June 11th, 2021, 12:12 PM GMT+0800
April 16th, 2021, 12:48 PM GMT+0800
Orient Capital Research MD Andrew Collier shares his views on the possibility of China rescuing its biggest distressed asset manager, Huarong. Collier, a former President of the Bank of China International USA, believes that China will protect Huarong, however smaller, local AMCs are more vulnerable. He speaks to David Ingles in Hong Kong and Tom Mackenzie in China during our special Huarong coverage. (Source: Bloomberg)
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China’s State Council Tuesday issued a decree ordering a “deepening” of reform of the budget management system. The key point is an order to reduce financial risk and increase transparency of local government finance. This order follows the recent cancellation of the Ant Group IPO and stricter regulations of Ant’s online financial lending platforms, along with rising bond defaults. These events suggest an increasing trend toward de-risking and credit restriction in the economy. However:
- Is the government serious this time about credit restriction or is this going to lead to new forms of “creative financing” for local governments?
- Will holders of offshore USD debt issued by local corporations face a growing wave of defaults, as we have seen onshore with companies such as Huarong Asset Management?
The Huarong case is a real outlier. As far as I know, it’s the first central SOE to get to near default status. Bloomberg is reporting that a 600M bond due in Singapore is being repaid. Clearly this whole thing is political. I would, however, look at it from two frameworks. The first is the global investor reaction and attitude by Beijing, and the second is the systemic risk issue internally.
Globally, I think Beijing is far less reluctant to allow USD credit to default now than they may have been two years ago. First, their success with Covid has given them a degree of confidence in their ability to weather crises. Second, there has been a rapid increase in foreign capital entering China, mainly into CGBs but also into other bonds and equities. The Russell Index inclusion was quite significant, for example. Their attitude internally seems to be, we are one of the most successful and largest economies in the world, why should we be concerned about international opinion? This is particularly true post-Trump, as he squandered what little leverage we had.
That doesn’t mean they are unconcerned about global opinion or defaults in general. There are issues of pride, access to capital (less important in my view), and the fact that Huarong is centrally state owned (an embarrassment for the MOF). (I think I read that the MOF is transferring its stake to CIC but I may have that wrong — if that is true, that is an interesting development, as the MOF would clearly be trying to distance itself from this disaster). But what they may do is repay many of the bonds, particularly this first one coming due, to quiet the global concern, but let one or two others default, as a warning bell to investors to examine these credits more closely. Bottom line, this international analysis of domestic Chinese finance is way more important (at least to the PBOC) toward improving the financial system than the money itself. Similar to the WTO entry in 94.
No signs of credit restraint in China
Andrew Collier | Mar 24, 2021
There is widespread talk within Beijing following the leadership meetings about a return to lower credit growth following years of excesses. This is being echoed by the western media. The Financial Times just published a piece saying that Xi Jinping is “curbing the credit fuelled excesses of the past decade.” However, the data does not yet indicate a decline in credit. Instead, there is a continued effort to de-risk the financial system, reduce the influence of large conglomerates such as Alibaba, but not touch the bulk of credit supply. This may change with March’s data but it is not yet apparent.
The credit crackdown “narrative”
As the Financial Times noted in an article published on March 18:
“The campaign initially focused on P2P platforms and other components of China’s once rampant shadow banking sector — the off-balance sheet activities that financial institutions used to funnel credit to borrowers, especially those in the private sector who found it difficult to borrow directly from banks. It has since been extended to internet finance and property. Some analysts warn that in curbing the credit- fuelled excesses of the past decade, Xi and Liu risk an overcorrection that could stifle innovative areas of financial activity and, ultimately, economic growth. From 2016 to 2019, the average annual increase in China’s corporate bankruptcies exceeded 30 per cent.”
Policy makers are intent on demonstrating their commitment to credit restraints. Guo Shuqing, Chairman of the China Banking and Insurance Regulatory Commission said this month: “From a banking and insurance industry’s perspective, the first step is to reduce the high leverage within the financial system.” Speculation in the property market is “very dangerous”, and bubbles in U.S. and European financial markets “may soon burst,” according to press reports.
