Author Archives: Andrew Collier

China’s Lehman Moment?

Is China facing a “Lehman Moment” due to high shadow banking debt?

China’s shadow banking differs substantially from that of the U.S. before the financial crisis. There, the shadow lending funding the property boom consisted of collateralized and leveraged mortgage products that were highly liquid, traded instruments. Many official banks participated in this business, along with “shadow” non-banks such as insurance companies.

In contrast, China’s current shadow banking is funded mainly by the banks with few liquid instruments. Thus, the pace of decline is is more controllable compared with the U.S. crisis. Three-quarters of LGFV debt is bank debt, for example, with bonds and private investments accounting for the remainder. The recapitalization, or default process, is under the jurisdiction of the banks (with political input from the local governments and the PBOC).

Bank loans?

Where could China see a run on a bank or shadow bank? The one recent example in January 2023 of a near default by an LGFV, Zunyi Road and Bridge, was averted by a 20-year bank extension of 60 billion yuan in outstanding debt, and no repayment of principal for 10 years. It’s unclear if Zunyi will set a pattern. Regulators have hinted that it would not because they don’t want the banks to encourage the growth of bad debt or see bank margins hurt.

However, no LGFV wants to be the first to default as it could cause a chain reaction among all LGFVs, and possibly some local SOEs, and hurt the career advancement of the provincial or city party leaders.

There are many channels of debt in China’s property market. However, they all directly or indirectly go through the banks. That means that the PBOC and the Central Financial Work Commission in the Central Committee of the Politburo, along with lesser political actors in the provincial governments, have some ability to pull the strings—when the puppets threaten to dance their own tune. Significant losses will be absorbed by the weaker institutions, including poorer provincesweaker rural banks (which may be absorbed by stronger SOE banks), and home-owners with few legal tools for compensation for lost property. The deleveraging process in the property market will be a series of lengthy, local battles, not a single war.

Beijing’s Evergrande Solution

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Beijing believes the risks of a US-style financial crisis caused by a property bubble outweigh the risks of an Evergrande default. But it is also encouraging a “soft” landing for the resolution of Evergrande’s debt problems that would avoid political unrest and a bank crisis. How will Beijing resolve this conflict?

Beijing plans to force the local governments to resolve debt issues locally. This passes the responsibility from the center to the periphery. The Politburo’s attitude is that the provinces have benefited from the success of companies like Evergrande, so it is up to them to solve it. This absolves the center’s financial responsibility.

More importantly, the geographic diversity of debt solutions is likely to avoid a systemic problem in the economy or financial system. One question is crucial: What is the capacity of local governments to absorb Evergrande’s debt?

Catalysts and transmission in the Minsky Moment

A rapid deleveraging of assets requires both a catalyst and a transmission mechanism. China differs substantially from the United States pre-crisis in that it does not have the large pool of securitized assets that led to the U.S. mortgage crisis. The majority of lending to the property market is through the banks. Liquid instruments in the shadow banks – through Trusts, wealth management products, and interbank loans – have been sharply curtailed over the past five years. Even for Evergrande, only about 10 percent of liabilities are WMPs.

The potential catalysts for a property-driven financial crisis include:

  • A collapse in Evergrande’s outstanding WMPs that causes a run on WMPs across China.
  • A rapid reversal in property prices that convinces buyers to sell, a pro-cyclical action that would accelerate the downturn in the property market.
  • A widespread belief that the central government is no longer interested in supporting rising property prices and is willing to accept the collapse of the entire market (even before any specific policy actions have been taken nationally).

“Common Prosperity” and the Economy

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What does Xi Jinping’s “common prosperity” mean for the economy?

Andrew Collier | Aug 30, 2021

Executive Summary

Xi Jinping launched his vision for common prosperity officially in an internal meeting in the Politburo on August 17. This was a follow-on to the harsh regulations imposed on China’s technology sector. Although Xi has been using the term “common prosperity” for several years, its appearance in his speeches doubled in 2020, according to a Bloomberg analysis. What does this term mean for the economy and the markets? We draw several conclusions:

  1. Targets related to inequality that enhance Xi’s popular appeal will be at the top of the list. This includes wealthy entrepreneurs and their companies and those deemed not contributing to the construction of a socialist society.
  2. Luxury goods and those involved in “corrupt” consumption will suffer either from press campaigns or actual policy changes such as higher taxes, reduced profit margins, or other financial measures.
  3. The property market will continue to be curtailed. This follows the reduction of risk through the Three Red Lines policy in 2020 (which I presume was launched by the central bank and not the Politburo and was a reasonable policy). However, a serious attempt to enact a property tax is unlikely.
  4. Fundamental restructuring will not occur that could meaningfully contribute to improving income redistribution. This includes the state sector and the use of the VAT instead of general income taxes.

