In August, the U.S. approved China National Chemical Corp.’s proposed $43 billion takeover of Swiss seed company Syngenta AG, overcoming domestic opposition on security grounds. Given the history of Chinese foreign acquisitions, one of the concerns remains the ability of ChemChina to raise the funds for the proposed purchase. In this note, we analyze several sources of capital and the political implications of the financing behind the deal.
China’s Rmb 2 trillion bond swap program is designed to lower interest costs for provincial governments by exchanging bank debt for lower cost bonds. Beijing has not clearly defined the debt, leaving much responsibility to provincial governments. This will lead to difficult negotiations among all levels of government and financial institutions.
In addition, given total local debt at Rmb 17 trillion – and probably closer to Rmb 24 trillion – the current program will need to be radically expanded. The initial Rmb 2 trillion program only covers bank loans. But these cover just 20% of the total estimated Rmb 10 trillion. In addition, there is additional debt from Trusts and other institutions. As a result, the state banks could be responsible for up to Rmb 16 trillion of debt. Assuming default rates of 50%, we estimate in the worst-case scenario this could cause a 70% decline in combined bank equity and profits.
Survey Results: Slowing Revenue Continues. Three-quarters of our survey pool saw falling VIP revenue in March and expect further declines. However, most are “neutral” about the current state of the industry.
China’s Insurance Shadow Banks
Insurance Firms Replace Trusts as Shadow Banking Channels as Local Governments Seek Capital
“Many LFGVs now consider the insurance funds as their life-saving straw to improve the debt structure as the whole country keeps a watchful eye on the risks related to local government debt.” – Chinese Insurance Executive.
China officially has 17 trillion yuan in local debt. Almost half of the debt has been incurred by off-balance sheet companies, known as Local Government Financing Vehicles (LGFVs). We visited a number of these local projects and collected data on a wider group. The objective was to understand their source of capital – banks, trusts, bonds, and whether this source of debt represents a systemic risk to the Chinese economy. In addition, we also analyzed the structure and history of local government financing, with the aim of predicting how the leadership will handle the debt burden under the circumstances of a slowing economy.
Summary: Chinese Trusts currently have 11.7 trillion yuan ($1.9 trillion) in funds outstanding for investment. These Trust assets make up approximately one-quarter of all Shadow Banking funds in China. As China’s economy slows, there is concern that Trusts – and by extension Shadow Banking in general – will undergo a wave of defaults. Using a list provided by the Central University of Finance and Economics in Beijing, we have analyzed a list of 31 failed Trusts to see what common themes they provide and what they suggest for the future of the industry. The principal conclusion is there is a surprisingly lack of government support for these failed Trust investments. In only four cases did the Trusts, most of which are government owned, provide capital. The majority of the failed trusts were simply liquidated. This suggests the implicit obligation by the Trusts to support their products may not be in force.
eijing’s desire to pump up the Chinese economy is leading it into dangerous territory.
Although China has piled on debt, the country has been relatively cautious about one of the big areas that led to the U.S. financial crisis: leverage. It was the slicing and dicing of mortgages into digestible bitesized chunks called derivatives that was a key contributor to the U.S. financial meltdown in 2007. Once they unwound, they threatened the banking system itself. Until recently, China has avoided complicated derivatives and other forms of leverage. However, desperate to keep the economy from slumping, the Chinese reluctance to wander down the leverage path seems to have faded.
A decade ago, when China was struggling to clean up its banking system, regulators pulled a rabbit out of a hat. They set up a series of “bad banks” – called Asset Management Companies (AMC) – and took Rmb 1.4tn ($125bn) of debt off the hands of the four State Banks in Beijing. It was a big success, leading to the listing of the “Big Four” banks in Hong Kong and a healthier financial system. Now, they’re trying to pull the same trick again – this time across the country.
Chinese economists are quick to point out that the country has plenty of money to pay off its debts and could easily avert a financial collapse. The government, they say, could function as lender of last resort. How does one confirm whether there are sufficient resources in China to provide adequate capital for a massive collapse in economic activity, including a popping of China’s property bubble?