September 9,2008 China:Banks We believe this can largely be attributed to the following factors: 1.While the slowdown in the real estate sector has cut deeply into China real estate developers'profitability and hurt property developers'equity holding interest,the still- high gross and profit margins of 30%+at developers provided a cushion for debt holders such as banks. Moreover,given the perceived high gross margin of residential property projects, developers managed to attract continued funding from banks as well as domestic and foreign private investors. 2. Funding for the real estate industry as a whole appears to be sufficient as of 1H08, despite moderation in loan growth to the sector,aided by a surge in financing from the private sector(Exhibits 8 and 9).Developers continued to have high funding surplus levels in 1H08. 3. China developers had a relatively high cash balance at the beginning of 2007, following active fund-raising activities in 2007(Exhibits 8 and 9). Exhibit 8:Brisk financing activity helped listed developers improve cash positions in 1H08 Cash flow analysis of 65 listed China real estate developers Rmb mn 2000 2001 2002 2003 2004 2005 2006 2007 1H08 Cash flow from operations 1.143 (1.6391 3,717 3.418 1.389 623) 112.56534.272 31.663) Cash flow from investing 2.431(1.876)29323.128)4.452)2485)【5247 (14.540 Cash flow from financing 3.831 7.314 1.6949.2939.686185532.84076.132 45.522 Net cash inflows (outflows) 2542 3799247927466.62314253115028 27320 5,109 Ending cash balance 10,962 14,745 1710621.064 28,091 27481 45,802 72.849 78122 No.of firms with net cash outflows 26 20. 19 25 2 35 25 15 39 Note:cash flow from financing includes debt and equity issuance as well as new loans from banks. Source:Wind. Exhibit 9:Funding surplus for real estate industry as a Exhibit 10:But funding growth to the real estate industry whole increased up to 1H08 as booming real estate slowed as loans and pre-sale proceeds growth declined market attracted capital to the industry YoY growth in key funding sources for property investment Rmb mn 2004 2005 2006 2007 1H08 -Selt-raled but not equlty--Equty Real estate investment completed Development costs 901.8201.109.6971.31.1321753.199915.022 Land premium other 414.004 466,235 577.114 774,766 404.545 Total 1,315,8241,575,9321,938,2462,527.9651,319,567 Yoy growth 30% 20% 23% 30% 33% Funding Source Pre-sale 739534 774915 8135581082847 450820 Equity 234.471 307 278 356.194 184 416,593 Loans 315.841 383.467 526.341696.098405.880 Self-raised but not equity 286.285 396,617 502.514 478.016 329.890 Foreign investment 22.820 25,196 39.444 64.999 34.570 Other 118.725 229.125 449.970 724.518 279.581 Total 1.715.6762,116,5982,688,0213.725.6621,917,334 Yoy growth 31% 23% 27% 39% 23% Funding surplus 399,852 540.666 749.775 1,197697 597,767 Source:CEIC. Source:CEIC. Risk of cash flow squeeze increasing,particularly in 4008/2009 Despite still-stable credit quality at China banks,we see a looming real estate credit risk in 4008 and 2009 if the real estate market continues on its current downward trajectory. Goldman Sachs Global Investment Research 6
September 9, 2008 China: Banks Goldman Sachs Global Investment Research 6 We believe this can largely be attributed to the following factors: 1. While the slowdown in the real estate sector has cut deeply into China real estate developers’ profitability and hurt property developers’ equity holding interest, the stillhigh gross and profit margins of 30%+ at developers provided a cushion for debt holders such as banks. Moreover, given the perceived high gross margin of residential property projects, developers managed to attract continued funding from banks as well as domestic and foreign private investors. 2. Funding for the real estate industry as a whole appears to be sufficient as of 1H08, despite moderation in loan growth to the sector, aided by a surge in financing from the private sector (Exhibits 8 and 9). Developers continued to have high funding surplus levels in 1H08. 