Unprecedented Financing Pressure Crushing China's SMEs, Trillions in Non-Standard Debt Coming Due, PBOC Action Expected

Analysts from China Merchant's Bank lays out why the current default wave is a far greater risk than the earlier rounds because of far greater magnitude and far tighter liquidity conditions among other reasons. SMEs are under serious financing pressure, suffer liquidity mismatch, soaring financing fees, ROEs below the cost of capital and the disappearance of non-standard financing as they have to roll over their non-standard debts. Since financing remains tight for SMEs, the PBoC may be forced to ease more than it wants in order to prevent systemic risk. More yuan depreciating RRR cuts are likely on the way.

华尔街见闻： 躲不过的“违约”——民企债务依赖的刚性正在显露

The author of this article is China Merchants Securities Xie Yaxuan, Li Yuze, Wang Yuting, the original title "[Must read depth] financing dilemma, risk transmission and policy research judgment"

Using the two-point method + double-level framework to observe, private enterprises have been forced to curb by tightening leverage and making large net profit methods; debts with high interest, delayed deleveraging and “maturity mismatches” are quickly revealed, pressuring refinancing capabilities. The cash flow pattern of internal and external difficulties has caused private enterprises to suffer a shortfall in liquidity.

Can external financing slow down the pressure on private enterprises? Even if it does not constitute a "threat", it is "lucky". Unlike the previous round of tight credit, innovations in the table have led to the construction of complex endogenous co-insertion between banks and banks, banks and non-banks, non-banks and non-banks. In the reverse process of idling, the non-bank idling multiplier will exponentially decay, and it is difficult to add non-standard to offset. In addition, the debt of private enterprises is in an embarrassing situation. The ABS is too small, and the non-standard external financing outside the system is “hard to protect”. The cash flow of private enterprises is experiencing the darkest moment.

The Google translate is a mess, but basically the money multiplier is slamming into reverse.

The analysts see Q3 as the high point for liquidity risk:

Static observations, credit risk may be concentrated in the third quarter. According to our previous calculations, whether it is deduction or revision, the non-standard concentration will be in the second and third quarter of this year (the second quarter may be delayed). Even if the credit bond financing is restored, it is difficult to make up for the gap caused by the non-standard collapse after the hedging expires. Excessively intensive non-standard breaches will damage the financial system through non-interbank, non-bank-interbank chains, which will undoubtedly further weaken the broad money derivation.

This entire section is bold in the original:

In general, the transformation of the micro-structure has caused the current credit crisis to be much greater than in the past. If the policy decision simply duplicates the broad monetary policy in 2014, it is not difficult to fill the financing gap in the short-term linkage of the bank's asset side. If broad credit is used, it is difficult to avoid the "old disease" in which private enterprises suffer discrimination. At the same time, the credit volume and non-standard maturity are disparity, and it is difficult to achieve effective conversion of financing methods. Therefore, it is not excluded that the central bank will restart the orientation policy in the third quarter. Whether it is targeted reduction or targeted interest rate cut, or whether specific enterprises can obtain credit concessions, the purpose is to prevent the financing gap of the private enterprise sector from becoming a systemic risk from a structural perspective.

The PBoC may have to turn on the liquidity fire-hose if it wants to offset the collapse the non-bank lending.

Private enterprises have strong profit margins and ROE (yellow). Centrally-owned SOEs (gra). Local SOEs needed help in 2016 (steel and coal overcapacity).

On the one hand, the ROC of state-owned enterprises and private enterprises has risen and leveled, revealing the favorable targets of supply-side reform. As one of the variables that determine ROE, ROIC produces differentiation between private enterprises and state-owned enterprises. The ROIC recovery of local state-owned enterprises began in the initial stage of the supply-side reform. The growth of private enterprises' ROICs was not as obvious as that of state-owned enterprises, and the second was flat, which did not drive ROE growth. The differentiated return on investment shows two pictures:

First, the price logic and the improvement of concentration caused by the supply-side reform are actually more inclined to state-owned enterprises, especially local state-owned enterprises;

Second, the return on investment returns of private enterprises is a bit "cold", and the correlation between ROE improvement and ROIC is limited.

