Sucker for Bad Loans... history to repeat itself?

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http://www.scmp.com/comment/article/1544348/china-must-allow-bad-loans-fail-good-its-economy


China must allow bad loans to fail for the good of its economy

Andy Xie says China must tackle the related problems of overcapacity and high leverage to stabilise its financial system, and this requires resolve to sort out bad loans and the property market in particular




China's structural reforms have stalled. The decision to deepen reforms, taken at the Communist Party's third plenum last autumn, has produced few tangible results so far. Worry over financial stability seems to be a major factor in blocking meaningful reforms.

The recent measures, marketed as a mini stimulus, aim to shore up financial stability. The targeted reductions in deposit reserve ratios, for example, are helping some banks that are experiencing a liquidity crunch due to mounting non-performing loans. Mini-stimulus measures, like the redevelopment of urban slums, channel loans to local governments that need new loans to service the existing ones. Such measures merely prolong the unsustainable status quo.

China has stimulated the economy with debt since 2008. Most of the current debt stock is from the period after the global financial crisis. Local governments, property companies and supporting industries, as well as property buyers, leveraged up to absorb the debt. Rising leverage and land prices - the primary collateral - formed a temporary equilibrium that channelled money into overinvested industries.

Overcapacity and high leverage pose a mortal threat to financial stability. The former destroys profitability of capital- intensive industries and their ability to pay banks. Overcapacity isn't limited to commodity industries. Residential and commercial properties have massive oversupply, as does the financial industry, pumped up by the credit bubble.

The current stabilisation measures merely keep everyone afloat. But, as long as overcapacity remains, more of these measures are needed to prolong stability, because industries with overcapacity bleed cash and always need money to stay afloat. The stabilisation measures will never lead to a solution.

China must deal with overcapacity to stabilise the financial system. Cutting some capacity will expose some bad loans, lower gross domestic product, and hurt the revenues of some local governments. But overall profitability will improve and banks will be able to function normally again. The steel industry, for example, suffers from serious overcapacity. The post-2008 stimulus artificially boosted prices. Local governments saw expanding steel mills as an easy way to increase GDP and fiscal revenue. Now the bubble is deflating. Steel prices are down 40 per cent from the peak.

Obviously, profitability has crashed. But local governments have protected their steel mills from closure by persuading banks to roll over loans and add some more. The longer the situation lasts, the more value is destroyed, and the more losses the banks will eventually suffer.

Oversupply similarly afflicts the property market. On the residential side, more than 4 billion square metres of housing is under construction, while there may be over 40 million empty flats in the existing stock. The combined total could accommodate 300 million people. A plan is needed to deal with this inventory overhang, or the banking system will face deep trouble for years to come.

Some of the mini-stimulus measures sustain liquidity for local governments and the banks that are exposed to the troubled industries. But this is only a stalling tactic, and will work only if the tide of hot money surges again, which is unlikely. Authorities have to deal with overcapacity and the non-performing loans.

Capacity needs to be reduced for financial stability. The steel industry, for example, has to consolidate into a few large companies. Inefficient mills should close. But local government resistance and banks' unwillingness to expose their non-performing loans are in the way. Therefore, the central government needs a special task force to deal with both.

In the property market, construction should stop in cities where new property is not selling in sufficient numbers to justify extra supply. Local governments have an incentive to keep things going, for the sake of GDP growth. And banks want to sustain the perception that the underlying loans are good.

But the property industry is such a catastrophe that Beijing should set up another task force to clean it up. Vested interests are creating the perception that all is OK, hoping that speculation will revive to bail them out. Waiting will only lead to more waste.

The central government has been focusing on affordable housing and the redevelopment of slum areas. These projects need to take into account the oversupply in the commercial market. Rather than building more, the government should consider offering cash subsidies for citizens who qualify for affordable housing, so they can buy in the market. That won't solve the problem, given that such demand is small compared to the supply overhang, but it would at least cut down waste.

Non-performing loans won't sink China. The country has enough potential in productivity increases to pay off whatever the losses are from the huge policy mistake of 2008. As the bubble deflates, the economy is becoming more efficient. China should be able to handle a loss of 10 trillion yuan (HK$12.1 trillion) over five years. But we must deal with the problem now, rather than cover it up. Holding up bankrupt entities is like propping up zombies and will only increase the cost.

There is no miracle cure for China's problems. Action is needed now to recognise, then solve, the issues of overcapacity and non-performing loans.