3. China developers had a relatively high cash balance at the beginning of 2007, following active fund-raising activities in 2007 (Exhibits 8 and 9). Exhibit 8: Brisk financing activity helped listed developers improve cash positions in 1H08 Cash flow analysis of 65 listed China real estate developers Rmb mn 2000 2001 2002 2003 2004 2005 2006 2007 1H08 Cash flow from operations 1,143 (1,639) 3,717 (3,418) 1,389 (623) (12,565) (34,272) (31,663) Cash flow from investing (2,431) (1,876) (2,932) (3,128) (4,452) (2,485) (5,247) (14,540) (8,687) Cash flow from financing 3,831 7,314 1,694 9,293 9,686 1,855 32,840 76,132 45,522 Net cash inflows (outflows) 2,542 3,799 2,479 2,746 6,623 (1,253) 15,028 27,320 5,109 Ending cash balance 10,962 14,745 17,106 21,064 28,091 27,481 45,802 72,849 78,122 No. of firms with net cash outflows 26 20 19 25 27 36 25 15 39 Note: cash flow from financing includes debt and equity issuance as well as new loans from banks. Source: Wind. Exhibit 9: Funding surplus for real estate industry as a whole increased up to 1H08 as booming real estate market attracted capital to the industry Exhibit 10: But funding growth to the real estate industry slowed as loans and pre-sale proceeds growth declined YoY growth in key funding sources for property investment Rmb mn 2004 2005 2006 2007 1H08 Real estate investment completed Development costs 901,820 1,109,697 1,361,132 1,753,199 915,022 Land premium & other 414,004 466,235 577,114 774,766 404,545 Total 1,315,824 1,575,932 1,938,246 2,527,965 1,319,567 Yoy growth 30% 20% 23% 30% 33% Funding Source Pre-sale 739,534 774,915 813,558 1,062,847 450,820 Equity 234,471 307,278 356,194 699,184 416,593 Loans 315,841 383,467 526,341 696,098 405,880 Self-raised but not equity 286,285 396,617 502,514 478,016 329,890 Foreign investment 22,820 25,196 39,444 64,999 34,570 Other 116,725 229,125 449,970 724,518 279,581 Total 1,715,676 2,116,598 2,688,021 3,725,662 1,917,334 Yoy growth 31% 23% 27% 39% 23% Funding surplus 399,852 540,666 749,775 1,197,697 597,767 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% Jan/07 Feb/07 Mar/07 Apr/07 May/07 Jun/07 Jul/07 Aug/07 Sep/07 Oct/07 Nov/07 Dec/07 Jan/08 Feb/08 Mar/08 Apr/08 May/08 Jun/08 Total Loans Deposits/downpayment on presales Self-raised but not equity Equity Source: CEIC. Source: CEIC. Risk of cash flow squeeze increasing, particularly in 4Q08/2009 Despite still-stable credit quality at China banks, we see a looming real estate credit risk in 4Q08 and 2009 if the real estate market continues on its current downward trajectory
September 9,2008 China:Banks We believe depressed real estate transaction volumes and slowing real estate loan growth (Exhibit 10),compounded by higher operating cash outflows due to the expansion in development driven by the optimistic industry outlook that followed last year's property price surge,could lead to a cash flow squeeze at real estate developers that expanded aggressively in the past two years. Despite the current slump in the real estate market,we see continued expansion in development,which could,in our view,aggravate developers'cash flow problems in 4Q08/2009.For instance,floor area under development rose 24%ytd until July 2008,vs. 23%yoy in 2007(Exhibit 11),and new project starts increased 15%ytd until July 2008 despite a weakening housing market outlook(Exhibit 12). Exhibit 11:Optimistic forecasts by developers in 2007 Exhibit 12:New construction starts have also risen yoy led to continued development expansion in 2008 YoY growth in residential floor space starts(%) YoY growth in floor space under development(%) 2004 2005 2006 2007 July 08 YTD 2004 2005 2006 2007 July 08 YTD National 19 18 19 23 24 National 10 13 18 23 15 Beijing 6 (13) ⑥) (4) Beijing (12) (10) (6) (12) 26 Shanghai 13 6 (1) (4) (13) Shanghai 2 (70 (15) (23) 10 Tianjin 21 20 20 10 12 Tianjin 30 29 18 5 12 Chongqing 20 23 28 16 25 Chongqing 10 19 33 22 Chengdu 0 14 52 39 35 Chengdu (13) 34 28 8 10 Guangzhou 8 (3) 5 5 12 Guangzhou 20 (24) 13 35 (19) Shenzhen 15 (3) (9) (1) (1) Shenzhen 59 (16 (37) 19 (17) Wuhan 24 14 6 9 26 Wuhan 36 17 (8) 7 9 Dalian (9) 16 43 