More and more homebuyers are suspending mortgage repayments in China for projects facing construction halts. While the number of mortgage suspensions is still small and localized, if this trend is left unchecked and snowballs further, there is a risk that it could lead to a worsening of credit profiles for Chinese banks and chill the recent uptick in real estate sales.
Such behaviour toward mortgage servicing is highly unusual. It is foolhardy for any mortgagor to suspend payments, as the bank has full legal recourse to getting its loan repaid, unlike the US where liability ends with the forfeiture of property. However, today’s situation relates not to individual financial stress, but is an attempt by homebuyers en masse to force a resolution to counterparty risk in respect to housing projects that have halted. Such risks exist because pre-sales money has been disbursed to developers, but there is a chance that some distressed developers could fail, saddling the unfortunate buyers with a mortgage and no property. Counterparty risks in the Chinese housing market are meant to be regulated via a requirement for presales to be safeguarded before delivery, but this is not necessarily upheld in all cases. Homebuyers could point to contractual breaches on project delivery as a reason to suspend repayments, and banks could be forced to embark on litigation, with outcomes that are difficult to predict given the circumstances.
Our base case is for the government to step in and untie the Gordian knot, making a call on where losses are to fall should distressed developers go under, as leaving matters to legal judgements could exacerbate negativity. In any case, a paradigm shift is happening. Developers may have to end their dependence on liquidity from presales, while homebuyers and banks will have to carefully assess counterparty risks in future.