It’s fair to say that China’s equity market has become rather erratic during the past few weeks and months. A staggering $3trn has been wiped off the value of Chinese equities after a three-week slump. Despite the authorities’ best efforts, the market is struggling to regain its composure.
Unfortunately, it’s not just Chinese investors that are feeling the effects of the country’s bear market. There are now some signs that declining stock prices are forcing investors to sell their houses to recoup losses.
At the beginning of July, China’s securities regulator announced that property had become an acceptable form of collateral for margin traders. But five days later, a number of Chinese real estate agents reported that investors were rushing to sell their properties, at a 10% discount to the market price, in order to cover losses from equity investments.
For Asia-focused lenders, Standard Chartered (LSE: STAN) and HSBC (LSE: HSBA) this could be rally bad news. If investors really are looking to dump property to meet margin calls, it could spark a wave of selling across China’s already weak property market. This could in turn, force highly leveraged property developers out of business. The knock-on effects throughout the regional and global economy could be disastrous.
Difficult to tell
It’s difficult to tell how banks like HSBC and Standard would cope if a portfolio of China’s debt mountain suddenly turned bad. Although, it’s reasonable to assume that the two banks would face a hefty bill.
China is heavily indebted. Between 2008 and 2014 non-financial corporate debt grew at a rate of 24% per annum and at the end of 2014 the country’s total debt pile amounted to 220% of gross domestic product. Around 15% of the country’s annual GDP is now funding interest payments.
This could become a problem for HSBC. The bank’s new strategy, to withdraw from international market like Turkey, Brazil and possibly even the UK, redeploying assets in the Pearl River Delta and Southeast Asia, will leave the bank overexposed to China’s indebted economy. City analysts have already expressed their concern at the bank’s decision to go ‘overweight’ China, at a time when the country’s future is uncertain.
Still, in the short term, cutting 25,000 jobs and realigning its operations to focus on China should boost HSBC’s growth. However, a lack of international diversification could hold back the group’s long-term growth.
Standard Chartered has enough problems on its plate without having to worry about China’s debt.
Nevertheless, the group’s structural overhaul to shift capital and power to new regional hubs should ensure that the group has an experienced regional management in place if the economic situation within China deteriorates. By removing overlapping layers of management, Standard hopes to cut more costs beyond the $1.8bn in savings over three years it announced recently. HSBC already employees the regional hub model.
Unfortunately, Standard is already facing mounting losses from its exposure to commodity markets within Asia. It’s estimated that the bank will need to raise between £5bn and £10bn to cover non-performing loan losses and recapitalise the balance sheet after. As the prices of key commodities have only fallen further since this estimate was produced, the bank’s losses could be even greater than initially expected.
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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has recommended HSBC Holdings. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.