Andy Xie is an independent economist

 

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http://www.reuters.com/article/2014/06/06/singaporebondschina-idUSL3N0ON14G20140606

GIC bets big on Chinese debt

Fri Jun 6, 2014 1:27am EDT


By Lianting Tu

June 6 (IFR) - Singapore sovereign wealth fund GIC is making waves in the Asian debt markets with a series of unusually big investments in bonds from China.

According to market sources, in recent weeks, GIC has bought US$700m of unrated 4.7% bonds due 2019 from computer maker Lenovo, a US$400m 2019 private placement from property developer Vanke, and a HK$2bn (US$258m) 3.2% 2020 note from internet group Tencent Holdings.

Adding to the sudden increase in activity, the fund is said to have been behind the anchor order for the US$350m reopening of China Resources Land, as well as a big buyer in several other transactions.

The investments in unrated bonds and private placements mark a newly aggressive approach from GIC. It also contrasts with the liquidity-driven investment philosophy of other sovereign wealth funds, which typically prefer to invest taxpayers' money in high-rated and well-traded securities.

"A US$700m order for an unrated bond is a big thing for a sovereign wealth fund," said one banker.

Observers believe the shift in investment strategy marks a rebalancing of GIC's portfolio towards fixed-income assets and North Asia.

"GIC has been rebalancing into emerging markets in the last five years, particularly into China," said Enrico Soddu, an analyst at London-based Institutional Investor's Sovereign Wealth Center (SWC).

Based on SWC data, GIC's investments in North Asia grew to 13% of its portfolio last year from 8% in 2008. During the same period, it reduced its European exposure to 11% from 27%.

The latest deals, however, suggest GIC is allocating a greater portion of its portfolio to fixed income. GIC had 21% of its assets in fixed income at the end of 2013, up from an unusually low 17% in 2012, the SWC data showed. GIC does not publish a detailed breakdown of its investments.

"Before, GIC was just another bidder for public bond deals and was not a big player," said a source familiar with the matter. "Now, it is increasingly taking the anchor investor role."

Another source agreed, saying: "Lately, GIC has a shopping list of fixed-income names, with focus on China and tech paper."

The unusual approach, however, raises questions about GIC's concentration of exposure to Chinese fixed income.

"Given the diversification mandate, it's not typical for GIC to take concentrated positions on the equity side. Presumably, the same philosophy would apply to its fixed-income investments," said Joseph Cherian, practice professor of finance and director for the Centre of Asset Management Research and Investment at the National University of Singapore's Business School.

UNDER NEW MANAGEMENT

A recent management reshuffle at GIC could explain the shift in strategy. Last year, several senior managers were replaced, while the fund reviewed its investment strategy at the same time.

"This [the large bets on Chinese bonds] is perhaps possible under their new investment framework that was established last year, where an investment board oversees its active investments and pays particular attention to large investments, but with careful risk management," Cherian said.

Among the senior management, five of the seven positions were filled with new staff, all of whom were promoted internally. While implementing the management change, the fund also adopted a new investment framework with a reference portfolio based on the model of the Canadian Pension Plan Investment Board.

The reference portfolio targets a 65% allocation in equities and 35% in fixed income, which reflects the Singapore Government's risk appetite, according to the GIC website. The portfolio also includes an active portfolio, which allows the fund to use opportunistic strategies.

As of the end of 2013, GIC had assets under management of around US$315bn, according to the SWC. So, a 14% rebalancing means another US$44bn to invest in cash and bonds.

However, as it moves more heavily into fixed income, the GIC is not buying indiscriminately.

Vanke's five-year private placement pays a coupon of 4.5%, which is attractive relative to its 2018s currently yielding around 4%. Tencent's HK$2bn bonds due 2020 were priced at par to yield 3.2%, higher than its US$2bn due-2019 currently yielding around 2.9%.

Lenovo's US$1.5bn bond, priced to yield 300bp over US Treasuries on April 29, is one of the best-performing issues in the last month in Asia, according to traders. The paper was quoted at a spread of 221bp on June 4, or a cash price of 104, representing a 4.2% cash gain in the last five weeks and a US$29m paper profit for GIC.

Much of the rally, however, was due to the fact that portfolio managers heard the rumour that the GIC was the anchor on the deal.

The paper profit may be sizable, but GIC is not likely to flip the bonds for a quick gain.

