TheChek News Flow

Or at least they’re worried about what it will look like in the second half of this year, when we might start running into a funding “crisis”.

That’s what Andrew Collier of Orient Capital Research is suggesting, with our emphasis:

Based on our interviews, we believe the property sector will face a liquidity crisis when the peak of debts come due in the second half of 2017 and beginning of 2018. According to the Centaline Group, China’s property developers raised Rmb1.14trn in 2016 through privately raised company bonds, corporate bonds, medium term notes and related sources. This was a 26% increase YoY, for the first time breaking Rmb1trn. However, both domestic and foreign financing channels have been blocked since last October due to tightening regulations on capital raising, along with a strong U.S. dollar As a result, property developers are confronting a significant increase in the cost of financing that could cause them to reach crisis levels in the near future. We estimate Rmb544 billion in corporate bonds alone will come due in 2H 2017 and early in 2018.

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As was widely reported, there was indeed a chill cast over Chinese property funding in the third quarter of 2016 as regulators looked to cool an overheating market. “All the relevant [national] regulators and government departments have intervened to curb developers’ financing,” said Jonas Short at NSBO, a policy research group, to the FT. “It’s an example of the concerted action that you get when [Beijing] is convinced something must be done.” More so, from the same FT report in November:

Corporate bond sales by real estate developers have come to a complete halt this month while their issuance of trust products fell by a quarter in October compared with September. Trust products bundle corporate loans and other assets that are sold on to a variety of investors including bank depositors.

Now, before going on, do please remember that China’s property market is effectively the foundation of the country’s economy. As Citi said before, “property-related tax revenues and land sales proceeds jointly account for 42% of local governments’ direct income (fiscal revenues + local government funds). The property market, in short, has become the critical income source for local governments. This is the key reason why we believe a property market collapse could be ill afforded by central/local governments, though they do hope for a cooling of the property market.”

Then there’s the normal industry involved in the… industry: construction and real estate made up a fifth of real gross domestic product growth in the first half of 2016, according to China International Capital Corporation (via the FT). There’s also the very real issue of banks investing in property bonds and/or investing in shadow banking products (WMPs) which are in turn invested in property bonds.

You get the picture: it’s an important sector that they won’t want to see crash even if credit growth can’t keep going forever. China is, as has been widely explained, very probably pushing against its debt-capacity limits.

Remember too then, that what the regulators have tightened can by the same regulators be loosened.

So, yeah, the PBoC etc are clearly worried about over-investment into the bubbling property sector but it’s very very unlikely that they will keep credit so tight that they allow a crisis. While allowing some defaults to instil some sense of credit risk is part of the plan, anything that endangers financial stability is not.

All the more so since the shadow market — which is another funding avenue for the property developers — would not look pretty if those defaults were to cascade. An illustrative example from Michael Pettis’s latest newsletter:

The market “inefficiency” that allows WMP investors to earn higher yields than they would on bank deposits, while believing that they are taking no greater credit, maturity or liquidity risk, is simply calculated obfuscation. We will only know once the WMP markets faces its first major test whether WMP investors were the ones who were able to “arbitrage” this inefficiency, because banks were forced to absorb the credit and liquidity risks, or banks were the ones who benefitted from the “arbitrage” as they walk away from WMP, and forced investors to absorb the credit and liquidity risk…

While most market participants understand the credit risk distortions implied by WMP, they may be less clear about the liquidity risk distortions. By regularly buying and selling corporate bonds the SPIVs create liquidity in Chinese corporate bond markets as a function of the expansion of the WMP market. This liquidity creation can be highly self-reinforcing, however, and investors should be aware of the risk of liquidity gapping, i.e. a sudden sharp contraction in trading volume and market liquidity.

Gapping risk is exacerbated by the fact that while a lot of WMPs are backed by the very simple form of securitization described above, an increasing number of WMPs may be backed by more complex securitizations. Among them are those in which the SPIV invests in the stubs of other SPIVs, thus leveraging up products that are already levered, and in which there is a structural mechanism that links WMP redemptions far more directly than the normal contagion mechanisms.

So how will this particular liquidity worry turn out?

As Collier says: “PBOC, could, however, intervene on a case-by-case basis, particularly when the developer or project is sufficiently large to cause economic distress in a politically important location.” Which seems about right.

* Q4 sales confirmed further promotional pressure in France, especially from the main hypermarkets, Leclerc and Carrefour

* This is likely to weigh on profitability but will be offset by smaller formats and profits outside France, especially LatAm

* Buy rating on Carrefour (TP EUR28), Casino (TP EUR60 vs. EUR53); Reduce on Rallye (TP EUR17 vs. EUR12)

We maintain our ratings: Buy on Carrefour (TP EUR28 unchanged) and Casino new TP EUR60 vs EUR53), Reduce on Rallye (TP EUR17 vs. EUR12): We roll over our DCF base for Carrefour and Casino and change our estimates for Carrefour (-5% EPS 2016-18e) and Casino (+5.9%). We cut our estimates for Carrefour France slightly but still expect +15bps margin in 2017 and 2018 (Dia). We do not change our profit forecasts for LatAm but expect further losses in Asia in FY17. For Casino our estimates exclude Via Varejo with Cnova now discontinued. This has an impact not only on the operating profit lines but also on financial charges and minority interests.