At an economic conference, Influential PBOC advisor Ma Jun said noted the existence of asset bubbles in the stock and property markets and proposed a shift in monetary policy. He blamed changes in liquidity and debt for China’s stock rally last year and and home price increases in Shanghai. “Whether these issues may worsen depends on whether China will shift its monetary policy appropriately this year. These problems will continue if monetary policy remains unchanged, causing bigger economic and financial risks in the medium to long term,” he was quoted in the press as saying.
Is the government serious this time about tightening?
The numbers tell us credit growth will continue
Below is a rough estimate of various forms of credit and their growth trajectory. The lion’s share consists of bank loans. Since there is no forecast of this, I have used the February 2021 growth rate of 12 percent. This certainly could be modified down but we have yet to see this happen. The other area that is uncertain is local government debt. Since much (but not all) consists of bank loans, there is some double counting. Still, the overall trend suggests continued credit growth into 2021. None of the official targets indicate substantial declines – yet.
The government has not significantly altered its response to the economic slowdown through a large decrease in interest rates or an increase in M2. M2 rose 10.1% in February 2021 compared with 8.8% in February 2020, while the Seven Day Shanghai Interbank Rate is up marginally, to 2.23 percent compared with 2.15 percent a year earlier.
The budget deficit has increased steadily since at least 2007. The rate of increase recently is higher but the trend is clear. China did lower its target this year to 3.2 percent of GDP in 2020 from 3.6 percent in 2020. But that was a decline of just 2.7 percent to US$560 billion from US$576 billion.
Also, if we look at bank balance sheets, the growth was 10.7 percent in 2020. If that trend continues, on a much larger asset base, then this is another sign of credit growth.
Similarly, the data we can examine for state banks, large and small, show significant credit growth in both Q4 2020 with a slight decline for Q1 2021. However, that Q1 increase of 8.8 percent for large state banks and 11.8 percent for small ones is higher than nominal GDP and does not indicate credit restriction.
It helps to look at individual balance sheets. Here is an example of where the credit has been going, at least from bank lending. Angang Steel, one of the country’s largest steelmakers, enjoyed a 17.6 percent increase in long-term loans in 1H 2020. The steel sector was key to stimulus investment in 2020.
- Receivables days actual fell from March 2019 to March 2021 for the universe of all listed firms in China.
- Receivables days rose for both the steel and construction sectors. We can speculate that as construction boomed, the companies had ample credit and were able to extend payment terms to their customers.
Conclusion: No indication yet of lower credit growth
The 2020 stimulus was focused on construction and steel – the two classic areas of fixed asset investment growth. The PBOC and some senior leaders constantly talk about the danger of excess debt and credit bubbles. Action, though, has to be filtered through the state council, and the local provinces, which are ultimately responsible for growth. While there is some credit moderation, the signs do not yet suggest a significant decline and possibly even no decline compared with 2020. That could change with March or April’s data.
I am making four predictions for China in 2021:
- Weakening of the RMB
- Weaker economic conditions
- Real deleveraging
- Pressure on local bonds.
Capital inflows have been substantial, helping to reinforce the strength of the currency. Higher domestic Chinese interest rates, the rapid quelling of the virus, domestic Chinese stimulus, the relative weakness of western economies, slight loosening of capital restrictions, and the long-term potential of the Chinese economy have made it an attractive investment destination. Foreign ownership of Chinese equities has risen 55.5 percent YoY, foreign ownership of bonds are up 37.9 percent, loans 20.2 percent, and deposits 9.1 percent.
So what are the potential problems? First, it’s likely that much of the inflows consists of repatriation of USD dollar assets owned by Chinese nationals. As western countries recover, they will be chasing short-term gains and will seek to move capital offshore once again. This is “fickle capital” as opposed to secular capital such as a fund such as Vanguard would control, and we are seeing this through re-indexing to include onshore Chinese equities.
