Asia Slides As China Overnight Repo Soars On Fears Of Another Domestic "Tapering" Episode, Preparations For Bank Loan Defaults

Tyler Durden's picture

Following the past two days of reports in which we noted that both the broader Chinese housing market was overheating and reflating at an unprecedented pace as 69 of 70 cities posted Y/Y home price gains, while a separate report showed a blistering 12% price increase in Shanghai new homes in one week, it was only a matter of time before the PBOC resumed its tighter policy posturing, which infamously sent short-term repo rates to 25% briefly in June and nearly led to a collapse of the already fragile local banking system, in an attempt to pretend it is still in control of what is now the world's fastest growing credit bubble and of course, Chinese inflation which is now impacted not only by record domestic credit production but by hot money flows from both the Fed and the BOJ.

Predictably enough, as reported overnight by the Global Times, the PBOC suspended its open market operations Tuesday without injecting money as usual, a move that analysts said was in response to a surge in foreign capital inflows in September. It was only the second time since July 30 that the People's Bank of China (PBOC), the central bank, has abstained from injecting liquidity into the market, and follows the last liquidity injection operation which took place last Thursday: since then the Chinese Cental Bank has been strangely quiet.

The PBOC normally conducts reverse repurchase (or repo) operations Tuesday and Thursday, injecting liquidity into the market by partially offsetting maturing bills. It injected 10 billion yuan ($1.63 billion) worth of seven-day reverse repo contracts on October 15, and then withheld the 14-day reverse repo on Thursday (October 17), the first time it had done so since late July. This drained a net 44.5 billion yuan from the market last week, according to Reuters calculations.

The central bank's move was in response to a surge in foreign capital inflows last month, which resulted in increasing liquidity in the market, Hao Yijun, a Shanghai-based bond trader at China Guangfa Bank, told the Global Times.  The PBOC purchased 126.4 billion yuan worth of dollars in September amid large dollar inflows, an increase of 99 billion yuan from August, the PBC's data showed Monday.

Withholding from open market operations and draining funds indicates a moderate tightening of monetary policy, Hao said.

And just like the last time the PBOC proceeded to "surprise" the market with its own tapering intentions, overnight funding rates soared, with the one-day repo rate surged 67 bps, most since June 20, to 3.7561%; while the seven-day repo rate rose 42 bps, most since July 29, to 4.0000%.

"Liquidity is tighter because there are some reverse repos maturing this week,” Shanghai-based Xu Hanfei, analyst at Guotai Junan Securities, says in interveiw; "PBOC’s decision to refrain from injecting funds via reverse repos suggests policy may be shifting to a tighter one to keep inflation in check amid capital inflows."

That, and of course to keep the domestic housing bubble - currently the world's largest and certainly bigger than that in London - in check.

However, all of the above is merely yet another exercise in futility, and prompted by manipulated inflation data which are hardly accurate and indicative of reality. As such, just like in the summer, all it would take for the PBOC to yield to the market is for repo and SHIBOR rates to soar into the double digits, and all shall return to normal. Which would mean a return to what China does best: injecting epic amounts of debt into the system.

Which brings us to the far more important story, one reported by Bloomberg overnight, and one which we predicted is inevitable over a year ago: namely that the Chinese banks, filled tothe gills with bad and non-performing debt, are finally preparing for the inevitable default onslaught and as a result have suddenly tripled their debt write offs in what can be best described as preparing for an avalanche of defaults.

From Bloomberg:

China’s biggest banks tripled the amount of bad loans written off in the first half, cleaning up their books ahead of what may be a fresh wave of defaults.

Industrial & Commercial Bank of China Ltd., the world’s most profitable lender, and its four largest rivals expunged in the first six months 22.1 billion yuan ($3.65 billion) of debt that couldn’t be collected, up from 7.65 billion yuan a year earlier, filings showed. That didn’t pare first-half profits, which climbed to a record $76 billion, as provisions were set aside in earlier periods when the loans began souring.