32 30 Dalian (22) 19 91 8 (2) Hangzhou 0 0 15 (5) Hangzhou 0 0 56 (43) 44 Source:NDS Source:NDS Our study of the cash flow statements of the 65 A-share listed China real estate companies shows that aggregate net cash flows are quite vulnerable to shrinking sales volumes and moderation in outside funding growth(Exhibit 13), given the sizable operating cash outflow following aggressive investment in construction and land acquisitions(part of the operating cash outflow) We believe A-share listed developers could face a substantial decline in aggregate cash balance in 2H08 and 2009,based on weaker transaction volumes,continued expansion in development scale,and our expectation of slowing external funding via bank loans and private funding,given the shrinking profit margins. We expect the cash flow position to start recovering in 2010,as we assume a potential rebound in transaction volumes following improvement in affordability and our expectation that developers will begin scaling back development to conserve cash in 2H08, and that the scaling back will continue in 2010. Exhibit 13:Cash flow squeeze should improve in 2010 if price cuts and higher household incomes improve affordability, and if property developers continue to scale back development Cash flow statement analysis and projection of 65 listed China real estate developers yoy change% Rmb mn 1H07 2H07 1H08 2H08E 1H09E 2H09E1H10E 2H103 1H082H08E1H09E2H09E1H10E2H10E Operating cash inflow 70.839120.68986.52172.90581.37386.53193.579108.164 1% 15% 259% Operating cash outflow 78.053147,747118.184153.934111,683117.268100.515105.541 51% 4% -6% -24% -10% -109% Net operating cash inflow/(outflow) 7.215) 27.058)31.663)(81.030)30.311)(30.737 6,937 2.623 339% 199% 1% 62% Net investing cash inflow(outflow) (3.809)(10.731)(8.6870(8.585(6.950(6.868)(5,560)(5.494 128% -20% -20% -209% -209% -20% Net financing cash inflow(outflow) 21.020 55.112 45.522 35,823 38.694 32.957 35.599 30,320 117% -35% -15% -8% 8% 8% Net cash inflow/(outflow) 10.022 17.286 5,109、(53.792）1,433(4.648)23.10227,449 -49% M -72% -91%1512% NM Ending cash balance 50,171 69,702 78,122 24,330 25,764 21,116 44,218 71,667 56% 65% -67% -13% 72% 239% Source:Wind,and Gao Hua Securities Research estimates. Goldman Sachs Global Investment Research
September 9, 2008 China: Banks Goldman Sachs Global Investment Research 7 We believe depressed real estate transaction volumes and slowing real estate loan growth (Exhibit 10), compounded by higher operating cash outflows due to the expansion in development driven by the optimistic industry outlook that followed last year’s property price surge, could lead to a cash flow squeeze at real estate developers that expanded aggressively in the past two years. Despite the current slump in the real estate market, we see continued expansion in development, which could, in our view, aggravate developers’ cash flow problems in 4Q08/2009. For instance, floor area under development rose 24% ytd until July 2008, vs. 23% yoy in 2007 (Exhibit 11), and new project starts increased 15% ytd until July 2008 despite a weakening housing market outlook (Exhibit 12). Exhibit 11: Optimistic forecasts by developers in 2007 led to continued development expansion in 2008 YoY growth in floor space under development (%) Exhibit 12: New construction starts have also risen yoy YoY growth in residential floor space starts (%) 2004 2005 2006 2007 July 08 YTD National 19 18 19 23 24 Beijing 6 8 (13) (6) (4) Shanghai 13 6 (1) (4) (13) Tianjin 21 20 20 10 12 Chongqing 20 23 28 16 25 Chengdu 0 14 52 39 35 Guangzhou 8 (3) 5 5 12 Shenzhen 15 (3) (9) (1) (1) Wuhan 24 14 6 9 26 Dalian (9) 16 43 32 30 Hangzhou 0 0 3 15 (5) 2004 2005 2006 2007 July 08 YTD National 10 13 18 23 15 Beijing (12) (10) (6) (12) 26 Shanghai 2 (7) (15) (23) 10 Tianjin 30 29 18 5 12 Chongqing 5 10 19 33 22 Chengdu (13) 34 28 8 10 Guangzhou 20 (24) 13 35 (19) Shenzhen 59 (16) (37) 19 (17) Wuhan 36 17 (8) 7 9 Dalian (22) 19 91 8 (2) Hangzhou 0 0 56 (43) 44 Source: NDS. Source: NDS. Our study of the cash flow statements of the 65 A-share