a> </li>
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<a href="https://www.smartkarma.com/insights/china-macro-exports-disappoint-but-it-s-still-early-in-the-game" target="_blank" data-smartkarma-citation="insights:52728" rel="noopener">China Macro: Exports Disappoint, but It's Still Early in the Game</a> </li>
<li>
<a href="https://www.smartkarma.com/insights/glut-and-famine-china-s-monetary-conditions-a-notch-tighter-in-may" target="_blank" data-smartkarma-citation="insights:51799" rel="noopener">Glut and Famine: China's Monetary Conditions a Notch Tighter in May</a> </li>
</ul>

Monthly Newsletter | Jun 2021
Total social financing (TSF) data for May reinforce our view that China's credit impulse is set to dive deeper into negative territory. This may put a lid on the commodities rally in the coming months and we expect the PPI to edge down in 2H21.
Net TSF flow fell 40% y/y. Adjusting for the blip in 2020, the CAGR for May would have been a less alarming +6% y/y. Beijing has done its part by greenlighting CNY4.27tn of local government bond issuance in the remainder of the year. But we fear credit growth in the private sector may remain subdued.
Headline loan growth was in line with our expectation. That said, corporate loan originations might have been buoyed by the unwinding of off-balance sheet activities and delayed bond sales. Meanwhile, new mortgages have continued to fall, but perhaps still not fast enough to rein in the runaway property market.
Deposit growth saw a sharp rebound from last month, mainly from non-sticky sources. New deposits from households and corporates were close to zero. Fiscal deposits, non-bank financial institutions and the interbank made up for the difference. 
Looking ahead, we see limited room for significant monetary maneuvers by the PBOC in either direction. In our view, any incremental policy shifts will likely be targeted at small businesses and real estate. Our base case is for the loan prime rates to hold steady at 3.85% and 4.65% for one-year and five-year tenors, respectively. However, we would begin to price in an increasing probability of a rate hike on the long end as a last resort to deal with the property bubble.



Exhibit 1: China TSF-based Credit Impulse (%)




Note: Index value = 12M change in new system credit / Nominal GDP
Source: PBOC, National Bureau of Statistics, Our analysis





Related Insights


China Macro: PPI Peaks, while CPI Eases Tightening Fears 

China Macro: Exports Disappoint, but It's Still Early in the Game 

Glut and Famine: China's Monetary Conditions a Notch Tighter in May 


Glut and Famine: We Might See Snow in China This Summer

The divergence between China's May PPI and CPI was materially wider than expected. At 7.7%, the gap has reached a new high. Cost pressures on mid/downstream producers are mounting, although in our view, a good portion of that risk has been priced into equity valuations. Consumer prices will likely remain benign for the rest of the year, owing to subdued food prices and Beijing's tight grip on the supply chain (Exhibit 1).
The sharp bounce in PPI is reminiscent of what we saw in 2010 and 2017. But the external environment is vastly different from both monetary and geopolitical perspectives. In any case, we believe we are close to the peak in the cycle, if we are not already there.
Headline CPI was benign, putting concerns over tightening to rest for the time being. To be clear, inflation will gradually trickle down to the consumer, but the pace appears to be steady. At the current rate, we see CPI ending the year at the 2% level. We believe this scenario is supportive of a rotation into consumer cyclicals.
Overall, the new trade and inflation data reinforce our view that monetary policy will stay the course in 2H21. But we will probably see moderately tighter lending conditions through the summer and autumn. Slower credit growth may also weigh on construction activity, curbing further commodity rallies. 
With consumer prices in check, policymakers will remain focused on frothy property values. The key policy risk continues to shift to the long end of the lending curve, with marginal upward strain on the five-year loan prime rate on which mortgage pricing is based.
<table class="table table-striped">
<tbody>
<tr>
<td style="width: 100%;">Exhibit 1: China | CPI &amp; PPI % Change y/y</td>
</tr>
<tr>
<td style="width: 100%;">
<figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/212/158/original/image_705612152181623231380328.png?1623231381" class="editor-image img-responsive" data-smartkarma-image-id="212158"></figure>
Source: National Bureau of Statistics
</td>
</tr>
</tbody>
</table>

The divergence between China's May PPI and CPI was materially wider than expected. At 7.7%, the gap has reached a new high. Cost pressures on mid/downstream producers are mounting, although in our view, a good portion of that risk has been priced into equity valuations. Consumer prices will likely remain benign for the rest of the year, owing to subdued food prices and Beijing's tight grip on the supply chain (Exhibit 1).
The sharp bounce in PPI is reminiscent of what we saw in 2010 and 2017. But the external environment is vastly different from both monetary and geopolitical perspectives. In any case, we believe we are close to the peak in the cycle, if we are not already there.
Headline CPI was benign, putting concerns over tightening to rest for the time being. To be clear, inflation will gradually trickle down to the consumer, but the pace appears to be steady. At the current rate, we see CPI ending the year at the 2% level. We believe this scenario is supportive of a rotation into consumer cyclicals.
Overall, the new trade and inflation data reinforce our view that monetary policy will stay the course in 2H21. But we will probably see moderately tighter lending conditions through the summer and autumn. Slower credit growth may also weigh on construction activity, curbing further commodity rallies. 
With consumer prices in check, policymakers will remain focused on frothy property values. The key policy risk continues to shift to the long end of the lending curve, with marginal upward strain on the five-year loan prime rate on which mortgage pricing is based.



Exhibit 1: China | CPI &amp; PPI % Change y/y




Source: National Bureau of Statistics





China Macro: PPI Peaks, While CPI Eases Tightening Fears

China

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China Properties: Like Clockwork, Real Estate Investments Haven't Skipped a Beat

Housing FAI in May continued a secular trend that may make or break China's recovery. Inventory drawdowns may afford developers some breathing...

Stanley Tsai, CFA

China Macro: Operation Twist | The Deposit Version

The PBOC’s latest deposit rate reform may encourage spending and investments at the margin, but it falls short of being a major market catalyst....

Stanley Tsai, CFA

China Macro: Consumers Remain on the Sidelines, as Their Home Equity Grows

China's latest macro data are uninspiring. We are particularly concerned about weak consumer spending. The other domestic GDP components also point...

Stanley Tsai, CFA

Glut and Famine: We Might See Snow in China This Summer

TSF data for May reinforce our view that China's credit impulse is set to dive deeper into negative territory. This may put a lid on the...

Stanley Tsai, CFA

China Macro: PPI Peaks, While CPI Eases Tightening Fears

In our view, China's PPI has likely peaked, while CPI will remain benign. The current trajectory suggests limited room for monetary maneuvers. And...

Stanley Tsai, CFA

Price Gauge

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