China Update: Implications of the New Policy to Lower Interest Rates on Outstanding Mortgages and Other Related Changes

Key points:

• China adjusts policies to balance property market and banking sector challenges.
• Lowering interest rates on outstanding mortgages to slow prepayment.
• Standardizing down payment ratios nationwide.
• Guangzhou and Shenzhen expanding the first-home buyer eligibility
• Policies seek stability, consumption boost, cautious optimism in outcomes

Introduction

China's real estate market has been a subject of immense interest, both domestically and globally. The Chinese government's continuous efforts to balance economic growth, housing demand, and financial stability have led to several policy shifts. In this article, we explore the recent policy changes announced on August 31, focusing on the implications of the new policy to lower interest rates on outstanding mortgages and other related alterations.

Unveiling the Policy Changes

On August 31, the People's Bank of China (PBoC) and the National Administration of Financial Regulation (NAFR) introduced two noteworthy policy changes aimed at addressing challenges within the property market:

1. Reducing Interest Rates on Outstanding Mortgages

In a significant move outlined in the "Notice of Measures Regarding Reduction of Interest Rates on Outstanding First Home Mortgages" (《关于降低存量首套住房贷款利率有关事项的通知》), the PBoC and NAFR announced that starting September 25, 2023, homeowners with outstanding mortgage loans can apply for refinancing. The new loan's interest rate will be determined through negotiations between the borrower and the bank. However, the new interest rate cannot fall below the minimum set by the local authorities for the specific city. The minimum mortgage rates vary across cities but the PBoC retained the first-time homebuyer mortgage interest floor at 20 basis points below the Loan Prime Rate (LPR) and revised down the second-time homebuyer interest rate floor to LPR plus 20 basis points.

The reduction in interest rates on outstanding mortgage loans benefits borrowers by reducing interest expenses and promoting consumption and investment. For banks, it effectively reduces the occurrence of prepayments, mitigating the impact on their interest income. Simultaneously, it also helps to limit the inappropriate use of household business loans and consumer loans to replace outstanding mortgage loans.

2. Streamlining Down Payment Policies

Through the "Notice of Adjusting and Optimizing Differential Housing Credit Policies" ( 《关于调整优化差别化住房信贷政策的通知》), the PBoC and NAFR removed distinctions between cities implementing property purchase restrictions and those without such limitations. This change standardized the minimum down payment requirements at 20% for first-home buyers and 30% for second-home buyers, regardless of the city's policy stance and across all city-tiers.

Currently, the four Tier-1 cities are implementing stricter down payment ratio requirements. For example, Shenzhen requires a 30% down payment from first-home buyers and 70-80% down payment from second-home buyers. Purchases in Shanghai necessitate a 35% down payment from first-home buyers and a 50-70% down payment from second-home buyers. The streamlining of down payment ratios to 20% for first-home buyers and 30% for second-home buyers will likely bolster housing demand in Tier-1 cities that are presently subject to more stringent down payment ratios.

3. Guangzhou and Shenzhen Expanding Eligibility for First-Home Buyer Benefits

Before the announcement of the two policy changes above, significant changes were announced by the authorities of Guangzhou and Shenzhen on 30 August 2023, aiming at easing the criteria for obtaining first-home loans. This policy shift, known as "认房不认贷" (literally translated as "Recognize the House, Not the Loan"), has been altered to expand the eligibility for the benefits of being categorized as first-home buyers. Under these revised conditions, regardless of whether any members of the household have previously utilized loans for property purchases if none of its members own a residential property under their name in Guangzhou or Shenzhen, banking and financial institutions are now required to apply the policies associated with first-home buyers.

This significant policy alteration permits homebuyers who either possess properties in other cities or have previously obtained mortgages and owned properties to enjoy the benefits of a lower initial down payment, as is typically afforded to first-home buyers. The key factor for eligibility is the absence of any additional property ownership in Guangzhou or Shenzhen. Once categorized as first-home buyers, mortgage borrowers can benefit from lower down payment ratios and mortgage interest rates compared to second-home buyers.

Using Guangzhou as an illustrative example, the revised policy entails a first-time homebuyer down payment ratio of 30% and a mortgage interest rate of 4.2%. In contrast, the down payment ratio for second-home purchases is set at 70%, with a corresponding mortgage interest rate of 4.8%. This policy adjustment is anticipated to promote more fluidity in the housing market, encourage property transactions, and alleviate the financial burden on aspiring homeowners.

