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Policy Confusion Reigns As China Caps Muni Debt, Uncaps Bank Debt, And Bad Loans Soar
Last week, China moved to increase the quota for issuance under the country’s local government debt swap program to CNY3.2 trillion. The program, designed to help the country’s local governments crawl out from under a debt burden that amounts to more than 30% of GDP, allows provincial governments to issue bonds with yields that approximate the yield on central government debt and swap the new bonds for outstanding LGFV loans which generally carry higher interest rates. Generally speaking, the debt swap will save local governments somewhere in the neighborhood of 300 to 400 bps.
Of course, as we’ve detailed exhaustively, these types of deleveraging initiatives come at a cost for China. That is, with the economy slowing, there’s a certain degree to which China needs to re-leverage by attempting to boost credit growth and juice aggregate demand. That reality, plus the fact that the banks which made the initial loans to local governments weren’t keen to swap those high yielding assets for the new, lower yielding bonds, prompted the PBoC to implement what amounts to Chinese LTROs which allow the banks to pledge the new local government bonds for central bank cash which can then be re-lent to the real economy. So, in a nutshell, local governments issue new bonds, the bank swaps existing loans for those bonds, then the PBoC allows the bonds to be pledged as collateral for new cash. Ideally, this would be a win-win; that is, local government save billions in debt servicing costs and banks have fresh cash to make new loans.
The only problem is this: what happens when local governments need to borrow more money to finance things like infrastructure projects? That question prompted the PBoC to relax rules on LGVF financing, a move which hilariously negated the entire refi effort by encouraging local governments to turn to the very same high interest loans that got them into trouble and necessitated the debt swap program in the first place.
There’s some (or maybe we should say "a lot") of ambiguity here regarding how much of local governments’ new financing needs can be met by issuing on-balance sheet bonds (i.e. the same type of traditional, low yielding munis that are part and parcel of the debt swap program only issuance is aimed at raising cash, not at refinancing old LGFV loans) and how much is new, off-balance sheet LGVF borrowing, and sorting that out is an exercise in futility (trust us), but whatever the case, China has now moved to cap local government debt issuance at CNY16 trillion for 2015. Here’s Xinhua with the story:
China's top legislature on Saturday imposed a ceiling of 16 trillion yuan (2.51 trillion U.S. dollars) for local government debt in 2015.
The decision was adopted at the close of the National People's Congress (NPC) Standing Committee bi-monthly session.
The 16-trillion-yuan debt consists of two parts, 15.4 trillion yuan of debt balance owned by local governments by the end of 2014, and 0.6 trillion as the maximum size of debt local governments are allowed to run up in 2015.
The 2014 debt balance surged over 40 percent from the end of 2013 H1, and valued 1.2 times of the final accounting of 2014 public budget, according to the statistics.
According to the Budget Law which took effect this year, and a State Council regulation, China should cap local government debt balance, and the size of local government debt should be submitted by the State Council to the NPC for approval.
Wang Dehua, researcher at Chinese Academy of Social Sciences, said the fast expansion of local debt was a result of former inaccurate statistics and the recent proactive fiscal policy as well as major infrastructure projects.
"The move will rein local government debt with law," said Ma Haitao, a professor at Central University of Finance and Economics.
Yes, "rein local government debt with law," but because this is China, and because one initiative designed to curtail leverage must everywhere and always be met with an initiative to expand credit growth lest Beijing, in an effort to get control of the situation should inadvertently end up choking off what little demand for credit still exists outside of CSF plunge protection borrowing, China has also decided to remove the 75% loan-to-deposit cap. Here’s WSJ:
China will remove a 75% cap on banks’ loan-to-deposit ratios on Oct. 1 following the adoption of a legal amendment by the national parliament on Saturday, according to state news agency Xinhua.
The ratio will instead be regarded as a liquidity monitoring indicator, according to the amendment passed by the Standing Committee of the legislature, known as the National People’s Congress, Xinhua said.
The 75% cap has been in place since its inclusion in a commercial banking law enacted in 1995, Xinhua said. China’s State Council, or cabinet, said in June that the ceiling would be scrapped in a draft amendment to the law.
Under current rules, Chinese banks must keep their loan-to-deposit ratios below 75%. For every dollar a bank collects in deposits, it can lend only 75 cents.
Analysts say the move could modestly boost lending, while also making banks safer as the ceiling encouraged many of them to disguise loans as investments or move them off their balance sheets.
Of course it’s not at all clear here how much of this decision is truly aimed at reducing risk and how much is simply a desperate attempt to encourage banks to lend. After all, the fact that Chinese banks disguise loans as investments and hold as much as 40% of credit risk off balance sheet isn’t exactly a secret, and in fact, it’s a critical piece of the puzzle when it comes to what is essentially a state-sponsored effort to keep NPLs artificially low (another part of the effort involves forcing banks to roll bad loans).