listed China real estate companies shows that aggregate net cash flows are quite vulnerable to shrinking sales volumes and moderation in outside funding growth (Exhibit 13), given the sizable operating cash outflow following aggressive investment in construction and land acquisitions (part of the operating cash outflow). We believe A-share listed developers could face a substantial decline in aggregate cash balance in 2H08 and 2009, based on weaker transaction volumes, continued expansion in development scale, and our expectation of slowing external funding via bank loans and private funding, given the shrinking profit margins. We expect the cash flow position to start recovering in 2010, as we assume a potential rebound in transaction volumes following improvement in affordability and our expectation that developers will begin scaling back development to conserve cash in 2H08, and that the scaling back will continue in 2010. Exhibit 13: Cash flow squeeze should improve in 2010 if price cuts and higher household incomes improve affordability, and if property developers continue to scale back development Cash flow statement analysis and projection of 65 listed China real estate developers Rmb mn 1H07 2H07 1H08 2H08E 1H09E 2H09E 1H10E 2H10E 1H08 2H08E 1H09E 2H09E 1H10E 2H10E Operating cash inflow 70,839 120,689 86,521 72,905 81,373 86,531 93,579 108,164 22% -40% -6% 19% 15% 25% Operating cash outflow 78,053 147,747 118,184 153,934 111,683 117,268 100,515 105,541 51% 4% -6% -24% -10% -10% Net operating cash inflow/(outflow) (7,215) (27,058) (31,663) (81,030) (30,311) (30,737) (6,937) 2,623 339% 199% -4% -62% -77% NM Net investing cash inflow/(outflow) (3,809) (10,731) (8,687) (8,585) (6,950) (6,868) (5,560) (5,494) 128% -20% -20% -20% -20% -20% Net financing cash inflow/(outflow) 21,020 55,112 45,522 35,823 38,694 32,957 35,599 30,320 117% -35% -15% -8% -8% -8% Net cash inflow/(outflow) 10,022 17,286 5,109 (53,792) 1,433 (4,648) 23,102 27,449 -49% NM -72% -91% 1512% NM Ending cash balance 50,171 69,702 78,122 24,330 25,764 21,116 44,218 71,667 56% -65% -67% -13% 72% 239% yoy change % Source: Wind, and Gao Hua Securities Research estimates
September 9,2008 China:Banks Key assumptions in our scenario analysis and projections include: Operating cash inflows likely to post substantial decline in 2H08/2009:We expect transaction volumes to remain weak in 2H08 and 1H09,in light of the 30+%decline in transaction volumes seen in 1H08,and high inventory levels. This,combined with our expectation of an additional 15%decline in house prices in 2H08,is likely to lead to~40%yoy decline in sales proceeds (or operating cash inflow) for China developers in 2H08. We expect transaction volumes and house prices to stabilize in 2H09 and begin turning around in 2010,given improved affordability.Hence,we expect stable operating cash inflows in 2H09,followed by 15%and 25%yoy growth in 1H10 and 2H10,respectively. ● Operating cash outflows will remain high in 2H08/2009:As shown in Exhibits 11 and 12,GSA under development continued to increase at a rapid pace of 24%ytd until July 2008.This,combined with 10%-15%yoy increase in the cost of building materials in 2008 should lead to a sizable increase in operating cash outflows,in our view. However,we believe a potential scaling back of development and potential lower land premium payments(~40%-50%of China developers'total cash operating outflows in 2H07)in 2H08 could partly offset the rising operating cash outflows from construction activities in 2H08.Hence,we expect operating cash outflows at A-share developers as a whole to increase 4%yoy and 30%hoh in 2H08. Looking ahead,we expect developers to continue to scale back development to conserve cash. Net financing cash inflows likely to moderate:We expect a moderation in growth of bank loans to developers,and a more challenging capital market for fund raising,to lead to a moderation in financing cash inflows at China real estate developers. In addition,we believe the expected lower profitability of real estate development projects could