Download Recapitalize the banks through more asset

In the first three quarters of 2009, Chinese banks’ net new loans totaled 9.38 trillion
RMB, or just over a trillion RMB per month.
Why the surge in lending?
China is an primarily export driven economy. Exports account for around X percent of
China’s GDP, while consumptions accounts for about a third. The imminent slowdown
motivated those who import Chinese goods to drawdown inventory levels and new
orders for Chinese good dramatically slowed. The rational response to lower demand
Chinese firms to reduce production and cut workers, but social pressures cannot allow
this. China must keep its industries exporting.
As demand has slowed
The pace and magnitude of this lending has stoked fears of a china banking crisis. Why?
Case against hard landing
Case for softer landing
PP NPLs are at this %
They are low because of 1, 2, 3
The CBRC knows this and hence its enforcement of 150% provisions for the three NPLs
categories.
This will likely contributed to even more overcapacity
There is evidence that the loans are not going to the real economy but instead to
stockpiling commodities, investing in A-shares, and real estate and property markets.
Those speaking most loudly about China’s GDP figures
The current weakness in the U.S. dollar is also helping Chinese exporters since the
renminbi is pegged to the dollar. China’s exports are still down in yoy terms, but are
moving up sequentially.
MONETIZING DEBT
China also has the option of monetizing portions of the banks’ debt. China currently has
a relatively strong national balance sheet— it’s gross external debt at the end of 2008
was $387 billion, it’s public debt of Y is relatively low, its projected deficit was X percent,
it has foreign currency reserves of $2.33 trillion. For these reasons china has not had to
put in place quantitative easing, but China could opt to monetizing its debt because of
their undervalued currency. The undervalued renminbi provides China them scope to
print money in proportion to the increased demand for the renminbi were government
controls over its purchase liberalized. If they overshoot and print too much, well they’d
just devalue their currency and boost exports! However this could potentially spark
inflation would be the death knell for the central government as inflation tax away its
citizens’ savings.
Recapitalize the banks through more asset management companies and debt for
equity swaps. STRATFOR sources have advised that Debt / Equity swaps are no
doubt under consideration for any future NPLs - either directly between the Banks and
borrowers, or again from the AMCs as the middle men.
China's economy expanded by 8.9 percent in the third quarter,
you still have to explain how china can escape from what has been the fate of EVERY
high-growth export-dependent economy in the past 20-30 years
Exports are up, largely because of the US dollars decline, to which the RMB is
pegged.
Summary
While China largely avoided the subprime mess, spillover from the ongoing financial
crisis in the West’s more developed economies has taken its toll on China’s export
sector. Beijing has been implementing massive fiscal stimulus and encouraged a new
lending spree that has averaged over a trillion yuan ($146.5 billion) per month in the first
nine months of this year. However, while the pace and magnitude of this lending has
stoked fears that China may be laying the groundwork for an imminent banking crisis of
its own, China could potentially delay the day of reckoning for some time to come.
Analysis
While China’s banking industry may have successfully sidestepped the subprime
debacle currently roiling the West’s more developed economies, the global contraction
hit China’s manufacturing and exporting industries hard. Beijing has sought to
counterbalance the external slowdown by stepping in as the spender and lender of last
resort. Beijing hopes that in combination with its fiscal spending and supportive
macroeconomic policies, increased bank lending will keep Chinese businesses from
closing shop until global demand returns once again. The pace and magnitude of this
lending has stoked legitimate fears that China may be laying the groundwork for an
imminent banking crisis of its own. There are, however, a few reasons why China could
potentially delay the day of reckoning for some time to come.
In the first three quarters of 2009, looser lending restrictions and pressure from Beijing
combined to boost China’s net loan formation to 9.38 trillion yuan ($1.37 trillion), up 153
percent compared to Jan-Sep of 2008 and already more double last year’s total of 4.23
trillion yuan ($619 billion). While the pace of lending in the third quarter slowed to 541
billion, net new loan formation could potentially total 10 or 11 trillion RMB by year-end,
which would be the equivalent of 33.3 or 36.6 percent of last years’ GDP.
CHART: NET LOAN FORMATION
Beijing has tried to offset the fall in exports by boosting domestic consumption by
offering credits or rebates for big-ticket consumer items like a cars and refrigerators.
The effort has been successful and consumer medium- to long-term (MLT) loans are up
about 222 percent when compared Jan-Aug of 2008. But consumer loans only make up
13 percent of total loans, and while every bit helps, the idea that china could ever
internally consume a large portion of their exports is a ways off.
