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China May Double Down On Debt Swap As ABS Issuance Stumbles
Chinese stocks jumped nearly 5% on Monday on disappointing macro data which betrayed a third consecutive monthly contraction in the manufacturing sector (remember, bad news is good news in a world hooked on central bank-dispensed monetary heroin). But a poor macro print wasn’t the only hint that more stimulus may be just around the corner, as Beijing is now reportedly set to double the local debt swap quota to CNY2 trillion.
Via Bloomberg:
China’s Ministry of Finance may set additional quota of 500b-1t yuan for local governments to swap debt into municipal bonds, according to people familiar with the matter.
Plan needs State Council approval, according to the people, who asked not to be identified because deliberations are private.
This should come as no surprise. As we’ve documented in excruciating detail, the country’s local governments are sitting on a pile of debt that amounts to around 35% of GDP. Visually, that looks like this…
That’s a problem because some of this debt was accumulated off balance sheet through LGFVs (an effort to skirt official restrictions on borrowing via shadow banking conduits) meaning in some cases yields are far higher (at roughly 7%) than they would have been otherwise. The idea is to swap this debt for muni bonds and save 300 or so bps, in what amounts to a giant refi effort. The program officially got off the ground midway through last month with Jiangsu province sold paper with maturities ranging from 3 to 10 years at yields between 2.94% and 3.41%.
The reason this program — and thus news of its expansion — serves as a catalyst for stock prices is that the PBoC allows the purchasing banks to pledge the muni bonds they buy as collateral for cash which can then be re-lent to the real economy. In other words, it amounts to a liquidity injection. China then went a step further and eased restrictions on local government funding via LGFVs (the same vehicles which got them into trouble in the first place), which effectively means that the pool of swappable debt is set to grow even larger than 35% of GDP and because any debt that’s swapped ends up creating an LTRO-eligible bond and thus a cash infusion to banks, what you end up with is a perpectual credit creation machine. This is on top of two RRR cuts YTD and three benchmark rate cuts in the last six months. In short: a lot of liquidity, which should be positive for China’s raucous equity mania.
However, something interesting is happening which harkens back to what we discussed in “China Has A Massive Debt Problem.” Recall that, in yet another effort to boost lending to the real economy, Beijing has eased restrictions on ABS issuance, the idea being that if banks can offload debt from their balance sheet, they will make still more loans. A ‘healthy’ (whatever that means in this context) securitization apparatus is essential to the entire idea of extend-and-pretend — just ask the 2006 US housing market.
What we’re seeing however, is a dramatic decline in ABS issuance YTD. Why? Well, because NPLs are on the rise and economic growth is declining swiftly, meaning bad loans are likely to increase going forward and as we outlined in “How China’s Banks Hide Trillions In Credit Risk,” the numbers are vastly understated. At the same time, the PBoC’s policy rate cuts combined with the local government debt swap effort (i.e. Chinese LTROs) mean banks don’t need to resort to ABS issuance to free up liquidity. Bloomberg has more:
Chinese lenders have cut offerings of asset-backed securities 45 percent to 43.4 billion yuan ($7 billion) this year, after a 15-fold jump in 2014, Bloomberg-compiled data show. They have reduced loans for four straight months, even as policy makers expanded the securitization quota by 500 billion yuan to free up space on their balance sheets for fresh lending.
The wariness contrasts with mounting support for asset-backed bonds among regulators, who reversed course in 2012 to allow sales they’d banned in 2009 after the products helped spark the global financial crisis. A jump in bad loans last quarter to the worst since 2008 amid the weakest economy in more than two decades has made banks hesitant to package their higher quality assets into debt securities.
“With more signs showing an economic slowdown, Chinese banks don’t want to lend more, so they don’t need to sell ABS to free up more room for lending,” said Ji Weijie, senior associate at Beijing-based China Securities Co. “Plus with rising bad loans, banks are reluctant to move good assets off their balance sheets”...
Another consequence of the combined 1.5 percentage point reduction in the reserve-requirement rate since November to 18.5 percent is that banks now have less need to sell ABS to free up space for lending.
Once again we see policy decisions working at cross-purposes in China, a key theme as the country marks a difficult transition from an investment-led economy to a consumption driven model. Boiled down to its simplest form: China is attempting deleverage and re-leverage at the same time.
Beijing has signaled a willingness to allow defaults (even, in some cases, by state-backed entities and indeed FT reported Monday evening that China's Zhongao defaulted after banks refused to roll its debt) which, in combination with the local government refi effort, suggests the government realizes the need to deleverage an economy laboring under $28 trillion in debt.
On the other hand, reining in shadow banking has led to a collapse in credit creation...

Which means that when policy rates fail, the shadow banking machine must be reactivated, hence Beijing's move to soften its stance on LGFVs.
Where all of this will end after the mutliple competing policy goals play out we don't know, but as far as the local government refi effort is concerned, even if we assume that only the existing stock of local government debt is run through the program (i.e. that any extension of LGFV financing is not swapped for muni bonds), that leaves a total of CNY20 trillion that can be channeled towards new loans via LTROs.
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The Difference between Rich and Poor, is whether their loans ever have to be Paid Back.
More precisely, the difference between the rich and the poor is that the value of the rich's assets rise at a rate higher than the rate of borrowing.
Is there any way Chicago can get in on the action? At least Chicago's China Town?
QE in Beijing Sweet-n-Sour Pork Style.
haha interesting thing but I've never actually seen or had sweet and sour pork in China or even a real Chinese restaurant (with a Chinese menu) in the west...
it's a western thing... like red salsa or wheat taco shells :P
still fucking delicious tho
Try asking for Tangcu Liji.
Every restaurant in China will do sweet-and-sour pork, on the menu, or by request. It's a well-known dish in China.
They'll just write it off.
Holy cow. BTFD. FREE MONEY.
Letting all the banks go broke would be an excellent way to deleverage! Provided of course that you convert your ficticious debt based fiat paper "money" into something real first.
You can expect undeveloped market structures not transmitting the intention of the CB to centralize more power and further eradicating the States debt creation powers.
In this exercise, they can run smack into hurting households thus all the messy policies to protect debt fueld assets of households.
When household savings (part of Country Savings) hit the debt treshold, what magic can you engineer to prevent unemployment (another unacceptable option) ?
Plenty of arbitrage opportunties. One of which is the collapse of wealth management products sold to households if these go/stop policies proceed. A further catalyst to potential fire sale of welath managment products lie in the deformed stock market (no different form anywhere else).
Can we please say it again and again and again.
Bad economic news - stock markets jump.
Talk about unchartered territory Whats going to end this madness. Either very very good economic news leading to stock market total collapse, or more and more bad news leading to stock markets going so high they implode.
I think the latter will happen.
All of chinas savings will be wiped out. The states bond market will collapse completely The economic systems of the world will be nuetered. Its that bad.
and I think this is exactly why Russia, China and India from BRICS are hoarding so much gold. When all fiat currencies fail, gold will still count. So those nations who have gold, will still have reserves. The others will have nothing.
A lot of countries have gold, including the US and EU countries. No one will want to start playing that zero-sum game again, especially not mercantilist China. When fiat collapses, no one will actually begin paying debts in gold. It'll remain in vaults, with various claims and probably no audits.
International trade will collapse, not like now, but literally to zero... and all the unlovely implications attendant thereto.