How Wealth Products Helped Inflate China Real Estate

(Bloomberg) -- Alarm bells are ringing in China as people in search of high yields keep investing their savings in wealth-management products. A history of bailouts had many of them believing that WMPs are implicitly guaranteed by the issuing bank or the state. So when Chinese developers started to offer similar WMPs at even better terms, wealthy Chinese snapped them up as well. Now that some of the country’s largest property firms are struggling to repay their debts, investors are discovering they aren’t risk free. The prospect of big losses could jolt the world’s second-largest economy.

1. What are WMPs?

They’re investments initially marketed by the wealth-management units of banks as a tool to attract funds. Like mortgage-backed securities were in the U.S., they’re building blocks of a shadow-banking system that exists largely off balance sheets of their issuers -- mostly banks. They typically offer a fixed rate of return of 3% to 5% over a short period, usually less than six months, compared with 1.5% for one-year bank deposits. The WMPs invest in everything from bonds to property and can be exposed to struggling industries like mining. The banks can keep them off their balance sheets provided the products are not principal-guaranteed, which most are not, but they are still subject to regulatory scrutiny.

2. What are the risks?

In offering WMPs, banks and other lenders can partially sidestep lending restrictions and capital requirements. They also can hand over the products to non-banks to manage in return for a predetermined interest rate. Lenders may face a liquidity crunch if investors turn cold on the products. Some WMPs have invested in each other, meaning one soured product could infect others.

3. How did developers get involved?

Almost all major private developers turned to offering WMPs as a way to raise capital after the government, worried about a growing debt bomb, tightened access to traditional bank loans for them at the end of 2020. (Guo Shuqing, the head of the banking regulator, a year ago called real estate “the biggest gray rhino” for China’s financial stability -- referring to a large yet overlooked threat.) They were sold not only to wealthy individuals but also to their homebuyers and even their own employees, touting returns above 6%. Unlike those offered by banks, the WMPs issued by developers are unregulated. 

4. How’d that go?

Initially the developers that joined the craze were able to use cash from property sales to pay their WMP investors. Then liquidity dried up and property sales slumped this year amid a debt crisis surrounding China Evergrande Group, one of the biggest developers. As of Nov. 10, at least 50 billion yuan ($8 billion) of WMPs linked to developers including Evergrande and Kaisa Group Holdings Ltd. have missed payments or had their payment terms revised. Some investors took to the streets to demand repayment, sparking fears of social unrest.

5. How much money is at stake?

The outstanding value of banks’ WMPs stood at 27.95 trillion yuan ($4.4 trillion) as of Sept. 30, 2021, official data showed. That’s equivalent to more than 27% of China’s gross domestic product. For those linked to developers, it’s hard to pinpoint an exact amount. Data from the China Securities Regulatory Commission show that over-the-counter exchanges, where those offered by developers are often sold, had about 852 billion yuan of WMPs outstanding as of July 2019, the latest information available.

6. What is the government doing?

The asset management industry was given until the end of 2021 to comply with tighter controls. These include removing any implicit guarantees, capping leverage, reducing mismatches in the duration of loans and increasing transparency on who issues and holds the products. Banks were forced to bring some of their WMPs onto their balance sheets. Separately, banks must set aside 10% of fees from managing the products to cover potential risks, and are banned from selling products touting expected rates of return or investing proceeds from WMPs into other WMPs. The problem is, the rules don’t apply to WMPs issued by property developers. 

7. Will the government rescue the real-estate companies?

Any bailout of property firms that relied on WMPs will be politically sensitive as it would involve rewarding billionaires who tapped into the murkier corners of China’s debt markets. That could be at odds with President Xi Jinping’s push to rebalance the economy away from the super-rich and create a more prosperous middle class. But letting them fail could deepen losses for those very middle-class investors who often bought the products, and set back efforts to boost the spending power of Chinese consumers. 

The Reference Shelf

• QuickTake explainers on China Evergrande, why China’s developers have so much dollar debt and the government’s “three red lines.”
• The U.S. Federal Reserve says what happens in China’s property industry could threaten world economic growth.
• Bloomberg Opinion columnist Niall Ferguson says rampant real estate development “financed by an unsustainable mountain of debt” is China’s looming economic disaster.
• S&P Global Market Intelligence summarized China’s moves to reduce risk in shadow banking.

©2021 Bloomberg L.P.

With assistance from Bloomberg