"GIC is the buy-and-hold type of investor, and it is likely looking at long-term gains. It is unlikely that it will use its bulky positions to move the market," said a Singapore-based bond trader.

GIC declined to comment. (Reporting By Lianting Tu; editing by Christopher Langner and Steve Garton)


prepare for CPF minimum sum to b raised to 100?

 

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Hong Kong faces increasing debt risk from China
By Jing Song
30 June 2014
Keywords: hong kong | china | hkma | debt

Hong Kong faces increasing debt risk from China

Mainland China’s debt risks pose an increasing threat to Hong Kong’s banking system, with analysts fearful that the exposure could have serious implications.

The Hong Kong Monetary Authority (HKMA) is looking further into how the lenders are exposed to China because the city’s bank are lending increasingly to mainland companies.

Hong Kong banks lent a total of HK$2.867 trillion ($370 billion), including trade finance, to mainland companies during the first quarter, according to a June report by the HKMA.

The figure means Hong Kong banks were 10.8% more exposed to the mainland in the first quarter, compared to end-2013’s HK$2.59 trillion. Last year, the bank’s mainland exposure grew 29% and accounted for 20% of their total assets at end-2013 versus 16% at end-2012.

For the first time in its quarterly report, the HKMA disclosed a detailed breakdown of China-related lending, highlighting how the authority is closely monitoring the cross-border lending market.

According to the report, China’s private sector borrowed 8.2% more than the year before and the public or state-owned entities 12.6% more; trade finance increased 30% while bank loans rose 8.1%.

Moody’s said its outlook on Hong Kong’s banking sector remains “negative” over the next 12 to 18 months, considering the worsening credit situation on the mainland. It cited the country's slowing growth, increasing corporate debt, especially in property and infrastructure, and potential risk of debt default.

The International Monetary Fund and rating agency S&P this year also warned of Hong Kong banking risks in terms of their increasing lending to China.

“The key risks that underpin the negative outlook are the banks’ growing exposures to mainland China, deteriorating credit conditions in the mainland, asset market imbalances in Hong Kong’s economy, and the government’s proposals on revised bank resolution regimes,” said Sonny Hsu, a senior analyst with Moody’s.

Potential risks for HK banks

Hong Kong banks have evolved as an important offshore financial conduit for the mainland.

They can offer low-cost funds to mainland groups compared with their Chinese rivals, and companies in China have in any case found it difficult to borrow from the domestic market due to the tight liquidity conditions.

Also, there has been an increase in cross-border trade and investment activity between Hong Kong and the mainland.

But the strong growth in lending by Hong Kong banks to mainland borrowers will put pressure on the banks’ liquidity profiles and capitalisation levels, according to analysts.

According to the HKMA, Hong Kong retail banks posted a non-performing loan ratio (NPL) of 0.46% in the first quarter, a relatively low level compared to mainland banks’ average of 1%. In March, the HKMA said Hong Kong banks’ China-related NPL was 0.25%.

However, if Hong Kong banks continue to increase exposure to China, and China’s economic growth slows down significantly, the banks’ NPL could rise close to 1% and might have bad loans of HK$28.7 billion, based on the total China-related loans of HK$2.867 trillion.

About 60% of Hong Kong bank loans to China companies have underlying collateral, according to a HKMA officer in April.

But usually the Chinese borrowers’ collateral is in the mainland and sometimes it is not easy for Hong Kong banks to claim the collateral, analysts said.

There have already been cases where Hong Kong-listed mainland companies had gone bankruptcy but investors still have difficulties in tracing the companies' mainland assets.

“Hong Kong banks may need more time to evaluate the borrowers’ assets and liabilities. They also need to face a different legal and regulatory environment if the debtors can’t pay,” said Liao Qun, chief China economist with Citic Bank International.

China debt risks accumulating

Meanwhile, risks are still accumulating in the mainland credit market.

China has overtaken the US as the world's largest issuer of corporate debt with $14.2 trillion outstanding as of the end of 2013, according to S&P.

There are also signs that Chinese banks are borrowing record amounts from international bond investors to meet Basel III global banking regulations, while Hong Kong banks are one of the major investors in these bonds, according to analysts.

Chinese financial institutions issued $14 billion offshore bonds this year, compared to last year’s year-to-date amount of $2.7 billion, according to Dealogic. The markets Chinese banks are tapping include Hong Kong, Taiwan, Singapore and the Europe.

