Category Archives: Macro

China’s Bond Swap – How to Price Risk

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.

China’s Insurance Investments in Trusts – More Risks

The growth of investments by China’s insurance industry into Trusts started in October, 2012 after the China Insurance Regulatory Commission (CIRC) released Document 91. This was the first time regulators gave explicit permission for insurance firms to invest in domestic Trusts. By the end of 2014, insurance firm investment in Trusts and cross-shareholdings nearly doubled to Rmb 281 billion. Approximately two-thirds of insurance investment in Trust plans are in property and infrastructure, each accounting for one-third of total investment. Both of these pose industry and systemic risks. In our previous report, we looked at investments by the insurance industry in alternative assets. In this report, we drill down on the relationship between the insurance sector and the Trusts in particular.

P2P and the State Banks in China

There are now more than 1,700 P2P online lending companies in China with a volume of $42 billion in 2014 to 630,000 cumulative borrowers. Although the loan balance is small compared with the total consumer loans of $3.8 trillion and business loans of $9.6 trillion at the end of 2014, it is growing at 3x to 4x per year. The real question is how far are the regulators going to allow private companies to take market share from the state banks?

China’s New Shadow Banks – Insurance

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.

New Tricks for Capital Flight

Growing Use of Service Sector
“A VAT invoice issued by a restaurant in China could have more legal power than the receipt provided by an overseas company” — foreign commercial banker in Shanghai.

Chinese and western banks have discovered a new way to illegally transfer funds abroad – payments for services through false invoices, fake subsidiaries, and study abroad schemes.

China’s Local Debt Problem

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.

Failed Land Sales in China

For the past decade, land has functioned as a giant piggy bank for China’s cash starved local governments. Whenever they ran short of funds to pay for anything from retired steelworkers to eye exams there was usually a piece of land ready to put on the market. Unfortunately, the piggy bank is running on empty.

In 100 Chinese cities tracked by the China Real Estate Information, the volume of land sold fell 47 percent for third quarter this year. Revenue dropped a shocking 75 percent, with prices down 52 percent. For the first time in years, when they put up land for auction local governments suddenly found themselves with unsold parcels. In the past six months, almost 20 percent of land for sale failed to find a buyer.

Trust Failures in China – The First Wave

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.

China’s Shibor Crises and the Fundamental Economy

The attitude among the top leadership – and the history of the PBOC’s relationship to the Shibor – suggests that the concerns are not liquidity but the fiscal structure of local governments. The difference is important; if you think the PBOC failed to react to the Shibor hike because it was “teaching the banks a lesson,” then you miss the point that the PBOC considers the Shibor to be a sideshow compared to the issues in the larger economy.

China’s Shibor Crisis and the Fundamental Economy