2016-03-10

Chinese Banks May Swap Bad Debt for Bad Equity

The first chart below is evidence of state support in the market. Banks are among the largest companies in the Shanghai Composite.
Support may have already ended though.
Bloomberg: China's Stocks Sink as State Funds Go Absent, Developers Decline
The suspected failure of state funds to prop up stocks on Thursday removes one of the key supports for the world’s worst-performing equity market this year amid deteriorating economic data and disappointment over stimulus measures announced during annual policy meetings this week.

Banks may also be rallying on news that China will allow the banking system to take equity stakes in companies.

Reuters: China to ease commercial banks' bad debt burden via equity swaps - sources
China's central bank is preparing regulations that would allow commercial lenders to swap non-performing loans of companies for stakes in those firms, two people with direct knowledge of the new policy told Reuters.

The new rules would reduce commercial banks' non-performing loan (NPL) ratios, and free up cash for fresh lending for investment in a new wave of infrastructure products and factory upgrades that the government hopes will rejuvenate the world's second-largest economy.

...The sources, who spoke on condition of anonymity, said the release of a new document explaining the regulatory change was imminent. The People's Bank of China (PBOC) did not immediately respond to requests for comment.

"Such a rule change shows banks' bad loans have risen to such a level that this issue has to be tackled now before it's too late," said Wu Kan, Shanghai-based head of equity trading at investment firm Shanshan Finance.

State banks have extended loans to government financing vehicles and state-owned coal and steel producers, so this policy can help give lenders time to deal with non-performing assets as China pushes supply-side reforms, Wu added.
Will the equity stakes dilute all shareholders equally, fall on private investors at the expense of the state, or transfer state assets to the banks? The latter would represent a backdoor privatization of assets if the banks were able to sell the assets later. Or will the banks be short-changed on equity value and have losses transferred to their books, to be dealt with down the road with another bailout?

The cynical take is China is simply doing this to reduce debt levels and allow banks to lend even more. Based on where that credit is going, we can look forward to more housing bubbles if this is the case. Also bank balance sheets loaded with overvalued equity in bankrupt coal mines and steel mills, along with home loans to buyers with single-digit equity stakes.

2 comments:

  1. I agree that this will be used primarily as a tool to allow for more debt issuance. Also it is a signal to the Chinese that technicalities like the ability of creditors to force bankruptcy will no longer be possible.

    I think this will lead to much greater capital outflows from China, reason being that the credit spigots will be wide open with even less scrutiny in order to prop up these zombie companies. It has always been possible to skim money off the top, and the Chinese have done so en masse in large volume, but this new round will be even more extreme. Furthermore whereas previous skimming primarily went to domestic speculation, the new round will be primarily headed overseas.

    If you imagine ship builder boss years ago he saw big orders, big boats being made, his company's name on ships all around the planet, he legitimately thought that China was growing to become an economic superpower. But now the orders are gone, his company has been broke for years, and the government is stepping in to say "keep your workers busy doing anything, I don't care what, just keep them working." The boss says he has no boat orders to work on and no money to pay employees with, so the party just tells the banks to continuously lend whatever amounts are necessary to keep the peasants active. The boss will as usual skim off the top, probably in gigantic amount, and instead of keep the money in China because he envisions it to be a growing superpower, he will take it all overseas because he sees China as becoming a Great Leap Forward backwater.

    This will be 4/4 on Central Bank failures. Yellen raised rates = dollar down gold up. Kuroda went NIRP = stocks down yen up. Draghi blew his bazooka = euro up stocks down. Next is PBoC bails out the country to keep the economy going and try to attract Chinese to keep their investments domestic = real economic collapse and RMB deval

    - Luke

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    1. The only constant seems to be stocks down.

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