Second, once the Biden administration takes office, because Congress and Washington in general have taken to heart the Trumpist anti-China line, multilateral approaches to reduce Chinese corporate influence will be introduced. This will increase the likelihood of long-term problems for Chinese corporates globally because a coherent international policy is likely to be more effective than the haphazard approach we’ve seen under the Trump administration.
Prediction 2: Weaker economic conditions
China has been relying on fiscal stimulus through infrastructure investment funded by bank loans and bond issuance. Unfortunately, fixed asset investment in some cases has barely exceeded pre-Covid levels. The largest increase in November was in electricity, gas and water production – these are not sectors that contribute heavily to economic growth. Construction overall was 9.2 percent lower YoY. The data for equipment utilization in China from Komatsu in Japan suggests only modest YoY increases for the 2H 2020.
Prediction 3: Real deleveraging
This has been a tough global and domestic economic environment, a signal for additional stimulus. There have been multiple interest rate cuts and cash injections into the economy in 2020, representing a withdrawal from Xi Jinping’s 2016 intent to reduce debt. He has had to face the trade war and the Covid crisis.
However, despite the backpedaling, recent statements suggest the leadership in the State Council does seem concerned about debt. The state media made this official in an article in late November. “If previous rounds of withdrawing stimulus policies are a guide, ‘tight money’ and ‘tight credit’ are inevitable, and policy rate hikes are also normal,” the China Securities Journal said. “However, we shouldn’t see the monetary authority proactively raising the policy rate for some time to come.”
Prediction 4: Pressure on local bonds
The 2009 stimulus package has left the provinces struggling for tax revenue. Land sales and one-off charges have not kept up with expenditure, sometimes directed by the central government. As a result, the provincial fiscal deficit has skyrocketed from zero in 2008 to more than 10 trillion yuan in 2019. This will lead to more defaults (or near defaults) among local government bonds, along with actual defaults among the local government financing companies that are considered part of the local government, even though legally they are private firms.
For more information, please contact Globalsourcepartners.com
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Evergrande and stress in China’s property market
Andrew Collier | Sep 28, 2020
China’s property market has long been the weak link in the economy. It is the bubble that supports growth – including local consumption, fixed asset investment, and local government fiscal revenue. Although property sales remain healthy, the developers themselves are increasingly under financial strain. The case of Evergrande’s reportedly requesting a bailout from the Guangdong government is one major example.
As a result, corporate, loan and bond defaults are rising. Beijing has been tightening credit to the property sector to reduce the potential risks of a real estate crisis. However, the current difficult economic conditions, along with a shortage of capital, have raised the risks to the sector. A “Minsky Moment” is most likely avoidable due to the ability of the state to shift capital, but significant risks remain to economic growth.
Will China have a financial crisis due to a collapsing property market?
The reports in the Chinese press that China’s largest developer, Evergrande Group, has requested a bailout from the Guangdong Provincial Government have raised fears that China’s property market is on the verge of collapse. The unverified reports include a list of Evergrande’s debtors. According to that list, almost half of the company’s CNY835 billion in debt is from non-bank lenders, including private and state corporations, trusts and local government companies.
The company, which has over $120bn of debt, said in a filing to Hong Kong’s stock exchange last week that the documents were “fabricated and pure defamation” and that it had reported the matter to China’s security authorities, according to the Financial Times.
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Could the collapse of Evergrande cause a financial crisis? Yes. Property owners both with Evergrande and other developers would abandon the property asset class; banks and other financial lenders would withdraw loans, leading to bank defaults; and local governments would see their largest single source of capital evaporate.
Is this likely to occur? No. Beijing or one of its proxies would step in (they may now already be doing so) and recapitalize the company. In fact, as one of China’s wealthiest provinces, Guangdong would be a likely candidate to act as the overseer of Evergrande’s recapitalization, just as the policy banks have been put in charge of the dissolution of HNA. However, even a recapitalization would be extraordinarily messy and could dent confidence in property as an asset class.