Xi Jinping is most determined to reduce the challenge posed by large, powerful companies (such as Jack Ma) but lacks the interest – or power – to alter the country’s underlying economic structure, particularly the state sector, which could significantly improve income equality in China. (For full report, contact Global Source Partners).

China Credit Risks: Bloomberg TV

Orient Capital Andrew Collier on China’s Credit Risks, ‘Common Prosperity’

September 6th, 2021, 12:17 PM GMT+0800

Orient Capital Research Managing Director, Andrew Collier, discusses a potential default risks in China of indebted companies such as Evergrande and Huarong. Andrew also tell us what “common prosperity” term may mean for the country’s economy and the markets. Andrew is a former president of the Bank of China International USA, and the author of a book on shadow banking in China. He speaks with David Ingles on ‘Bloomberg Markets: China Open’. (Source: Bloomberg)

China’s Education Crackdown – How Far Will This Go?

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China’s Education Crackdown – How Far Will This Go?

Andrew Collier | Jul 27, 2021

Executive Summary

The new regulatory crackdown on the educational sector in China was a surprising move by China. New Oriental Education’s shares plunged 17.5% on the news. What really is a shock is how small the companies are in this sector – EDU has a market cap of just $6.6 billion. What is going on and how far will this go? Is China reverting to a 100 percent state-owned economy?

China’s “mini-decoupling”

There are a couple of micro reasons for the latest regulatory crackdown.

First, the education companies, as with many of the smaller tech companies, are listed in the U.S. China is intent on reducing the ability of Chinese companies to access capital in the west. This is to further the goals of financial decoupling. Eliminating the VIE structure and NASDAQ listings would reduce the power base of private entrepreneurs in China. In addition, education is focused on getting students into international schools and teaching them foreign languages, particularly English. According to the Chinese Society of Education, about seven in 10 students in kindergarten through 12th grade receive after-school tutoring in major cities like Beijing, Shanghai, Guangzhou and Shenzhen, the Wall Street Journal reported. This does include studying for the internal college tests but much of it is internationally focused.

This teaching of international studies is not something that Beijing wants to encourage. The party doesn’t want private domestic or foreign capital or foreigners controlling China’s educational system. The education ministry must pay attention to the propaganda department; every educational establishment has a party secretary, which controls the educational system. This has been going on the ground for some time but is now being formally instituted through the regulators.

Second, education in general is part of the data/information world. Xi Jinping would like to reduce the ability of any non-state actors to control anything to do with this sector. Education, loosely, falls within this camp. So between foreign listings and information control, Beijing gets to kill two birds with one stone. This follows the clear examples of state control over Ant Financial, Wepay and other financial and data-oriented firms.

U.S. IPOs are a problem for China. U.S. capital that is given to Chinese entrepreneurs provides a foreign capital base. This is now being discouraged. That’s not to say there wouldn’t be disruption to China’s financial system and to global investments if there is a continued cancellation of U.S. IPOs – what I would call a “mini-decoupling.” According to the U.S.-China Economic and Security Review Commission, in October 2020, there were 217 Chinese companies listed on NASDAQ, the New York Stock Exchange (NYSE) and NYSE American, with a combined market capitalization of $2.2 trillion. In 2020, Chinese- based companies raised approximately $11.7 billion in the United States through 30 initial public offerings.

The interesting question is whether private capital in China’s growth story really matters. If the state controls the regulators, does ownership of capital truly mean ownership of power?

The large pools of capital (trusts, local government companies, private funds, and even private companies) creates an incentive structure separate from the state. The PBOC, the CBIRC, and the State Council can reach into this network, but they have limits to their control. Such features as the huge pool of local debt cannot be eliminated without disastrous consequences for the economy. And this debt has many private strings to it. Thus, the death knell for the private economy in China should not yet be written.

Bloomberg TV Interview – Huarong and the Economy

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)

Huarong and China’s Economy

Global Source Partners

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:

  1. Is the government serious this time about credit restriction or is this going to lead to new forms of “creative financing” for local governments?
  2. 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 inChina

No signs of credit restraint in China

Andrew Collier | Mar 24, 2021

Executive Summary

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.

  1. Receivables days actual fell from March 2019 to March 2021 for the universe of all listed firms in China.
  2. 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.