With Fed Rate Rise, Will Hong Kong’s Red Hot Real Estate Finally Cool?

The impact of the Federal Reserve’s rate rise will be far reaching.  With the Hong Kong dollar pegged to the greenback, the HIBOR base rate continues to rise.

Although not in strict tandem, short term rates have finally begun to rise.

Despite the inexorable rise in short-term rates, Hong Kong lenders held steadfast until August 8, when HSBC, Hang Seng Bank, Standard Charter and Citibank adjusted their prime rate to an effective rate of 2.25%.  This was the first change since 2008.  Typically, Hibor linked mortgages revert to prime when a rise in Hibor makes prime-linked mortgages cheaper.

The pain will shortly be felt, as new borrowers have been forced into variable-rate mortgages as banks prepared for the rise.

While Hong Kong banks may adjust to the risk with variable rate loans, developers have less room to avoid the pain.  Thanks to the rise in Hong Kong property prices, along with the weaker yuan, and restrictions on mainland development in tier one cities, mainland developers have joined the feast in Hong Kong, but may have come to the table late and without a full menu.  Prices and volume appear to have peaked.

Source: Midland Realty

Two of the largest mainland developers, Country Garden, HK 2007 and China Evergrande, HK 3333  bought land at the peak and are therefore vulnerable to a fall.

Mainland developers [are] in a more vulnerable position to any price corrections in the Hong Kong residential market. Their projects in Hong Kong may struggle to break even, or potentially run into losses, if prices decline by more than 15 per cent or 20 per cent,” said Cindy Huang, an analyst at S&P Global Ratings.

UBS has predicted Hong Kong home prices will tumble as much as 10 per cent from this month to the end of 2019, while Citibank forecast a 7 per cent fall in the second half this year.

That is roughly when Evergrande and Country Garden plan to start selling thousands of units now under construction in Tuen Mun and Ma On Shan.

In January, Evergrande Group paid the highest amount per square foot – about HK$8,300 – ever recorded in Tuen Mun, when it bought a site that is expected to be developed into a 1,982-unit project on 8 Kwun Chui Road from Henderson Land Development for about HK$6.5 billion (US$830 million). Henderson reaped an 80 per cent profit on the deal for the land that it bought in June 2015.

Adding in construction costs and interest expenses, the total investment cost for Evergrande’s Tuen Mun project will be about HK$14,410 per square foot.

That means Evergrande will need to sell flats in the development at about HK$16,600 per square foot to generate a reasonable profit of about 15 per cent. However, used homes at a nearby development, Wheelock Properties’ Napa, have been selling for about HK$14,200 per square, which means Evergrande is vulnerable unless home prices continue to climb.

Wheelock Properties, a Hong Kong developer, benefited from buying land early. In 2013, it paid HK$1.39 billion – or just HK$3,683 per square foot – for the Napa site. In 2017, its average flat sold for HK$11,500 per square foot, giving Wheelock a 67 per cent profit, after adding in construction and other costs.

One mainland developer may escape the “late penalty”. Vanke Property (Hong Kong) bought a parcel for HK$3.8 billion in 2015, or HK$4,541 per square foot. That gives it more room to still make a profit if profits begin sliding. To achieve a 15 per cent profit margin, Vanke would only need to price its Le Pont flats at about HK$11,790 per square foot.

“[Vanke Property (Hong Kong)] bought the land relatively early when land in the area was sold at around HK$4,000 per square foot,” said Alvin Lam, director at Midland Surveyors, who added the developer may escape from any possible market downturn as its land price is relatively low.

Like Evergrande, Country Garden also got in late.

Last September, Country Garden paid about HK$2.44 billion, or HK$10,498 per square foot, for a 60 per cent stake in a plot in Ma On Shan owned by Wang On Group.

For Country Garden to net a 15 per cent profit, the 547-unit project would need to sell its flats at about HK$18,219 per square foot.