On the other hand, private enterprises ROIC is not bad, but why is the solvency sharply weakened? For the split of the ROE, we move further to: ROE-ROIC=(ROIC-r)* net financial leverage. The credit qualification curve on the right side of the equation shows that pure return on investment can cover debt interest rates to a large extent. Obviously:

1) The improvement of the credit qualification of state-owned enterprises is the result of the linkage of ROIC;

2) The ROIC of private enterprises has not deteriorated significantly. Why is the deviation from the credit qualifications of state-owned enterprises more and more obvious? Mapping three possible factors, one is that the level of debt is acceptable, but the cost is generally too high (r is larger); the debt structure is unbalanced; finally, the financial leverage is quite high, the financing cost is slightly lower than the investment return, and the credit qualification will be A rapid decline.

Therefore, based on the above splits, it can be found that the internal cash flow level and the increase in net profit have led to a simultaneous rebound in ROE between state-owned enterprises and private enterprises, but the driving factors are quite different. The former comes from the improvement of ROIC (real return on investment), which is related to the expansion of financial leverage or debt size. So is the guesswork about the debt structure of private enterprises appropriate? We further observe the characteristics of the debt structure level (external cash support) below.

Local SOEs have seen their return on equity climb above their return on capital, but high financing costs have left private firms underwater:

Debt-to-asset ratios of private firms have risen thanks in part to high financing costs, slowing their deleveraging efforts.

Moreover, the financing of private enterprises has been discriminated against, the high interest-bearing debts and the prevalence of “short-term borrowing and long-term use” have intensified the risk of rolling debts.

On the one hand, the ratio of interest-bearing debt to total debt symbolizes the difficulty of financing, while the average proportion of interest-bearing debt of private enterprises has been higher than 50% since 2013, and the side also reflects the pain point of discrimination in the financing stage. At the same time, compared with state-owned enterprises, the adjustment of interest-bearing debts of private enterprises is lagging behind, and the above-mentioned asset-liability ratio has suddenly increased into two sides, all indicating that external debt is “addiction”.

On the other hand, the “maturity mismatch” method of reducing debts weakens the ability of private enterprises to resist risks. In the wide-currency cycle of 2014-2015, debt costs are low, and companies continue to roll short-term debts for long-term use. However, due to the reversal of financing conditions, state-owned enterprises have not changed much in terms of profit improvement and background advantages. As for private enterprises, it is difficult to realize short-term borrowing. This is why we will see that most of the subjects that have been breached this year can be attributed to liquidity risk, and even the issuance of bonds may become the trigger for redemption pressure.

This chart shows the share of interest bearing debt versus total debt for private, local SOE and central SOEs (top to bottom lines). The gray shaded area shows the widening spread between private firms and central SOEs.

This next chart shows the ratio of short-term/long-term debt at private firms (red, left axis) and SOEs.

Private firms are seeing the fees associated with financing explode.

3, the picture of cash flow: private enterprises cash flow pressure, unprecedented

The cash flow is the most direct portrayal of “internal and external troubles” from the perspective of cash basis. Based on the above discussion, it is not difficult to find that the differences between the private enterprises and the state-owned enterprises in 1) profits have increased sharply, and 2) the former is more obvious in the debt structure. In fact, the above two major subjects have already reflected the shortcomings of corporate cash flow from the side, but it is not straightforward because of the use of accrual accounting. If we look directly at the cash flow level, private companies are experiencing the darkest moments.

On the one hand, the internal hematopoietic function of private enterprises is insufficient, reaching the lowest point since 2008. The internal hematopoietic function of the enterprise is measured by the net profit of operating and investment cash flow. Since 2016, the free cash flow gap of private enterprises has expanded significantly in the negative interval. After the financing conditions were reversed, the decline was even faster. The difference between cash flow and profit growth is essentially the result of the interaction between the downstream corporate debt rolling and the increase in accounts receivable.

Net cash flow at private firms (red bars) is in the red versus well the black at SOEs (gray).