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Andrew Collier | Sep 14, 2020
Ant Group’s proposed IPO, expected soon, raises the profile of China’s largest private online financial company. However, there are macroeconomic and political considerations that will affect the growth trajectory of both Ant and other private online financial firms. There are also competitive threats to Ant from the digitization policies at the PBOC and the online finance programs among the commercial banks. More generally, the company’s growth offers lessons on the role of online financial firms in China’s macroeconomy.
Some of our conclusions:
- Centralized digital currency: The PBOC is unlikely to compete with Ant and similar firms in digital transactions. Despite the introduction of a centralized digital currency, the PBOC’s main focus is on monetary policy and systemic risk – not consumer finance.
- Systemic risk: However, as digital finance increases in size, the risks of this sector’s impacting the macroeconomy increases. Due to new rules on online money management, Ant has shifted its business model to fees for transactions rather than directly managing assets. If digital payments begin to move bank assets to Ant’s platform, the PBOC is likely to step in once again to reduce Ant’s influence.
- Bank competition: The real risk to Ant comes from its competition with the banking industry. The increase in Ant’s “service costs” suggests that banks are demanding a larger fee for the services they are providing to Ant. This competition could stifle Ant’s growth in the future.
Among other costs, in 2019 Ant paid CNY46.7 billion in transaction fees, or 38.1 percent of its revenue, mostly for Alipay. Ant’s prospectus warns, “We cannot assure you that the transaction fee rate and any other fee or cost will not increase in the future.” It also earns significant revenue by acting as an agent for other financial firms, a revenue stream that could decline if the service providers, such as the politically dominant state banks, reduce Ant’s agency commission.
However, Ant Group’s prospectus carefully avoids disclosing precise details about fees paid or charged for financial payments or money management.
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There is no doubt China is moving quickly to digitize its financial system – at least for those able to access capital to make purchases, borrow, and invest funds. The private sector through companies like Ant and Alibaba have a strong role to play due to China’s interest in encouraging the development of its technology sector. Unlike other aspects of China’s political and economic system, the central bank is primarily concerned with monetary policy and financial stability, not control of the entire financial system.
The issue of state control does, however, come into play with the question of the revenue streams for digital payments, fund management, and other digital services. Here, the state banks, which control approximately half of lending activity, are going to be prioritized over private competitors due to the importance of savings deposits and lending activity. That is the challenge for Ant.
From a risk point of view, Beijing would like to see the growth of its online domestic firms to improve economic efficiency. However, they need to balance those efficiency gains against a) control of financial capital, particularly bank deposits; and b) financial risk, as online firms have fewer regulatory constraints compared with brick-and-mortar firms. These political and regulatory conflicts are going to restrain the growth of the online sector.
(For full report, contact Global Source Partners)
This is from a report originally written in March 19, 2018. Ant’s business clearly has changed but the analysis may still be useful.
Ant’s Over-leveraged Funding Structure
“Ant Financial has got just enough bullets to cause a small–scale financial crisis.” Economist with a State Owned Bank.
l Growing Market Share. Ant Financial has quickly taken market share from traditional banks, trust companies and other financial firms. Eventually, the regulators may reduce Ant’s consumer lending business to prevent losses by the bigger banks.
l Undercapitalized “Bank.” We estimate that Ant’s outstanding credit stands at 49x Ant Cash Now’s registered capital. This 2% capital adequacy ratio is far below the CBRC 8% requirement for commercial banks.
l Little Oversight. Ant Financial has lending data for Ant Credit Pay as it utilizes a “virtual credit card” and tracks user purchases. However, there is little data on Ant Cash Now’s loans issued directly to users. This raises red flags about potential defaults.
l Main Driver Behind Securitization. In 3Q 17, Alibaba and its finance units accounted for 82% of consumer credit ABS. This is a significant concentration of risk.