lead to a decline in private financing inflows. Accordingly,we expect cash flow from financing activities to decline 35%in 2H08 from the peak in 2H07. Exhibit 14:New loans to developers as a%of total new sector loans declined in 2008,suggesting banks are becoming cautious on this sector Consumer loans Total loans Developer loans Total consumer loans Of which:mortgages Yoy As of As%of As%of growth Yoy As of total New new Yoy total Yoy total Rmbbn Total %) Total (%loans (% loans loans(%) Total (%)1oans(%) Total (%loans (% 2004 18.85711.1 946 17 5.02 140 7 1.98826.3 10.5 1,600 35.8 8.5 2005 20,684 9.7 1.107 17 5.35 161 9 2,19410.4 10.6 1,840 15.0 8.9 2006 23,828 15.2 1.406 27 5.90 299 10 2.,406 9.6 10.1 2,250 22.3 9.4 2007 27,77516.6 1,767 26 636 361 92 327536.1 118 3,000 33.3 10.8 1Q08 29,387 16.2 1.900 19 6.47 133 8.2 3,39832.3 116 3,111 29.8 10.6 2Q08 30,50915.2 1,950 18 6.39 51 4.53,53326.8 11.6 3,300 25.6 10.8 2008E 31,802 14.5 2.015 14 6.33 247 6.1 3,799 16.0 11.9 3,540 18.0 11.1 Source:PBoC,CEIC,Goldman Sachs Research estimates. Cash inflows from active fund-raising activities have offset net cash outflows for operating and investing activities and helped developers strengthen their cash positions over the Goldman Sachs Global Investment Research
September 9, 2008 China: Banks Goldman Sachs Global Investment Research 8 Key assumptions in our scenario analysis and projections include: • Operating cash inflows likely to post substantial decline in 2H08/2009: We expect transaction volumes to remain weak in 2H08 and 1H09, in light of the 30+% decline in transaction volumes seen in 1H08, and high inventory levels. This, combined with our expectation of an additional 15% decline in house prices in 2H08, is likely to lead to ~40% yoy decline in sales proceeds (or operating cash inflow) for China developers in 2H08. We expect transaction volumes and house prices to stabilize in 2H09 and begin turning around in 2010, given improved affordability. Hence, we expect stable operating cash inflows in 2H09, followed by 15% and 25% yoy growth in 1H10 and 2H10, respectively. • Operating cash outflows will remain high in 2H08/2009: As shown in Exhibits 11 and 12, GSA under development continued to increase at a rapid pace of 24% ytd until July 2008. This, combined with 10%-15% yoy increase in the cost of building materials in 2008 should lead to a sizable increase in operating cash outflows, in our view. However, we believe a potential scaling back of development and potential lower land premium payments (~40%-50% of China developers’ total cash operating outflows in 2H07) in 2H08 could partly offset the rising operating cash outflows from construction activities in 2H08. Hence, we expect operating cash outflows at A-share developers as a whole to increase 4% yoy and 30% hoh in 2H08. Looking ahead, we expect developers to continue to scale back development to conserve cash. • Net financing cash inflows likely to moderate: We expect a moderation in growth of bank loans to developers, and a more challenging capital market for fund raising, to lead to a moderation in financing cash inflows at China real estate developers. In addition, we believe the expected lower profitability of real estate development projects could lead to a decline in private financing inflows. Accordingly, we expect cash flow from financing activities to decline 35% in 2H08 from the peak in 2H07. Exhibit 14: New loans to developers as a % of total new sector loans declined in 2Q08, suggesting banks are becoming cautious on this sector Developer loans Total consumer loans Of which: mortgages Rmb bn Total Yoy growth (%) Total Yoy (%) As % of total loans (%) New loans As % of new loans(%) Total Yoy (%) As % of total loans (%) Total Yoy (%) As % of total loans (%) 2004 18,857 11.1 946 17 5.02 140 7 1,988 26.3 10.5 1,600 35.8 8.5 2005 20,684 9.7 1,107 17 5.35 161 9 2,194 10.4 10.6 1,840 15.0 8.9 2006 23,828 15.2 1,406 27 5.90 299 10 2,406 9.6 10.1 2,250 22.3 9.4 2007 27,775 16.6 1,767 26 6.36 361 9.2 3,275 36.1 11.8 3,000 33.3 10.8 1Q08 29,387 16.2 1,900 19 6.47 133 8.2 3,398 32.3 11.6 3,111 29.8 10.6 2Q08 30,509 15.2 1,950 18 6.39 51 4.5 3,533 26.8 11.6 3,300 25.6 10.8 2008E 31,802 14.5 14 6.33 2,015 247 6.1 3,799 16.0 11.9 3,540 18.0 11.1 Consumer loans Total loans Source: PBoC, CEIC, Goldman Sachs Research estimates. Cash inflows from active fund-raising activities have offset net cash outflows for operating and investing activities and helped developers strengthen their cash positions over the