In contrast, Henderson Land achieved a profit margin of 68 per cent at its nearby Double Cove project by just selling its flats at about HK$15,000 per square foot. It had bought the land there in 2009 for HK$3,253 per square foot.

“These mainland developers have responded to this challenge by slowing down their land purchases in Hong Kong this year, due to expectations of thin margins and tightened financing conditions,” said Huang of S&P Global ratings. “Refinancing pressures continue to hamper mainland developers [however]. This lower rate of land acquisition in Hong Kong is likely to continue.”

Quote Source: South China Morning Post

With the rising prices, Hong Kong has grown to be among the least affordable markets in the world.

Developer stocks, which have seen explosive growth on both the Mainland and Hong Kong have finally been declining, along with the indexes thanks to both the creeping interest rates and the US China trade war.  The majority have fallen close to 20% from their peak. There is most likely more pain to come.

 

 

 

 

China Minsheng Bank Officer In Custody as Wealth Management Product Evaporates

China Minsheng Bank 1988 HK, today released a statement that an officer was being interrogated by police over “illegal conduct”. No further details were given regarding the officer,  Zhang Ying, the president of Hangtianqiao sub-branch of the Beijing branch of the Company.

The South China Morning Post reported that the conduct was related to the evaporation of 3 billion yuan in a Wealth Management Product, WMP.

If correct, the picture painted is a disturbing one.

The Minsheng case involved an “innovative” WMP in which yields were amplified by purchasing a secondhand WMP. Consecutive interest rate cuts and a flood of WMPs sold on the mainland market over the past three years have already seen wealthy investors shun common WMPs with unattractive yields.

According to investor contracts seen by the South China Morning Post, Minsheng’s private banking customers purchased transferred WMPs from the original investors. Bank employees told the buyers that the original investors urgently needed cash and were willing to cash out of the WMPs, which at the time were not yet due, and forego part of the supposed yields. As a result, the original WMPs that guaranteed principle and at least 4.2 per cent annual return “turned into” a product with more than 8 per cent annual return. Bank employees said the products were exclusively for longstanding private banking customers who owned at least 10 million yuan in financial assets.

Last week an investor happened to ask a friend who works at a bigger branch of Minsheng about the WMP at Hangtianqiao, but was told it didn’t exist. Officials at the Beijing branch of Minsheng subsequently reported Zhang Ying to the police, who then arrested her. By Thursday night all investors had become aware of the situation.

The situation casts doubt on Minsheng’s internal controls and management.  Ironically, the company highlighted its wealth management business in its annual results filing:

3. ..The Company vigorously expanded major businesses including asset management, asset custody, financial market and interbank financial services, and actively built the “Apex Asset Management (非凡資產管 理)” brand. As at the end of the Reporting Period, the balance of wealth management products amounted to RMB1,427,816 million, representing an increase of 34.89% as compared with the end of the previous year.

The bank cannot afford bad management or controls as it reported lackluster annual earnings on March 30, with revenue and earnings relatively flat despite 20% loan growth thanks to an increase in impairments of 25% as well as lower net interest margins dropping from  2.26 to 1.86. Loan growth surpassed deposit growth which only increased by 12.8%.

Net income growth would have been negative if it weren’t for the operating expense decline, which was not due to cost savings, but to a May change in reporting from Business Tax to Value Added Tax.  (This mid-year accounting nightmare was applicable to finance, life services, property and construction companies. The Big 4 Banks showed the same dramatic decrease in operating expenses.)

Prior to the illegal conduct event, Minsheng was targeted as sell by Deutsche Bank in March, which cited concerns regarding its heavy interests in shadow banking and its reliance on wholesale funding.  It’s target price was at $7.31 hkd. At its last close at $7.86 hkd, it had a market cap of 323.7 Billion hkd, ($41.6 US) which would make it about half the size of US Bank, USB, the fifth largest bank in the United States.