Background to the Policy Changes

The Chinese property market has exhibited persistent sluggishness throughout the current year. This state of affairs is notably underscored by the China Real Estate Information Corporation's (CRIC) report detailing a substantial contraction in contract sales volume among the top 100 developers. During the month of August, the contract sales volume witnessed a decline of 42.4% in a year-on-year comparison (Y/Y), following a prior downturn of 32.4% in the preceding month of July. Notably, there was also a marked decline of 34.5% Y/Y in the sales value.

Residential properties have increasingly lost their appeal as investment avenues for Chinese households. Simultaneously, the Chinese equity markets, wealth management products, trust instruments, and other investment vehicles have exhibited volatility and subpar performance. The convergence of limited investment prospects vis-à-vis the substantial quantum of household savings, coupled with the persistent descent of bank deposit rates, has prompted an escalating trend of mortgage borrowers opting to prepay their mortgage loans. Furthermore, the availability of more affordable household business loans via the PBoC’s targeted re-lending facilities, designed to infuse additional credit into the private sector, has notably contributed to the surge in mortgage loan prepayments.

In the first half of 2023, Chinese households collectively undertook prepayments amounting to approximately RMB 2.5 trillion on their outstanding mortgage loans. This sum represents a significant 6.4% of the RMB 38.8 trillion worth of outstanding household mortgage loans, as tallied at the conclusion of the year 2022. This turn of events has tangibly impacted the profitability of banks, consequently sparking concerns within the PBoC and the NAFR.

Policy Shifts Emerge Amid Mortgage Borrower Exodus

In the throes of an ongoing exodus of mortgage borrowers, a pivotal development unfolded on July 14, 2023, when the PBoC addressed the matter in a press conference. The central bank explicitly voiced its "support for and encouragement of commercial banks and mortgage borrowers to engage in negotiations for alterations to contracted terms or the substitution of existing loans with new ones, all under the guiding principles of market orientation and the rule of law." Moreover, a noteworthy stride was taken at the semi-annual work conference on August 1, 2023, wherein the PBoC articulated its intention to direct commercial banks toward a reduction in the interest rates levied on outstanding mortgage loans, aiming at stopping the wave of mortgage loan prepayment.

The crux of the matter lies in the fact that new mortgage loans are intricately linked to the 5-year Loan Prime Rate (LPR), supplemented by a premium or discount as regulated by PBoC and local governments contingent upon regional housing market dynamics. In stark contrast, the landscape for outstanding mortgage loans is marked by indexing to the 5-year LPR, subject to an annual adjustment only on January 1, even in the event of a mid-year reduction in the 5-year LPR. Therefore, the interest rates on outstanding mortgages have become much higher relative to new mortgage interest rates.

Despite the above-stated directives, banks have yet to enact the guidance furnished by the PBoC with respect to lowering interest rates on the substantial cache of nearly RMB 39 trillion outstanding mortgages nationwide. Notably, the PBoC precludes borrowers from transferring their mortgages across banks, effectively conferring a monopoly status upon the banks concerning outstanding loans. Predominantly, banks exhibit cautious restraint in safeguarding their net interest margins, consequently manifesting resistance towards the PBoC's call for a reduction in interest rates applied to outstanding mortgages.

However, recent developments indicate a shifting demeanor among the prominent banking institutions in China. China Construction Bank (00939:xhkg), China Merchants Bank (03968:xhkg), Agricultural Bank of China (01288:xhkg), and China CITIC Bank (00998:xhkg) collectively affirmed, during their half-year results announcement conferences, that they are preparing to implement interest rate reductions on outstanding mortgage loans. A similar sentiment was observed within the Bank of Communication (03328:xhkg), reportedly convening an internal meeting on August 30 to inaugurate a project aimed at decreasing interest rates on existing mortgage loans.

It's against this intricate backdrop that the PBoC and the NAFR jointly released the two noteworthy Notices on August 31, signifying a pivotal step in regulatory evolution.