On the other hand, net free cash flow + net cash flow from financing reflects the beginning and end of the debt cycle of private enterprises. From the wide-currency cycle of 2014-2015 to the tight credit cycle since 2017, the sum of the three net cash flows of private enterprises highlights the liquidity dilemma. Different from the above-mentioned free cash flow gap, and the net cash flow from financing, the cash flow of private enterprises has turned from negative to positive, further supporting the above conclusion that the internal cash flow of private enterprises is weak and can only be supplemented by external cash flow. However, the soaring financing costs have led to a narrowing of refinancing channels, rolling debts are unsustainable, and the sum of net cash flows is forced to face a downturn. On the contrary, the state-owned enterprises themselves have advantages in financing, coupled with the help of supply-side reforms, the cash flow is becoming more and more full.

In summary, the impact of credit crunch on private enterprises should not be underestimated. First, through the expansion of accounts receivable, the differentiation of net profit and free cash flow gap will be aggravated; secondly, the means of expanding debt and pushing up profit will be interrupted; It is to curb the debt "mismatch" and restrict the ability to renew debt.

At this stage, the pressure on private enterprises' cash flow is unprecedented. Under the pattern of internal liquidity collapse, whether external debt can effectively roll over becomes the key to judge whether the subsequent credit risk will continue to spread. Below we will discuss further the possible impact of tight credit.

Private firms have increasing relied on raising non-standard financing whereas SOEs benefited from reform efforts and higher profits:

Major defaults were avoided in 2013 because shadow banking stepped in where banks stepped out.

The same credit contraction, the magnitude is not the same

1. The past experience of deja vu: Why did the tight credit in 2013 not cause a large-scale default?

The cooperation between Yinxin and China is the main mode for the development of the first phase of the shadow banking. We have discussed in the non-standard measurement _20180626 from the perspective of “ Expiration Nightmare: “Large Asset Management” . From 2008 to 2013, the “channel-non-standard” asset expansion drive model is based on the cooperation of silver letters. , the bank's cooperation and other channels are supplemented by carriers. This type of model docking financial investment is prevalent. This is also the same as after 2010, the credit crunch, the expansion of the physical financing gap, and the need for financial support, while the city investment company and the real estate industry are the main digestive subjects.

In terms of social integration, the sudden increase in non-standard net increments from 2012 to 2013 is not unrelated to the bank-investment cooperation model. Among them, the proportion of new trust loans jumped to 10%, hitting the peak of history. However, with the beginning of the No. 8 document in early 2013, the bank's financial management investment began, and the process of non-standard returns was gradually accelerated.

Trust lending surged in the prior "deleveraging" wave and defaults surged.

Then, has there been a large-scale debt default at that time? The trust product redemption crisis has been one after another. When the credit bond and asset securitization markets have not matured, the credit financing channels are concentrated in bank loans and non-standards. The non-standard loans are concentrated in private enterprises, urban investment platforms and local enterprises with “two highs and one surplus”. The rise of the bank-trust cooperation model has made up for the bank's financial management's appeal to high-yield, and it is also a detourary supervision, and disguised lending to “forbidden investment” enterprises. In fact, before the issuance of the Notice on Regulating the Relevant Issues Concerning the Investment Operation of Commercial Banks' Wealth Management Business, in early 2012, the model of trust-taking off-balance-sheet business showed signs of stopping, and the number of new projects was scarce, which also indicated the pressure of entity refinancing. The emergence of.

Based on the data at the time, 1) the trust redemption crisis was basically concentrated in the end of 2012 and the beginning of 2013. After the issue of the 8th document, the trust products that were breached were more frequent, and 2) the capital demanders for default were private enterprises. Most of the projects invested in real estate are followed by coal projects.

Judging from the reasons for the difficulty of redemption, the focus is on 1) the tight cash flow of the enterprise, and 2) the financing party to repay the private credit, and the trust products cannot be issued in a rolling manner, so there is pressure for redemption. In fact, this is a very similar situation to the companies that defaulted this year.

Trust defaults in 2013:

Trust defaults by industry (coal 4, real estate 15).

Skipping to the punch, the surge in financing dwarfs the trust surge back in 2012 adnd 2013, therefore the risk is far larger and could pose systemic risk.