Mortgage Loans More than Doubling

Like the majority of Chinese banks, Minsheng saw a major increase in mortgage loans in 2016.

Given the recent sales restrictions imposed by the government after the explosive sales increases in first tier cities, this growth cannot be sustained.  There will, however, be an increase in risk if home prices fall.

China Bank Rally Takes A Breather

After a series of moves and reviews, the big 5 Chinese banks blasted upwards in February, outpacing the rocketing Hang Seng.  Over the past couple of days, however, they’ve retrenched.   If Morgan Stanley and Short trading interest are to be believed, this is a temporary reversal.

The banks include:

Name	Acronym	HK symbol
Industrial & Commercial Bank of China	ICBC	1398
China Construction Bank	CCB	939
Agricultural Bank of China	ABC	1288
Bank of China	BOC	3988
Bank of Communications	BOCOM	3328

Despite rising Non performing loans, shrinking net interest margins and capital requirements, these banks have surpassed the rising Hang Seng thanks to interest rate rises, increased lending, China stimulus and PPI rises.

Timeline of positive factors:

1/24/2017 – Interest rates raised on medium term rates on loans.

2/03/2017 – Interest rates raised on short-term debt, reportedly in the interests of liquidity due to perceived resulting from the Chinese New Year.

2/14/2017 – Morgan Stanley published a bullish report on China Banks. Banks.

2/15/2017 – Bloomberg reported that options trading reacted positively to the bullish stance of Morgan Stanley on the big 4 banks, (all of banks listed above excluding BOCOM, which isn’t included in the  big 4).

None of these banks have reported annual earnings.  While earnings seasons has just about ended in the US, annual earnings reports for Hong Kong listed stocks are trickling in.  Regardless of the annual earnings, they won’t reflect the February 2017 change in interest rates and producer price inflation which Morgan Stanley reports.

Given the significant decline in short-term selling ratios for all but BOC, 3988 HK, the recent drop could signify a temporary drop versus a long-term decline.  At least for the short-term.

 

 

 

 

Index Changes HSI and HSCEI: In with the New, Out with the Old

Old Timers Li & Fung, 494 HK and Tsingtao Brewery, 168 HK  will be booted out of Hong Kong Indexes due to poor performance and or international dealings.  They’ll be replaced by home-grown Geely, 175 HK,  and infant IPO Postal Savings Bank, 1658 HK, favoring made in China and SOE investments, respectively.  The stock performance and market caps give a clue to the underlying reason but don’t explain it all.

Data Source: Bloomberg

The mature, 50-member Hang Seng Index, HSI, loses Li & Fung, a member since 2000, as its profits and core earnings continue to drop.  It’s last reported interim statement showed a gross revenue drop of 6.4% and a core profit drop of 14.2%.  Li and Fung, a Wal-Mart and Marks and Spencer supplier, most recently reported getting 62% of its sales coming from the US.  It’s being replaced by Made In China and Sold in China: Geely Auto.  As Li and Fung’s stock has dropped, Geely has shot upwards, helping it achieve a market cap 3 times the size of veteran Li and Fung.  Geely’s sales climbed 50% in 2016, fueled by a 50% drop in the sales tax on cars with less than 1.6 liter engines.  While Geely’s annual sales climbed 50%, it reported on January 6, 2017 a preliminary profit climb of over 100%.

Geely has apparently kept the pedal to the metal with January year on year sales reported at an   annual increase of 71% although down 5.15% from December.  This increase is astounding, with the Lunar New Year starting in 2017 on Jan. 28 vs. 2016 in Feb. and Ford and GM both reporting yoy China drops of 24% and 32%, respectively, from HK filings.