In other words, even China is now engaged in America's favorite pastime: covering up losses by releasing loss reserves at the same time... a somewhat paradoxical process as one indicates a rapid deterioration in current and future credit conditions, while the other merely takes advantage of generous accounting fudges and prior stability.

Erasing the worst of the bad debts may allow the banks to mitigate a surge in nonperforming-loan ratios amid rising defaults in the world’s second-largest economy. China has eased rules for writing off debt to small businesses since 2010 and policy makers are pushing the lenders to increase risk buffers following an unprecedented credit boom that began in 2009.


“The banks and the regulators’ interests are aligned in speeding up write-offs,” said Ma Kunpeng, a Beijing-based analyst at Credit Suisse Founder Securities Ltd. “This prepares them for a rainy day."


The China Banking Regulatory Commission, led by Shang Fulin, urged banks in April to set aside more funds to cover defaults, write off some bad loans and curb dividend payments while earnings are ample to create a buffer in case of an economic downturn.


Worries about the slowdown have persisted even after expansion of China’s gross domestic product rebounded to 7.8 percent in the third quarter. Growth may slow to 7.6 percent this year, the weakest pace since 1999, according to the median estimate of economists in a Bloomberg survey.

Naturally, it is not rocket science that the only reason why China is growing at its current pace is because it is once again injecting record amount of liquidity into the system, and if the credit spigot is open, th country growsl if it's shut - it stagnates, as we described in "China: No Leverage, No Growth."

But a far bigger problem is that while China's debt is already at record levels, it needs an increasingly greater "credit impulse" to generate the same or smaller amount of GDP "growth" as before, a phenomenon we described in April.

The nation’s debt-to-GDP ratio, excluding central government and financial debt, widened to 207 percent as credit growth continued to outpace productivity gains, Mike Werner, an analyst at Sanford C. Bernstein & Co. in Hong Kong, wrote in an Oct. 21 note to clients. That’s making investors nervous about bad loans rising at banks, he said.

But while banks are finally starting to catch up to the reality that their balance sheets are woefully unprepared for what may be an epic superbubble house of cards crashing on everyone's head, a key issue is that the price discovery process of insolvent entities in China is simply non-existant.

China’s courts have also been processing bankruptcies faster. The eastern province of Zhejiang, a region south of Shanghai that’s home to many of the country’s largest private companies, accepted 143 bankruptcy petitions last year, according to the most recent figures reported by its high court in May. That’s almost twice the number from a year earlier.


The rising bankruptcies may have helped Bank of Communications, the nation’s fifth-largest lender, become the most aggressive among the top five in expunging bad loans from its books so far: its write-offs surged sevenfold to 4.82 billion yuan in the first six months. A press officer for the Shanghai-based lender, known as BoCom, declined to comment.

Oh, so a "whopping" 143 bankruptcy petitions is considered "faster" and an improvement? And this is in a nation that has 4 times the population of the US? To be sure, the fact that China has a major denial problem about the true extent of its credit bubble has not escaped investors:

Third-quarter net income at the five banks may have risen 11 percent from a year earlier to a combined 226 billion yuan, according to Edmond Law, an analyst at UOB Kay Hian (Hong Kong) Research. Nonperforming loans probably climbed by a “mild” 5 percent in the three months to Sept. 30 as lenders continued to write off or sell bad debt, he wrote in an Oct. 10 report.


Uncertainty about the quality of assets at Chinese banks has made global investors nervous, sending stock in the lenders to near record-low valuations this year. ICBC fell 2.2 percent to close at HK$5.28 in Hong Kong and the shares are trading at 0.98 times estimated book value for 2014, while Construction Bank lost 2.3 percent and changed hands at 0.94 times book, according to data compiled by Bloomberg.

In conclusion:

“The China bank stocks are under pressure due to bad debt write-offs,” Sandy Mehta, chief executive officer of Value Investment Principals Ltd. in Hong Kong, wrote in an e-mail. “The new leadership in China is serious about the financial sector getting its house in order, and addressing any asset quality issues.”

