How times change in China. Or maybe not.
This year the People’s Bank of China replaced its monthly loan quota system with a new procedure — its Macro Prudential Assessment that is meant to monitor credit growth.
The change comes at a time when once again the flow of total credit is being ratcheted up, both from the banks and the nonbanks in an effort to support economic expansion.
Between the fourth quarter of 2008 and the end of the third quarter of last year, non-financial sector debt swelled 279 per cent and now amounts to 249 per cent of GDP, according to data from the Bank for International Settlements. Those numbers don’t capture the jump in credit in recent months.
China’s banks are meant to do their national service in a variety of ways — and never mind their obligations to minority shareholders.
As Chris Wood, strategist for the CLSA arm of Citic Securities, notes, recent talk of the banks converting part of their debts into the equity of their weaker corporate clients points to the “political reality that the interests of the banks could be subordinated to the interests of the real economy — a potential negative for shareholders in Chinese banks”.
It also suggests that another distressed debt cycle looms.
There have already been seven corporate defaults this year, with more likely. Credit spreads have widened sharply as a result, which means that after a rush of issuance of late, the bond market may not be as kind to issuers from now on, Mr Wood adds.
Many bold foreign investors are beginning to consider the opportunity either in buying up loan portfolios, or in extending rescue financing to those sectors where the banks are forbidden to lend. Options include offering funds to property developers for acquiring new land banks, and taking as collateral existing projects.
In April, Huarong and Cinda, the asset management arms of ICBC and Cinda respectively set up by Beijing to help clean up bad loans, reported strong earnings, particularly in their distressed debt businesses, with annualised yields of about 12 per cent on restructured loans and returns of more than 20 per cent on disposed assets, according to CreditSights, the fixed income research boutique.
The combined purchase of distressed debt assets amounted to almost Rmb400bn ($ 61.4bn) in 2015, up 31 per cent from 2014, with sellers including non-financial institutions as well as banks. Much of that activity came from restructuring property debt, CreditSights added.
While this shows that there is opportunity, it isn’t clear whether that opportunity extends to outsiders.
Since Guangdong International Trust and Investment defaulted in 1998 — becoming the first formal bankruptcy of a major Chinese financial institution after its failure to repay a $ 120m loan to a foreign lender — foreigners have ventured into this treacherous turf with caution.
There is a belief that China lacks a level playing field, that few transactions actually occur at market prices and that there isn’t a clear rule of law, although bankruptcy processes are far more transparent now.
Moreover, it isn’t obvious whether this cycle will be more or less virulent than the last one.
Huarong’s performance was based on disposals from the last cycle, leading CreditSights to wonder how sustainable such results are, given the structural slowdown, the painful progress in reforming state-owned enterprises and in reducing chronic overcapacity in numerous sectors. Many of the problem assets come from the heartland of China, an area that stretches from the rust belt in the north-east to the mines of Shanxi in the interior.
Industrial profits have recently improved. However, a big part of that improvement comes from activities separate to the core business of industrial companies and from investment income, according to JPMorgan data.
Further, those profits have been concentrated in just a few sectors, especially electronic equipment. State-owned enterprises have lagged behind both foreign-owned and private enterprises, as their profits dropped 5.7 per cent in the first three months of the year — admittedly an improvement over their 22 per cent plunge in 2015 — while income in the other two groups rose.
All these problems will inevitably show up on bank balance sheets. Still, that doesn’t mean that there will inevitably be a financial crisis in China. There is no sign of the liquidity issues that bring banks down. On the other hand, there is no sign that their balance sheets will improve any time soon either.
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