Ant Financial operates through two businesses, Ant Credit Pay, which is a “virtual” credit card customers use to buy goods through Alibaba’s online platforms, and Ant Cash Now, which provides loans in cash issued directly to users who pay in installments with interest. The capital is supplied primarily through securitized loans sold to wealthy investors. We believe there are several significant risks to the business:
l Awkward Scalability. Ant Now’s loans, because they are in cash, are untraceable, so the default rate data used for Ant Credit Pay transactions are not available. This makes the scalability and control of Ant Cash Now’s business much more difficult.
l High Leverage. In order to scale the business, Ant Cash Now has created a high level of leverage through securitized loans. Currently, total outstanding credit, including off-balance sheet items, are estimated at nearly 49 times Ant Cash Now’s registered capital, far above the regulated limit of 2.3x.
Andrew Collier | Aug 14, 2020
China’s Inefficient Stimulus
Prior to 2020, the largest contribution to growth of economic value add (with some fluctuation) has been the state sector. SOE value add bottomed out at -2.5% YoY in March 2020 but has since topped private value add at 4.9%.
The rapid improvement in the state sector side of the economy post-virus is clear in the data for certain state sectors, such as iron ore, whose operating rates actually increased during the onset of Covid.
The same rapid turnaround has been true for fixed asset investment and housing starts. After a sharp decline early on, both areas showed a relatively rapid improvement on a YoY basis.
China is relying on a combination of bank debt and bond issuance to fund this new wave of infrastructure- driven stimulus.In 2020, the central government authorized local governments to borrow 74.4 percent more for special projects than last year, increasing the allotment to 3.75 trillion yuan for 2020 from 2.15 trillion yuan in 2019. As of July 14, 2.24 trillion yuan of such special bonds were issued. In addition, local governments still have nearly 2 trillion yuan of general-purpose bonds to issue.
The longer-term issue is the productivity of the economy and its ability to generate growth. The infrastructure-driven stimulus will be less effective than other programs. The government appears to have backed away from the SME program of 2019 due to its failure to deliver growth and the urgent requirements during the current pandemic. Infrastructure projects can “crowd out” private investment and the high debt levels can increase stress to the banking system. Reliance on private credit will force the government to pay higher interest costs than for cheaper, bank debt.
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Andrew Collier | Jul 24, 2020
China has clearly been one of the success stories in handling the coronavirus. The flattening of the curve was a reflection of the nature of the tightly controlled political system. The numbers may not be completely trustworthy but even at multiples the caseload is still much lower than in other countries. As a result, the economy has picked up more quickly than elsewhere in the world.
However, the latest data for economic activity in China shows a continued split between sectors relating to heavy industry and infrastructure and the retail portion of the economy. Power generation and steel production are at high levels while passenger traffic remains low, and other indicators of local activity, such as traffic congestion, are weak.
China may be able to carry the economy forward through the industrial sector alone. But there are several red flags:
- Fiscal stimulus aimed at infrastructure is generating less efficient growth.
- Debt levels continue to climb.
- Small business – a driver of growth and employment – continues to struggle for access to capital.
- For the oil market, inadequate storage infrastructure may make further purchases for the strategic reserve difficult.
For these reasons, China may have a sluggish recovery, due as much to structural economic problems as the virus itself. This will be reflected in oil demand.
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China’s investment strategy – back to the state sector
The key to China’s economic rebound is the nature of the country’s stimulus. After reducing shadow banking, China in the past few years has emphasized private credit through the bond market and private borrowing such as mortgage loans.
This includes corporate bonds, along with bonds issued by the quasi-private/public local government companies (LGFVs). However, most important have been programs such as an increase in local government infrastructure bonds.
The target for these bonds was raised from RMB2.15T in 2019 to RMB4.75T in 2020. In addition, the fiscal deficit is increasing from 4.9% in 2019 to 11.6% in 2020. And that does not include off-balance sheet financing. Local governments are facing an RMB 11T fiscal deficit, partly due to tax cuts to help small businesses. This is another anchor weighing on future growth.
The corporate bond market has been particularly strong.