September 9,2008 China:Banks past two years,but we believe a potential sharp decline in sales volume and financing cash inflows in 2H08/2009 could quickly lead to sizable cash outflows at those listed China developers. We estimate that,based on the aforementioned assumptions,the 65 A-share listed developers as a whole would experience sizable net cash outflows in 2H08 and 2009 vs.an inflow of Rmb27bn in 2007,and lead to cash flow squeeze at some of those developers in 1H08 and 2009. We believe the cash flow issues could be even worse for non-listed developers that could have weaker cash positions and less access to the capital market than their listed peers. Real estate loan NPLs may surface in 4Q08 if sales volume remains low We believe the liquidity situation could deteriorate quickly in 2H08,particularly at some stretched,mid-sized developers that expanded aggressively in 2007,and lead to bank credit quality risk as early as 4008,because: 1.Sales volume and property prices could continue to weaken in 2H08,which could put pressure on developers'operating cash inflow. 2.Funding needs are normally higher in 4Q as developers typically pay construction companies at year-end for the part of the project that has been completed in the year. We estimate that~33%of the full-year development costs were incurred in the fourth quarter over the past three years. 3. Banks could have a lower loan quota in 2H08 as most banks have already used up 65%-70%of the 2008 full-year loan quota in 1H08,with only 30%-35%left for 2H08. Several banks indicated that new property loans in 1H08 were due to withdrawal of real estate loan commitments granted in 2007,largely on projects that are already under construction,and indicated that new loans to the property sector will be much lower in 2H08 4. Declining profitability of development projects could lead to lower funding inflow from private sources. Lending loopholes and fall in collateral value could lead to some real estate loan losses We believe the tightened lending standards and regulatory requirements for developer loans and mortgages by China bank regulators will help banks control property lending risks and minimize credit costs.These requirements include: (1)a minimum 35%of equity investment requirement by developers in a real estate development project; (2)prohibition of higher-risk land-purchase loans to developers;and (3)the implementation of a "closed"monitoring process for development loans. However,we believe lending loopholes could expose China banks to potential credit risks if developers start to fail.Some typical loopholes include: Development loans and proceeds from home sales could be diverted to land purchase and other development projects; Appraised value of real estate loan collaterals could be over-estimated; Some loans may not be fully secured and could hence expose banks to credit risks; and Goldman Sachs Global Investment Research 9
September 9, 2008 China: Banks Goldman Sachs Global Investment Research 9 past two years, but we believe a potential sharp decline in sales volume and financing cash inflows in 2H08/2009 could quickly lead to sizable cash outflows at those listed China developers. We estimate that, based on the aforementioned assumptions, the 65 A-share listed developers as a whole would experience sizable net cash outflows in 2H08 and 2009 vs. an inflow of Rmb27bn in 2007, and lead to cash flow squeeze at some of those developers in 1H08 and 2009. We believe the cash flow issues could be even worse for non-listed developers that could have weaker cash positions and less access to the capital market than their listed peers. Real estate loan NPLs may surface in 4Q08 if sales volume remains low We believe the liquidity situation could deteriorate quickly in 2H08, particularly at some stretched, mid-sized developers that expanded aggressively in 2007, and lead to bank credit quality risk as early as 4Q08, because: 1. Sales volume and property prices could continue to weaken in 2H08, which could put pressure on developers’ operating cash inflow. 