Mortgage Rate Adjustments and Their Economic Ramifications

Within the realm of projected investment outcomes resulting from these new policies, delving into various facets is paramount for a comprehensive understanding. Street analysts have gauged the average variance between new mortgage rates and outstanding mortgages, arriving at an approximate difference of around 80 basis points. In the intricate taxonomy of Chinese political mechanisms, the term "notice" (通知) operates as a conduit for disseminating directives to subordinate entities, encompassing execution requisites and conveying awareness to pertinent units. This practice contrasts with more rigid implementations, such as "resolutions" (决议), "decisions" (决定), and "commands" (命令).

Evidently, the market has adeptly assimilated the imminent shifts in policy. Notably, the aforementioned notice encourages bilateral negotiations between banks and mortgage borrowers. However, it remains steadfast in upholding the prohibition against the transfer of mortgages. In essence, borrowers aren't afforded the opportunity to seek alternatives by exploring competing offers from different banks to finance the prepayment of existing mortgage loans. Should borrowers deem the outcomes of negotiations unsatisfactory, their recourse narrows down to utilizing personal funds or procuring external sources of funding—other than mortgages—to settle the outstanding loan amount. This could potentially deter numerous borrowers and inadvertently bestow considerable monopolistic leverage upon banks. Consequently, exercising caution is prudent when gauging the ensuing repercussions.

Envisioning a scenario where 50% of the RMB 38.6 trillion (as of June 2023) of outstanding mortgages undergo renegotiation, each securing an average 40 basis point reduction in mortgage rates (50% of the 80 basis points disparity), the ensuing implication becomes evident. This configuration translates to a substantial annual interest expense reduction of RMB 77 billion for Chinese households, yet concurrently spells a decline in interest income for banks. Pertinently, the PBoC has also reportedly granted banks the liberty to curtail interest rates on deposits. According to the media, this entails a 10 basis point reduction for 1-year deposits, a 20 basis point cut for 3-year deposits, and a 25 basis point reduction for 5-year deposits. This strategic maneuver seeks to alleviate the potential impact of dwindling outstanding mortgage interest rates on banks. However, this modification in deposit rates similarly exerts downward pressure on interest income for Chinese households.

The joint initiatives from the PBoC and the NAFR resonate as potent indicators of the Chinese government's concerted efforts to stabilize the property market and amplify household consumption. Yet, juxtaposed with this aspiration is the concurrent objective to safeguard the banking sector's profitability—thus reinforcing their resilience against potential setbacks from escalating problem loans emanating from property market exposure, the shadow banking domain, and local government debt strains. Consequently, the net stimulative effect arising from the fusion of mortgage rate reductions and deposit rate adjustments might materialize as relatively modest within the broader economy.

Potential Impacts of the Recalibration of Down Payment Ratios and Expansion of First-home Buyer Eligibility

The streamlining of down payment ratios across the country will tend to stimulate housing demand in Tier-1 cities. However, the housing inventory surplus in China and the lack of demand for housing mostly affect tier-3 and tier-4 cities, which have ample land supply. At the same time, young people are leaving those cities for job opportunities in Tier-1 and Tier-2 cities. Housing demand in Shanghai, Beijing, Shenzhen, and Guangzhou is less of an issue to begin with. Similarly, the move by Guangzhou and Shenzhen to expand eligibility for first-home buyer benefits is positive for housing demand, but it is the lower-tier cities that need to boost housing demand the most. Many of these lower-tier cities have already relaxed similar policies. Therefore, the policy changes of lowering the down payment for second-home buyers and expanding eligibility for first-home buyers may have significant impacts on boosting household demand for housing in Tier-1 cities. However, their effectiveness in resolving the property inventory overhang and the problems faced by many developers may be limited.

Investment Implications

In conclusion, China's latest multifaceted policies at the intersection of mortgages and property regulations underscore a delicate balance between stimulating demand, ensuring financial sector stability, and boosting household consumption. As these dynamics reverberate through various sectors, cautious optimism underlines the potential for modestly positive outcomes, even as challenges persist in navigating the intricate web of economic intricacies.

The resonance of these policies within the market fabric enhances market sentiment, potentially nurturing a relatively more favorable environment for equity markets than the currently downbeat one. When complemented by lighter market positioning and better-than-feared earnings recently reported by Chinese corporations, the trajectory of the market appears aligned towards an upward movement.