For entity financing, especially for private enterprises that rely on non-standard financing, it is not only difficult to obtain new non-standard support, but the pressure of constructing the centralized maturity will also create a high point (for the specific measurement process, see “ Expiration Nightmare:” Tube non-standard measurement _20180626》. Assume that the channel non-standard and social welfare non-standard average duration is 3-3.5 years, and the total non-standard amount due this year is about 7 trillion. Moreover, considering that non-standard products may have the inertia of redemption, the second quarter and the third quarter will be the peak of concentrated expiration.

In summary, the intricate relationship between banks and non-banks has constructed a very different feature from the previous round: 1) the inter-bank vacancy in the bank + the nested idling between non-silveres exacerbates the fragility of the system, and the new asset management The rule of the law, the reverse process of going to the "bubble" will appear in the form of a multiplier, the new non-standard sharp reduction will be the inevitable result, and 2) if the non-standard breach occurs in a large area, the bank and non-banking are hard to say "being alone", 3 The physical financing gap, especially for private enterprises that are not subject to non-standards, will not only be unable to renew their liabilities, but will also face a large number of non-standard maturities in the third quarter.

Timing of maturities, by type of debt. Left hand scale is trillions of yuan.

Net financing at private firms has collapsed:

Second, P2P, financial leasing and private lending are difficult to protect themselves. P2P and financing leases increased by more than 300 billion in the month, which seems to ease the pressure on non-standard maturity. However, this type of financing is not only short-term, high cost, but also in the strict background of laws and regulations in recent years, or will shrink, it is difficult to become a "breakthrough."

Finally, although ABS has a policy of “protecting the car”, the market is too small. Asset securitization is encouraged by the policy, but the contradiction between “far water” (a small inventory of ABS) and “near thirst” is not enough to slow down the liquidity pressure of enterprises. Coupled with the improvement of penetration criteria, not all SMEs meet the requirements.

The analysts conclusion:

Based on the above analysis, we can easily find out:

1) In the past, private enterprises have been tightened by pushing up leverage, and the means of making large net profits have been curbed by tight credit; the debts with high interest-bearing debt, sluggish delays and “mismatch mismatches” have been exposed too quickly, and the ability to refinance has been suppressed. The cash flow pattern of internal and external difficulties has caused private enterprises to become a gap in physical liquidity.

2) Can external financing slow down the pressure on private enterprises? Even if it does not constitute a "threat", it is "lucky". Unlike the previous round of tight credit, innovations in the table have led to the construction of complex endogenous co-insertion between banks and banks, banks and non-banks, and between non-bank and non-bank. In the reverse process of idling, the non-silver idling multiplier will exponentially decay, and it is difficult to add non-standard to offset. In addition, the debt of private enterprises is in an embarrassing situation, the ABS is too small, and the non-standard external financing outside the system is “hard to protect”, and the cash flow of private enterprises is experiencing the darkest moment.

3) Static observation, credit risk may be concentrated in the third quarter. According to our previous calculations, whether it is deduction or revision, the non-standard set expiration will appear in the second quarter of this year. Even if the credit bond financing is restored, it is difficult to make up for the gap caused by the non-standard collapse after the hedging expires. Excessively intensive non-standard breaches will damage the financial system through non-interbank, non-bank-interbank chains, which will undoubtedly further weaken the broad money derivation.

In general, the transformation of the micro-structure has caused the current credit crisis to be much greater than in the past. If the policy decision is to simply copy the broad monetary policy of 2014, it is difficult to fill the physical financing gap in the short-term linkage of the bank's asset side. If wide credit is used, it is difficult to avoid the "old disease" in which private enterprises suffer discrimination. At the same time, the credit volume and non-standard maturity are disparity, and it is difficult to achieve effective conversion of financing methods. Therefore, it is not excluded that the central bank will restart the orientation policy in the third quarter. Whether it is targeted reduction or targeted interest rate cut, or whether specific enterprises can obtain credit concessions, the purpose is to prevent the financing gap of the private enterprise sector from becoming a systemic risk from a structural perspective.