China property: Country Garden feels frost that will wilt bank returns

You know things are bad when a former Steady Eddy is buckling at the knees. Country Garden, China’s largest and previously safest property group, has reported a 96 per cent drop in earnings. This has worrying implications for investors.

Net profits fell to Rmb612mn ($88mn) in the first half, the biggest decline since Country Garden listed in 2007. The group’s fortunes mirror China’s economic health more accurately than peers. The company specialises in homes for mid to lower income people and avoids high-risk projects.

The read-across to smaller, more speculative peers is that some of them will report terrible numbers in the coming weeks. Ronshine China Holdings, Sino Ocean and Zhenro Properties are just some of the property groups expected to book steep net losses. For Central China Real Estate, that figure could run as high as Rmb6bn ($870mn).

Stalled construction projects and falling property sales will trigger a number of impairments. Developers are caught up in a vicious cycle of undercutting each other.

Banks will bear the brunt of the fallout. They are already suffering. Industrial and Commercial Bank of China, the country’s largest lender, reported a sharp rise in non-performing loans for the first half on Tuesday. The NPL ratio for the real estate sector was more than four times the lender’s average. At Postal Savings Bank of China, real estate NPLs at the end of June rose 80-fold compared with December.

The problem is spilling over mainland China’s border. Hong Kong lenders show signs of stress. Credit impairment losses for the first half more than doubled at Dah Sing Banking Group. A significant part of these related to problem properties on the mainland.

HSBC has registered net impairment charges of $1.1bn, compared with a $700mn positive reversal a year ago. This is largely owing to its portfolio of Chinese real estate. The bank’s mainland exposure was more than $21bn at the end of last year. Nearly all Standard Chartered’s total credit impairment charges have come from the sector.

Highly geared property groups such as Evergrande will continue to grab headlines. But that business has long been seen as an outlier by investors. Moderately bad news from Country Garden is a more alarming portent of China’s economic weakness and the threat it poses to investment returns.