2. Funding needs are normally higher in 4Q as developers typically pay construction companies at year-end for the part of the project that has been completed in the year. We estimate that ~33% of the full-year development costs were incurred in the fourth quarter over the past three years. 3. Banks could have a lower loan quota in 2H08 as most banks have already used up 65%-70% of the 2008 full-year loan quota in 1H08, with only 30%-35% left for 2H08. Several banks indicated that new property loans in 1H08 were due to withdrawal of real estate loan commitments granted in 2007, largely on projects that are already under construction, and indicated that new loans to the property sector will be much lower in 2H08. 4. Declining profitability of development projects could lead to lower funding inflow from private sources. Lending loopholes and fall in collateral value could lead to some real estate loan losses We believe the tightened lending standards and regulatory requirements for developer loans and mortgages by China bank regulators will help banks control property lending risks and minimize credit costs. These requirements include: (1) a minimum 35% of equity investment requirement by developers in a real estate development project; (2) prohibition of higher-risk land-purchase loans to developers; and (3) the implementation of a “closed” monitoring process for development loans. However, we believe lending loopholes could expose China banks to potential credit risks if developers start to fail. Some typical loopholes include: • Development loans and proceeds from home sales could be diverted to land purchase and other development projects; • Appraised value of real estate loan collaterals could be over-estimated; • Some loans may not be fully secured and could hence expose banks to credit risks; and
September 9,2008 China:Banks Asset ownership at China real estate developers is often unclear,which could lead to complicated,or even failed,foreclosure processes. Please see Appendix I for more details on real estate lending loopholes. Real estate investment scale-back is a macro downside risk In the light of slowing demand for residential properties and weakening cash flow outlook at real estate developers,it seems to be critical for China real estate developers to reduce development scale to conserve cash and to survive We estimate that when holding other things equal,a potential 20 percentage point(pp) slowdown in nominal real estate investment growth translates into around 1pp less contribution to GDP growth from the sector2.The real residential real estate investment has become a much more important contributor to GDP growth,in our view,and the share of residential real estate investment to GDP has increased to about 7%in 2007 from 4%in 2002. Moreover,weak property sales and construction growth could have a negative impact on a number of related industries due to potential lower demand for: Building material and related commodities,such as steel and cement. ● Machinery,in light of the decline in the number of construction projects. Home durable goods,such as home appliances and furniture due to fewer upgrade needs. Exhibit 15:Residential real estate investment has Exhibit 16:...slightly above that in many developed become a more important contributor to China's GDP... countries Residential real estate investment as a%of total China GDP Residential real estate investment contribution as a%of GDP growth 12% 10% 8% 5 6% % 6% 6% 4 4% 4% 2% 199519971998199920002001200220032004200520052007 Note:Residential real estate investment data overstates its contribution to