CHART: RETAIL LOANS
Most of the corporate loans, or 43 percent of total new loans, were medium to longterm— loans with maturities of one year or more. The People’s Bank of China (PBOC),
China’s central bank, doesn’t report the allocation of the MLT loans by sector, but it’s
reasonably to estimate that more than half of corporate MLT loans have been used for
infrastructure and related projects, with the rest going to capital expenditure. Corporate
bill financing— whereby a bank loans cash to an enterprise against its receivable
earnings— constituted 15 percent of total new loans, an increase of about 817 percent
over the same period last year. This enormous increase indicates that businesses have
been strapped for working capital, especially in the first half of the year. In the third
quarter, bill financing has all but stopped, a consequence of the CBRC’s efforts to curb
fraudulent bill financing.
CHART: CORPORATE LOANS
If corporations aren’t generating cashflow, corporations won’t be able to shuffle around
their debt, let alone actually pay it down. This fact has many concerned about credit
deterioration further down the road, triggering a significant rise in nonperforming loans
(NPLs)— loans who service payments are delinquent for longer than a specified amount
of time or . An NPL ratio is a common metric used to gauge the relative health of a
given bank or banking industry. It measures what percentage of total loans is
“nonperforming”— while definition varies, china considers loans whose payments are
delinquent for more than 30* days to be nonperforming. The PBoC insists that the
Chinese banking industry is healthy and recently announced that the NPL ratio of
commercial banks was 1.4 percent, down from 1.8 percent at the end of 1H09. While
this may be true, the metric is slightly disingenuous because loads of bad debt is
periodically carved-out from the state-owned banks and handed over to an asset
management corporations (AMCs). The AMCs essentially buy the bad debt at face
value to recapitalizing the given bank through a clever process whereby the issue bonds
and give a little cash. Since 2000, more than 2.2 trillion yuan ($325 billion) has been
offloaded from banks’ balance sheets and placed under the stewardship of AMCs. The
NPL ratio is also flattered simply by the extension of credit in and of itself. By issuing
new loans, a given banks’ NPLs as a percentage of their total loans books decrease with
the issuance of new, ostensibly “healthy”, loans because the total loan book increases.
This partly explains why many in Beijing are concerned about rising NPLs should
China’s economic growth slow— without the constant issuance of new, “healthy” loans,
NPLs will nominally rise as their presence is truly felt amidst static loan book growth.
While Beijing has signaled that it intends to keep, for the foreseeable future,
accommodative macro policies largely in place in order to drive growth and keep
unemployment low, the concomitant expansion of China’s broad money supply raises
concerns about inflation. China’s broad money supply cannot grow at 35 percent a year
without eventually producing the “too many yuan chasing too few goods” situation.
Currently, the velocity of money— the number of times the same yuan is spent— is
undoubtedly lower, and hence the slight disinflation in China as of late. However, if it
were to take off, inflation could sound the death knell for the central government as the
citizenry becomes increasingly unruly as their earnings are taxed away by inflation. Just
as an aside, this the chart shows how effective Beijing has been at getting banks to lend,
as loans and money supply have gone up in tandem, unlike in the west where
governments flood the system with liquidity but banks refuse to lend it.
CHART: LOAN GROWTH & MONEY SUPPLY
To wit, in the first five months of this year, it is estimated that some 1.5 trillion yuan
($220 billion) made its way into not into the “real economy,” but into Chinese stocks and
property markets. This is a natural consequence of Chinese citizens’ limited investment
opportunities, but it’s not necessarily a bad thing, as modest asset reflation does in fact
increases the value of collateral which people have taken out loans against (not to
mention that local governments derive a large portion of their annual revenues from land
sales). However, the People’s Bank of China (PBOC), China's central bank, has sought
to attenuate this activity and temper asset inflation by recently mandating the purchase
of PBOC bonds worth 100 billion yuan ($14.6 billion) for those banks that it believes to
have been overzealous or imprudent in recent lending/investing. The compulsory bond
purchases removes from banks' ledgers capital that would otherwise be lent.
Perhaps the most serious concern for China’s banking industry is that in the event of a
double dip or sharp deterioration in the global macro backdrop, corporate earnings could
again decline, thereby pressuring corporates’ ability to service debt and/or pay down
principle. We believe the financing will remain largely in place because the long-term
nature of the loans, and the structural importance of the projects they’re financing,
suggests that the local and central government implicitly back them. So while the
current levels of lending and support are unsustainable in the long term, government
officials will likely do whatever is necessary to support business and keep unemployment
low, however dysfunctional or infeasible the projects or their financing may be.