Judging by the market's reaction, where the Shanghai Composite closed down 1.25% and the Nikkei was lower by 2% (with futures sliding even more on a renewed strength in the JPY), the market is finally starting to pay attention to the Chinese credit bubble, which unlike the US can afford only so much liquidity, either domestic or foreign, before the spillover sends far less anchored prices soaring.

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Cognitive Dissonance's picture

"....namely that the Chinese banks, filled tothe gills with bad and
non-performing debt, are finally preparing for the inevitable default

It's not bad Chinese debt Tyler. Just (severely) misunderstood.

Headbanger's picture

A flock of Black Swans flying this way!

Looks like the Chinese are about to have their very own "Lehman moment" which will crash Asian equities then Europe and the US markets very soon.

Just as most flu epidemics start in China, here comes the "Asian Financial Flu" to wreck our already weakened financial immune system!


Iam Yue2's picture

This says it all;

Autos are now the largest single manufacturing industry in the world. Not only do they directly and indirectly employ vast numbers of people, but they are also increasingly key to consumer spending. Thus it is no surprise that governments have tried to increase auto sales since the Crisis began in 2008.
China is the prime example of this trend. Annual sales in 2007 were just 6.3m in 2007 – no surprise, given that even today, average urban household incomes are just $4.8k and rural incomes only $1.7k. But since 2008 it has become the largest auto market in the world, as its lending policy has led to an auto sales boom, as the chart shows:
Bank lending (red line) has doubled (109%) since 2008, comparing January-September 2013 with 2008
Auto sales (blue line) are up slightly more (138%) over the same period
The growing difference is due to the rise of the ‘shadow banking’ sector
This has recently been between 55%-87% of total lending, as official lending has begun to be cut back
As the Financial Times has described, based on Ann Stevenson-Yang’s report for J Capital Research:
“Everyone’s offering 0% financing now and in some cases buyers end up with their car for free. How? The buyer pays for the car but with the guarantee of the money back in two years. The seller invests the money in the shadow banking system where he hopes for returns of 60% a year or so before selling up and giving it back. Not bad. But as Stevenson-Yang notes, in the past this kind of thing has “not ended well.” If you are getting 60% on your money (or even hoping to) you are not in an investment but in a pyramid scheme of one kind of another. And if you live in a country where any meaningful part of growth is built on such pyramid schemes you are living on the edge of a crisis.”
What does this mean for future auto sales growth? In the past few months, there has been little to stop the lending and sales boom. But next month’s Economic plenum may well start to move the economy in a new direction. China simply cannot afford to allow lending to boom forever, even if the risks of bursting today’s bubble are also large.
Anyone assuming that auto sales growth will continue at recent levels is clearly making an enormous gamble on the new leadership’s ability to navigate these very tricky waters. Most worrying is the thought that most companies haven’t even realised the gamble they are taking.

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Apostate2's picture

This explains why the HK banks are deperate to lock up USD accounts. So much so they are offering above rates for a lock-in of deposits on USD accounts.

USD flows need to be locked in for collateral loans on the HK exchange raising the rate of convertability for loans. Trying to back stop the repro on treasuries.







eddiebe's picture

NO place to run, no place to hide.

lolmao500's picture

Meh. Just do like US and Europeans banks, put all those crappy loans off books!

fonzannoon's picture

The usd got a bit too weak and the markets are a bit overheated. The fed knows no one will believe a taper rumor so they went with this. 

new game's picture

fonz - what choice did they have, but to loose face again?

on no where to hide: one last vestage of hope - the home paid for and adaquate supply

of provisions to fight the fight.  the fight is not predicable and how it will unfold, but suffice 

to say it won't be a "wam bam thank you (mam)" fight...

eddiebe's picture

Looks like today the PPT is propping the $. I'm amazed at how many fingers these guys have to plug the holes in the dam.

laomei's picture

Laugh... whatever bad debt they chinese majors have, it's far outweighed by their profits, to the point where it's just another case of chicken little stories being blown out of proportion while ignoring the fact that the US and most of the west has a fraud-based economy waiting for an excuse to collapse entirely.

Life of Illusion's picture


They need to call Blackstone to reinflate housing turn them into rentals and dump RBS onto the public,,,,,