GDP Note:Residential real estate investment data overstates its contribution to GDP as it includes land premium.At the same time,it does not capture GDP created as it includes land premium.At the same time,it does not capture GDP created by other industries that are real estate-related,in our view. by other industries that are real estate-related,in our view. Source:CEIC. Source:CEIC. 2 Nominal residential real estate investment(REl)in China constitutes about 17-18%of nominal fixed asset investment,which in turn takes up about 40%of GDP.From these we calculate nominal REl to be 18%*40%=7%of GDP.However,this number might be overstating the share of REl as REl statistics include about 30%land purchasing premium which should not be counted as part of the value-added GDP.Therefore,we estimate that real estate investment makes up about 5-6%of real GDP and a 20 pp decline in its growth rate reduces its contribution to GDP growth by about 1pp(5%*20pp). Goldman Sachs Global Investment Research 10
September 9, 2008 China: Banks Goldman Sachs Global Investment Research 10 • Asset ownership at China real estate developers is often unclear, which could lead to complicated, or even failed, foreclosure processes. Please see Appendix I for more details on real estate lending loopholes. Real estate investment scale-back is a macro downside risk In the light of slowing demand for residential properties and weakening cash flow outlook at real estate developers, it seems to be critical for China real estate developers to reduce development scale to conserve cash and to survive. We estimate that when holding other things equal, a potential 20 percentage point (pp) slowdown in nominal real estate investment growth translates into around 1pp less contribution to GDP growth from the sector2. The real residential real estate investment has become a much more important contributor to GDP growth, in our view, and the share of residential real estate investment to GDP has increased to about 7% in 2007 from 4% in 2002. Moreover, weak property sales and construction growth could have a negative impact on a number of related industries due to potential lower demand for: • Building material and related commodities, such as steel and cement. • Machinery, in light of the decline in the number of construction projects. • Home durable goods, such as home appliances and furniture due to fewer upgrade needs. Exhibit 15: Residential real estate investment has become a more important contributor to China’s GDP... Residential real estate investment as a % of total China GDP Exhibit 16: ...slightly above that in many developed countries Residential real estate investment contribution as a % of GDP growth 0% 1% 2% 3% 4% 5% 6% 7% 8% 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Note: Residential real estate investment data overstates its contribution to GDP as it includes land premium. At the same time, it does not capture GDP created by other industries that are real estate-related, in our view. 11% 9% 9% 7% 7% 7% 6% 6% 6% 6% 6% 5% 5% 4% 4% 4% 3% 3% 0% 2% 4% 6% 8% 10% 12% Ireland Spain Switzerland China Canada New Zealand Denmark USA Finland Netherlands Australia Italy Germany Norway United Kingdom France Sweden Japan Note: Residential real estate investment data overstates its contribution to GDP as it includes land premium. At the same time, it does not capture GDP created by other industries that are real estate-related, in our view. Source: CEIC. Source: CEIC. 2 Nominal residential real estate investment (REI) in China constitutes about 17-18% of nominal fixed asset investment, which in turn takes up about 40% of GDP. From these we calculate nominal REI to be 18% *40% = 7% of GDP. However, this number might be overstating the share of REI as REI statistics include about 30% land purchasing premium which should not be counted as part of the value-added GDP. Therefore, we estimate that real estate investment makes up about 5-6% of real GDP and a 20 pp decline in its growth rate reduces its contribution to GDP growth by about 1pp (5%*20pp)