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