• Trust loan default is not a big threat to the banking system
  • Only when there is >40% of price decline or >40% default on new mortgage lent since 2019 will trigger meaningful systematic risk
  • Various risk prevention measures have been implemented by government
  • Buy COLI (688 HK) and CG (2007) in property sector and CMB (3968 HK), PAB (000001 SS) and PSBC (1658 HK) in banking sector as they have been unwarrantedly oversold

How vulnerable are banks to the China Property sector? Manageable. Following the Basel III requirement, we have taken the CET1 ratio of 7.5% as the threshold for triggering systematic risks. Our analysis suggested that the banking system is well capable of handling the three key exposures that they have over China property (bank loans, trusts and mortgages). Even on the assumption that all property-related trust loans were bought by banks’ WMPs, the banking system can easily handle a 100% default on all existing property-related trusts. Even if development loans will be defaulted on the side as well, the banking system can take 92% of trust and 52% of development loan defaults before seeing meaningful systematic risks. On the mortgage front, banks will only start to see systematic risk when property price retreats by >40%, together with a 40% discount on the value from foreclosure of the pledged property. 

How likely will this happen? Unlikely. Putting all three components together, we estimate that in the scenario where property price declines by 25%/30%/35%/40%, CET1 ratio will only drop below 7.5% if there are more than 38.8%/23.7%/8.4%/2.6% of development loan default and over 69%/42.1%/14.9%/4.6% of trust default. Yet, we believe a 25% decline in property price is unlikely, given 1) the largest drop in ASP since 2007 was only 10.4% in Nov-2011; and 2) we are still in the positive territory in terms of price growth, but various risk prevention and supportive measures are already kicking in or on their way.