And speaking of artificially suppressed NPLs, even the fake numbers official NPL ratios are rising. Here’s FT with a bit of color on H1 performance for China’s big four:
The country’s big four state-controlled banks — Agricultural Bank of China, ICBC, Bank of China and China Construction Bank — reported only marginal gains in net profit for the first half of the year, while official measures of non-performing loans surged.
While the central bank eased policy last week, cutting the benchmark interest rate and lowering the reserve ratio requirement for banks, analysts expect China’s lenders to remain under increasing pressure as they grapple with the most difficult market conditions they have faced in recent years.
“It’s definitely going to get tougher before we see any turnround,” said Patricia Cheng, head of China financial research at CLSA in Hong Kong. “This is the usual trick of kicking the can down the road, adding new liquidity and hoping it goes to more productive businesses so companies can generate better returns and pay off debt,” she said. “But for the last few years, it hasn’t come true.”
Analysts at Moody’s, the credit rating agency, estimate that the move to cut the RRR — the amount of reserves that banks must keep with the central bank — by 50 basis points to 18 per cent will free up Rmb600bn-Rmb700bn ($94bn-$110bn) of liquidity in the banking system.
Andrew Collier, managing director of Orient Capital, an independent research house in Hong Kong, reckons the People’s Bank of China will continue to reduce the RRR in an attempt to support the banks and the real economy.
But he doubts that will be effective in tackling the main challenge of rising bad debts.
“There are trillions available in banks that the government is slowly releasing like air being let out of a basketball,” he said. “It will help banks’ profitability but it won’t help them overcome the real problem.”
No, it most certainly will not and in fact, one could plausibly argue that flooding banks with liquidity and forcing them to lend into a weakening economy where household and corporate balance sheets are feeling the heat from a stock market collapse and generally poor economic conditions, respectively, is a recipe for disaster in terms of NPLs. Here’s a bit more from FT:
[ICBC’s] NPL ratio rose to 1.4 per cent as of end-June, from 1.29 per cent at the end of March, while Bank of China’s rose to 1.4 per cent from 1.33 per cent and Agricultural Bank of China’s hit 1.83 per cent from 1.65 per cent. The ratio for CCB rose to 1.42 per cent from 1.19 per cent at the end of last year.
Not to put too fine a point on it, but China no longer has any idea what it's doing. On the one hand, NPLs are rising and there's every reason to think that creditworthy borrowers are becoming fewer and farther between as the economic deceleration gathers pace. Meanwhile, demand for credit has fallen off a cliff as evidenced by the fact that in July, lending to the real economy (i.e. not to the plunge protection team) cratered 55%. But China simply cannot afford to let the system adjust and rebalance, especially not when daily FX interventions are sapping liquidity and tightening money markets. So Beijing has resorted to forcing the issue by flooding banks with liquidty, an effort which, again thanks to currency management, has to be orders of magnitude larger than it would otherwise be which is why you're seeing RRR cuts, LTROs, hundreds of billions in reverse repos, and a mishmash of short- and medium-term lending ops.
So where, ultimately, does this leave China? Well, it's almost impossible to say. What the above demonstrates is the extent to which Beijing is continually forced to implement conflicting policy initiatives in a desperate attempt to deleverage and re-leverage simultaneously. At the risk of using an overly colloquial metaphor, this is just a giant game of whack-a-mole. The question is where and how it all ends.
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Wi Tu Lo
Don't worry. We got this covered. Sounds soooooo ECBish.
"The move will rein local government debt with law "
Oh, my... They haven't a clue do they?
I'm far enough away and so tired of caring that this may actually become amusing to watch...
One of the things I've noticed for a long time about "the law" (that most people seem to honor and cherish over their entire lifetimes for some reason) is it's total lack of consistency, especially when the "law givers" have their asses thrown up against a wall.
"Yes yes, that WAS "the law", now however we have amended it to THIS new law."
Really?
So you will be compensating all those prosecuted under the "old law"?
oh, picky, picky, picky!
Real justice means never having to say you're sorry.
And no survivors.
DUANG !
"China's Yuan, Fed song, they're part of the liquidity trap"
- Frank Sinatra
the guy in charge of swaps:
ho lee fuk?
lo he fuk?
wi lo fuk?
fuk mi lo?
See what nice things my right hand is doing? Left hand? What left hand?
Well I'm giving my little humble help to sink the chineese economy
Its been months since I buy any chineese made junk, and of ebay its been 2 years now!
This rotten computer keyboard and mouse have to hold on for a few mor years !
Protectionist!
How dare you withhold your economic activities from a foreign trading partner...one who has done so much for us, removing the burden of working for a living through public and private debt.
Everyone knows that the only path to economic recovery is to spend what we don't have to buy stuff we don't need from people who want to see us at the bottom of a well.
