NOTVERY LONG A few years ago, conventional wisdom was that China would do whatever it takes to save its biggest companies from bankruptcy. The times have changed. Three giant companies: Evergrande, the country’s largest real estate developer; Huarong, its largest investor in delinquent bank assets; and Suning, a retail giant, all suffer from financial difficulties.
The three companies’ long race to expand has come up against slower growth, tighter credit and tighter regulatory control. Their bonds are trading at haircuts of around 25% from face value, showing that investors have taken into account a significant probability of default.
People in the financial industry are wondering if the government will really let them fail. An analyst for a large asset manager who owns Huarong bonds said his company believes the state will eventually save the bad bank, given how critical it is to cleaning out non-performing loans from the system. financial. A former central bank adviser said Evergrande and Suning could be more consumable, posing fewer systemic dangers.
In the first place, the problems of these companies are a reflection of their own mismanagement. Evergrande has more debt than any other Chinese listed company. Huarong had a president who was executed for corruption. Suning pulverized money with abandon, buying trophies such as Inter Milan, the football club.
But the government’s willingness to let them go to the brink also indicates something else: its confidence that the banking sector is now strong enough to face a big crisis. This was not always the case. In 2015, Chinese banks were hit by a near-crisis when more than $ 1 billion in cash rushed out of the country and business failures increased. Several banks eventually needed bailouts.
Many investors still view them as being in a weak position. With few exceptions, Chinese banks listed on the Hong Kong Stock Exchange are trading well below their reported asset values, implying a high degree of pessimism about their outlook. The fundamental problem is their super-fast credit issuance over the past 15 years, when their loan portfolios have grown nine-fold, almost twice as fast as the overall economy.
Yet any fair assessment of Chinese banks must address the changes that have made them more secure. Regulators have settled some of their off-balance sheet baffles, illustrated by a reduction in their loans to other financial firms. These loans, which make it difficult to know where the risk lies, have climbed to 78% of GDP by the end of 2016. Today they are down to around 54%.
Banks are also better prepared for the bumps to come. They had capital buffers equivalent to 14.7% of their assets at the end of 2020, a record. Even though bad loans hit nearly 2% last year, the highest in more than a decade, banks have built up enough provisions to cover a near doubling. The government is also now requiring the largest banks to prepare resolution plans in the event of a problem.
These changes bring China more in line with global regulatory standards, albeit with a twist. In most countries, the overriding goal is to avoid having to force the state to bail out reckless banks. In China, however, the state already has controlling stakes in most of the major banks.
“The question is, do you wipe out equity that is already public money and then inject fresh taxpayer money? Or do you avoid erasing equity to begin with? Said Nicholas Zhu of Moody’s, a rating agency. Regulators, he says, are taking a blended approach, likely to support low-yielding senior debt but not junior debt such as perpetual bonds.
China’s weakest banks are almost entirely its smallest. They tend to have more questionable assets, less professional management, and thinner capital cushions. Rather than dealing with them one by one, regulators strive to tie them together. Mergers are underway in Liaoning, Shanxi and Sichuan provinces. “Consolidation is something that we are waiting for. This allows for higher demands on corporate governance and risk control, ”says Vivian Xue of Fitch, another rating agency.
Perhaps the biggest concern of Chinese banks today is not their recklessness, but the fact that regulators themselves are creating new risks with a new set of lending rules. Worried about the real estate industry, they asked banks to cap their mortgages and other real estate loans at 35% of their loan portfolios. Meanwhile, regulators last year ordered banks to increase lending to small businesses by 30 to 40 percent.
“In the past, regulators complained that banks all looked the same and wanted them to serve different customers,” said May Yan, analyst at UBS, a bank. “Some of the recent regulations make banks look alike. Their income trends are already more similar. Take, for example, the ten largest banks in China. Virtually all of them posted earnings growth of around 2% last year, with the lowest differentiation on record between their results.
This trend suggests that the main risk for Chinese banks is the lack of diversification. In addition to having similar loan profiles, their assets are massively concentrated in China. Foreign loans now represent only 2% of their loan portfolios. All loan loss provisions, capital buffers and improved governance can make them more secure. But ultimately, the only metric that really matters is the health of the Chinese economy. ■
This article appeared in the Finance & economics section of the print edition under the title “Brace, brace”