There’s an old canard about Chinese retail investors: They love owning property so much that they never sell. It’s easy to see where the idea comes from. Fifty-five percent of Chinese household wealth is tied up in property, and 80 percent of those properties are paid off in full. But China’s property market is cooling, and the country is in the midst of a radical re-balancing of individual investors’ portfolios – less real estate, more wealth management products (WMPs). That shift portends a major boon for financial institutions, particularly those with a strong portfolio of investment offerings.
Chinese households have been building wealth at an impressive clip over the last five years, and much of that has been redirected into the real estate market. The net worth of Chinese households has nearly tripled since 2008 to $32 trillion, second only to the United States. Real estate investment has tracked right alongside it, nearly doubling in value from $590 billion in 2009 to $1.4 trillion in 2013, according to the U.S.-China Economic and Security Review Commission.
Chinese investors have traditionally flocked to property because a savings account was the only viable alternative. But financial products have proliferated in recent years as regulators loosened their grip, financial institutions competed to offer higher-yielding products to customers, and the spread of mobile devices and high-speed Internet allowed easier access to financial products. Bank deposits fell from 68 percent of households’ gross financial assets in 2008 to 59 percent in 2013, Chinese bank analyst Victor Wang and his colleagues wrote a June report, “Follow the Money: Fewer Bricks Please.”
While they still represent a fraction of investors’ real estate holdings at 7 percent, wealth management products ($1.4 trillion, 61 percent annualized growth since 2008) are the new belle of the investors’ ball, growing faster than equities ($1.5 trillion, 20 percent), insurance products ($1.2 trillion, 20 percent) and mutual funds ($450 billion, 8 percent).
Non-deposit financial assets still account for a relatively small share of Chinese households’ total assets – 15 percent compared to 22 percent for bank deposits and 55 percent for property – but that share is going up. Taking into consideration factors such as the use of mortgages and taxes, Wang says housing prices would have to rise 30 percent over the next three to five years to compete with the 5.5 percent prevailing annual average return on wealth management products. And that’s not likely to happen.
Everbright, a Chinese bank, created the first wealth management product in 2004, and banks have driven the fast growth in the asset class ever since. The main attraction: circumventing the low government-mandated interest rates banks are allowed to pay on deposits. Customer assets are invested in a variety of different asset classes, such as corporate bonds, and they also offer downside protection in exchange for a ceiling on gains — banks make money through management fees and the fact that they retain the spread if the investment earns more than the maximum return. (If the underlying investment doesn’t perform as promised, the bank simply returns the principal, minus its fees.) Chinese banks listed on the Hong Kong stock exchange control more than half of the market, and the Industrial and Commercial Bank of China and China Construction Bank are the biggest issuers.
Those who buy into WMPs are often unaware of what, exactly, they are investing in. Thus, WMPs are part of China’s much-discussed shadow banking system, as are products called trusts, which are also growing quickly as part of household portfolios. Several wealth management products and trusts have defaulted over the last few years, raising concerns about the stability of China’s financial system. In March, China’s Banking Regulatory Commission created new rules on the management of WMPs, requiring banks to fence off their WMP-related operations in dedicated business units by September 2014, complete with separate risk management and accounting functions. The idea is to prevent banks from using other businesses, including their credit operations, to prop up WMP returns and provide liquidity. Banks will also have to disclose more details about their WMP offerings to a national information center, as well as disclosing risks to investors. They’re also now forbidden from guaranteeing returns.
Wang says the new regulations are “a necessary step to enhancing WMP operations and minimizing potential disputes” and does not believe the rules will have much impact on the bottom line of banks that sell large numbers of them. In fact, Credit Suisse expects the wealth management product market to keep growing – after all, putting money sitting in a savings account into another bank-offered product is a relatively easy substitution, and the property market seems like an increasingly grim place for investors. To wit: Credit Suisse Chinese housing analyst Jinsong Du expects housing prices to stay flat over the next five years. Property stocks soared in July as several developers reported higher June orders, but Du says it’s more telling that unsold inventories rose sharply, too. If households do start accelerating sales of real estate, it would compound an existing oversupply problem. In China’s 25 largest cities, an average of 672,000 square meters of new housing came online in June, while only 442,000 square meters were sold, indicating that new supply is outpacing buyer appetite.
What’s more, home sales in 10 major cities last week were down 16 percent year-over-year and 19 percent year-to-date, while the average price of a new home in 70 Chinese cities fell 0.47 percent in June, the second consecutive decline. Meanwhile, Dong Tao, Credit Suisse’s Chief Economist for Non-Japan Asia, writes in a July note that despite appearances, the People’s Bank is hardly in easing mode. At best, its highly targeted liquidity-enhancing measures indicate a shift from a tightening stance to a neutral one. “The central bank remains very cautious about reviving speculative activity in the property market,” says Tao. Translation: Don’t expect a major monetary stimulus to juice the housing market.
Who stands to gain the most? According to Wang, it will be the banks with strong high-end retail businesses. And those banks whose business models evolve from relying on arbitrage from low-interest, low-risk bank deposits to a wealth management model stand to gain an estimated $71 billion in fees in 2018 as Chinese households reallocate their fast-growing wealth to financial products.