* An Essilor-Luxottica combination very likely to materialise at parity agreed on 13 January 2017 in our opinion

* Short-term newsflow un-supportive for both stocks, but absolutely not the reason for merging

* Essilor Buy, raise TP to EUR132 (from EUR125); upgrade Luxottica to Buy (from Hold), raise TP to EUR61 (from EUR54)

Maintain Buy on Essilor, upgrade Luxottica to Buy: Our new TPs for Essilor and Luxottica are based on (i) valuing the NewCo by adding the net present value of synergies to our standalone valuations of Essilor and Luxottica (unchanged), and (ii) using the exchange ratio accepted by Luxottica’s controlling shareholder Delfin: 0.461 Essilor share for 1 Luxottica share. Based on our new TPs (EUR132 from EUR125 for Essilor, EUR61 from EUR54 for Luxottica), Essilor and Luxottica imply 23% and 21% upside respectively

5 per cent rate is too high, says Council of Mortgage Lenders chief

Regulators should reduce the “stress test” interest rates applied to mortgage borrowers to judge whether they can afford a home loan, since they are “locking people out of the market” at their current level, lenders and brokers said.

Under rules brought in by the Bank of England’s Financial Policy Committee (FPC) in 2014, lenders are required to assess whether borrowers could still afford their mortgage if base rates were three percentage points above their current level at any point over the first five years of the loan. Once lenders include their margins, stress rates typically hit 5 per cent and above. 

Peter Hill, chairman of the Council of Mortgage Lenders (CML) and chief executive of Leeds Building Society, said regulators should look again at these hypothetical rates of interest given the shift in economic circumstances since the rules were introduced.

“The question I would ask is can we foresee rates over five years being at that level? It feels quite unlikely,” said Mr Hill. “Is this stress rate realistic in the current environment — because it’s locking people out of the market.” He said he was not speaking on behalf of the CML but in a personal capacity. 

Mr Hill said the requirement had been laid down at a time when there was serious concern among regulators and the government that the housing market was overheating. Annual house price growth in London, where activity was at its most pronounced, hit 20.1 per cent in the year to May 2014, according to figures from the Office for National Statistics.

However, the annual growth rate in London had since fallen back to 8.1 per cent in the latest ONS figures (direct comparisons between the figures are qualified, since in June 2016 the ONS index was merged with the Land Registry house price index). Across the UK, prices rose by 6.7 per cent in the year to November, and the Bank of England cut interest rates to a new record low last summer. 

The FPC defended the calibration of the affordability test as recently as November, when it said in its review of financial stability that the 3 per cent level “remains proportionate”. 

“The market-implied path for Bank Rate has fallen since 2014,” it said. “But the FPC judges that, given the long-term nature of mortgage contracts, it would be imprudent to rely too heavily on potentially volatile market-implied measures of future interest rates. In addition, the current calibration of the affordability test strengthens resilience in the face of adverse income and unemployment shocks.”

The stress rate minimum applies only to the first five years of a mortgage, so fixed-rate deals for five years or longer are officially exempt. In practice, however, brokers said lenders were applying the same affordability tests to all mortgage applicants regardless of the length of fix. 

Adrian Anderson, director at broker Anderson Harris, said borrowers were incredulous when told that, though they were looking at taking out a ten-year fixed rate mortgage at around 2.5 per cent with base rates at 0.25 per cent, they were being stress-tested for affordability at 6.5 per cent. 

The stress rates had a “particularly big impact” on older borrowers, he added. “If lenders are assessing a mortgage on a capital repayment basis until retirement age, a 50-year-old has 17 years to pay off the mortgage, stressed at 6.5 per cent. We need some stress test but it does seem to me and many clients that it is very high.” 

David Hollingworth, director at broker London & Country Mortgages, said lenders were unwilling to differentiate their affordability tests based on the length of a fix because of the risk that customers would flock to the longer-term offers. “There’s an argument that everyone would lock into a longer-term fixed rate not because it was the right product for them, but because it opens the gate to a larger borrowing amount.” 

There remained a case for the regulator to review stress rates regularly, he said, but there was likely to be little appetite today to trim them. “With higher inflation feeding through there will be some concerns about whether it is the right time to loosen the reins on stress testing,” he said.

Predictions about where interest rates would be over five years remain hard to call. “The flip-flopping in the last six months as to what base rates will do over that period has gone from a likely cut to the potential for a rate rise. The reality is that nothing has happened,” Mr Hollingworth said.