Ooh, I love swimming. Can I use my credit card to buy a Chinese-made inflatable raft?
Sure. But don't expect it to work wheb you need it.
got confussed after the third re swap, fucken eh. think ill play monoply, at least i can roll the dice...
just paper over paper like a 2 hundred old row home...
Look at this bit of naivety/coy bullshit.
"China will remove a 75% cap on banks’ loan-to-deposit ratios on Oct. 1 following the adoption of a legal amendment by the national parliament on Saturday, according to state news agency Xinhua.
Analysts say the move could modestly boost lending, while also making banks safer as the ceiling encouraged many of them to disguise loans as investments or move them off their balance sheets. "
WHY would the banks impair the new bandwidth allowance to bring what is already hidden off balance sheet on balance sheet instead of just using the new bandwidth to make new loans?
-Especially is the current loans held off balance sheet are non-performing...
That's pretty much what they're hoping they will do. Keep the crap swept under the off-balance-sheet rug and do more in the open in a desperate attempt to boost growth.
It won't work.
When things get wierd it becomes time to build Stadiums. The US needs a good chumy project with the Chineese neighboors, The project"T bills for Stadiums" will kick off a cross cultural love fest. Congress will pass a law to enable a Chinees NFL franchieses the tradmark will be rebranded to the CPFL. Chineese Peoples Football League, there will have to be negotations on Ad rights.
Whomever the new president is can take this on and make their mark in History as the greatest president who ever was.
Exproding Ecronomeeeee muddafuckerz!
universal advice: leverage up; how's anybody gonna collect?
Hey, if they are going to drop Apple down to $90 again can they let me know so I can buy $500k worth before the algos run it back up to $125 within the first hour of trading?
Option butterfly?
Take both trough and peak?
Inscrutable world over all.
Yes, Chinese financials are believable and ever so honest. Think I many go all in on the free market there. Ha-ha! No, I'll buy my chicken feed here.
Our serfs are better than their serfs.
China looks to be in for an extremely bumpy ride as a lot more investors question the risk of holding yuan assets. The general consensus held by everyone from deposit holders in Hong Kong to high-yield-bond investors in Europe was that growth would continue. Money flowing into China over the years has pushed along the misallocation of credit on a grand scale and continued the build-up of bad assets in the banking sector.
An estimate by Goldman Sachs has indicated China might be facing credit losses of as much as $3 trillion as defaults ensue from the expansion of the past four years. Nomura claims $90 billion left the country in July with the pace accelerating since the People's Bank Of China shocked the world by ditching its currency peg to the U.S. dollar. Capital flight for the first three weeks of August may be approaching $100 billion despite the use of harsh anti-terrorism and money-laundering laws to curb illicit flows. The write-up below looks deeper into this shift and its implications.
http://brucewilds.blogspot.com/2015/08/chinas-massive-capital-outflows.html
eh?!!
All commercial and public loans should in fact be honest to goodness investments, for profit yields higher than debt repayments plus interest. If that isn't the case you just go broke.
If these 'analysts' are saying loans should not be investments, but rather should just amp consumption and activity on credit, that's a pretty screwed up way to look at the role of credit in a market economy. And yes, your deposits are going to fall, and capital is going to find a more sane economy to hang out in, where profits actually matter, so loans will fall, and aggregate demand will fall further.
In other words; these guys are implicitly saying there that a market is gone and that only unsustainable stimulus programs matter now.
So even as the real economy fades, the state stimulus proportion and private deposits will both fall, so not even money on the corporate 'sidelines' for recovery-summer 2017.
Alternatively, if all loans were in fact sound investments they would not even be worried now about either domestic consumption or an export demand slow-down. And their banks and local govts would not be in the shitter.
good lord ... more cow-bell!
[Apparently those analysts are the same ones some Australian state govts have been listing to for the past 2 decades.]
"At the risk of using an overly colloquial metaphor, this is just a giant game of whack-a-mole. The question is where and how it all ends."
The answer is in the question, the mole gets wacked! https://www.youtube.com/watch?v=0WzVWw226bs
China banks warn of rising bad loans and falling margins as economy slows
28 August 2015, by Engen Tham and Shu Zhang Shanghai/Beijing (Reuters)
http://www.reuters.com/article/2015/08/28/us-china-banks-results-idUSKCN0QX1HH20150828
When their actions cancel each other out you can tell they don't have a clue and have completely lost control. Banning shortselling is the last refuge of a deseperate politician. The half lives of their failed policy actions keep getting shorter and shorter which now is happening within a few weeks to a few days.
Why does the Fed raise rates now. Stifle demand here right before christmas and the xmas ordering season.
It's like they are trying to start something.
Something wicked this way comes.
What's China's doing now used to be know as 'fire fighting' in the IT business. (Don't know whether or not that term is still in use there.)