The key drivers behind the strong growth in the banks' mainland exposure are mainland and overseas corporates' expanding cross-border trade and investment activities, relatively low funding costs in Hong Kong compared to China, and credit demand diverted to Hong Kong from within China due to tighter liquidity conditions on the mainland.

Adding to fears is that China is seeing more problem debt products in the domestic market. This year, the country’s first corporate bond default – by solar-cell maker Shanghai Chaori – occurred, suggesting the government is less willing to bail out troubled firms.

Chaori was sued by one of its creditors last week and was asked by a local court to go into the bankruptcy process. The company said that it could only pay Rmb4 million of a Rmb89.8 million coupon due in March.

Risk contagions

Will China’s onshore debt risks spread to the Hong Kong banking system? Investors have already started to think about the questions.

Moody’s answer is that the Hong Kong banks have so far maintained conservative credit standards on their mainland-related lending and report good asset quality metrics.

One major determinant factor is China’s economic growth.

“If China can remain a growth rate at above 7%, there is little chance that the domestic debt problem leads to systematic massive defaults and exerts on overseas markets like Hong Kong,” said Liao Qun.
http://www.financeasia.com/News/388258,hong-kong-faces-increasing-debt-risk-from-china.aspx

 

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Qilu Bank's lawsuit against government finance body exposes rift in China's debt market

Case is odd also because the government lending vehicle is a stakeholder in the bank, according to observers

A Chinese bank is suing a local government financing vehicle over a bad loan in a rare public display of a deepening rift between lenders and borrowers in China's murky US$3 trillion local debt market.

Qilu Bank, based in the city of Jinan in the coastal province of Shandong, announced in its last year annual report, published online in Chinese and English, that it was suing a local government financing vehicle (LGFV) over unpaid debt.

The unusual step also highlights growing strains in the market confronted by slowing economic growth and a property sector that has started to cool off after decades of runaway expansion.

The bank said the Urban Construction and Comprehensive Development Company of Licheng District failed to make payments on a 35.4 million yuan (HK$44 million) outstanding loan, along with 6.1 million yuan in unpaid interest.

“To the best of our knowledge, this is the first official disclosure of a LGFV default on a bank loan,” wrote Nomura analysts in a research note distributed to clients on Monday.

Neither Qilu Bank nor the company in question answered phone calls requesting comment.

Much of the mainland's massive debt overhang and its accompanying industrial overcapacity was incurred by local governments using such vehicles, known as LGFVs, to get around laws prohibiting local governments from borrowing directly.

These entities, financed by local banks, were linked to the local governments and conducted investment activities on their behalf.

They dabbled in real estate, battened on subsidies to strategic industries like solar power, and otherwise helped contribute to China's industrial overcapacity and its real estate asset price bubble.

Until recently banks have been willing to roll over LGFVs' debts indefinitely, avoiding write-downs and keeping reported non-performing loan (NPL) ratios at levels well below what analysts considered realistic - a strategy analysts say worked fine so long as China maintained double-digit economic growth.

Chinese banking sources agreed that while de-facto defaults by LGFVs are common, the public nature of the disclosure was unusual given the fraternal relationship between the two entities.

Both are headquartered in Jinan, and according to the Qilu report, the Licheng District LGFV is one of its shareholders, holding 0.08 per cent of its shares.

“LGFV defaults are to be expected and are inevitable,” said a loan officer at a Shanghai-based Chinese bank, who spoke on condition of anonymity, but said in most cases the defaults were hidden from public view using accounting methods.

However, pressured by regulators to clean up their books, banks have grown less willing to roll over the loans and more sceptical about local governments' readiness to bail out failed their financing arms.

A senior bond trader at a major Chinese state-owned bank in Shanghai noted that while investors still largely considered debt issued by provincial-level financing vehicles to be effectively guaranteed, that no longer held true for lower-level entities.

“Bonds issued by provincial LGFVs are privately guaranteed by related local governments, but I don't think lower-level LGFVs' debt is guaranteed in a similar way.”

Beijing has said it is trying to move away from the investment-intensive economic model that spurred the development of local financing vehicles, and the central bank announced in January that it would move to eliminate those with “unclear functions” and unsustainable finances.

The local government financing vehicle bond market has yet to experience a public default.

Beijing did allow China's first default of a publicly traded bond in March, and since then other firms have also defaulted, but none of them have been operating under presumed government guarantees the way LGFVs do.