As Home town Geely replaces exporter Li and Fung; Tsingtao Brewery, the first China incorporated  H-listed stock in history, is being removed from the younger Hang Seng China Enterprises Index, HSCEI; to be replaced by recent IPO Postal Savings Bank.  Tsingtao has faced declining sales; its last reported revenue drop of 5.3%.  However, perhaps more importantly, it has also been hit by rumors that Asahi Breweries of Japan is hoping to dump its 19.99% ownership interest. (The majority-holder of Tsingtao is Qingdao SASAC).  An index removal could reflect the  dissatisfaction of the effects of outside interests on Chinese companies.

The possible rationale for replacing Tsingtao  with Postal Savings Bank is more difficult  to explain than Geely replacing Li and Fung.  While Geely has been climbing, Postal Savings Bank has actually declined in price since its September IPO.  It’s first half report for 2016 was uninspiring, with loans increasing but net interest margin dropping significantly and a low core ratio.  It’s non-performing loan ratio of .78 is difficult to believe as world behemoth China’s Industrial and Commercial Bank,  1398 HK, ICBC, reported a npl ratio of 1.55 for the first ½ of 2016.  In the first half, ICBC had a capital adequacy ratio of 13.11 vs.  Postal Savings Bank’s first half CAR of 10.04% .

Postal Savings Bank had a less than spectacular IPO, heavily dependent upon its mostly majority state-owned cornerstone investors, which purchased over 75% of the offering.

 

 

Source: HK filings

*Acquisition Loans “may be” financed by SOE China Banks: China Construction Bank, 939 hk, Bank of Communications, 3328 hk, and Agricultural Bank of China, 1288 HK.
**One of 4 asset management firms set up in the 1990’s to deal with bad debt, related to the big 4 banks.  China Great Wall was linked with Agricultural Bank of China.

Rather than a strictly index-related move, the inclusion of Postal Bank could be more to the aid of those cornerstone investors,  which would face an expiration of their 6-month lock-up period close to the time of the index inclusion.  Whether this will give Postal the boost it needs remains to be seen.

 

 

 

 

 

ICBC of China Issues 117 Million Credit Cards in 1st Half, Why It Matters

As a tantalizing pre-cursor to 1st half earnings, ICBC HK 1398, stated that it issued over 117 million credit cards with 1st half consumption of 1.4 trillion yuan, ($211.25 Billion). However you look at it, that’s a lot of plastic.  However, in relative terms, it’s not quite as stunning.  Particularly for consumption dollars, the increase is substantial, compared to the 1st half 2015 filing:

Why it matters. In terms of market cap, ICBC is the second largest bank in the world after Wells Fargo Bank.  In China, it’s the largest.  Its credit card issuance and consumption therefore give a view of credit card growth in China, which has historically had a higher dependence on debit cards. It’s also a window to consumer credit use in China and the growth of an important revenue source for ICBC.

For ICBC, and the majority of banks in China, debit card issuance has far exceeded credit card issuance.  Based on the last 2 annual reports, ICBC’s credit cards as a % of total cards has inched up , although growing more than debit card issuance.

Based on the annual report, confirmed by the 1st half 2016 results, Chinese consumers who do have credit cards are getting more comfortable buying on credit.  This should be good news for Chinese banks, since they’ve been squeezed by lower net interest income after multiple interest reductions by the Central bank.

Source: Reuters

Add to that a market slowdown and increasing, NPL’S, and banks are grasping for sources of income other than net interest.  ICBC , despite its size and  international holdings, needs that extra income.  The last quarter showed minimal growth in net profit, with commission and fee income representing a consecutively larger part of revenue.

Source: HK filing

While quarterly filings don’t break out bank charges, the last annual showed them to be about 5.6% of gross revenue.

Comparing this to the increase in annual card issuance, the 12.5% increase in annual bank cards issued brought about a 7.3% increase in total revenue.  While the latest statement mentioned only credit cards, the increase bodes well for an increase in a significant portion of income.  With a trailing p/e of 5 and below, it needs all the help it can get.  Judging by historical filing, we should see if this assumption holds around 8/27 of this month.