China Proposes Unprecedented Nationalization Of Insolvent Companies: Banks Will Equitize Non-Performing Loans

Tyler Durden's picture

In what may be the biggest news of the day, and certainly with far greater implications than whatever Mario Draghi will announce in a few hours when we will again witness the ECB doing not "whatever it takes" but "whatever it can do", moments ago Reuters reported that China is preparing for an unprecedented overhaul in how it treats it trillions in non-performing loans.

Recall that as we first wrote last summer, and as subsequently Kyle Bass made it the centerpiece of his "short Yuan" investment thesis, the "neutron bomb" in the heart of China's impaired financial system is the trillions - officially at $614 billion but realistically anywhere between 8% and 20% of China's total $35 trillion in bank assets - in non-performing loans. It is the unknown treatment of these NPLs that has been the greatest threat to China's just as vast deposit base amounting to well over $20 trillion, which has been the fundamental catalyst behind China's record capital flight as depositors have been eager to move their savings as far from China's domestic banks as possible.

As a result, conventional thinking such as that proposed by Bass, Ray Dalio, KKR and many others, speculated that China will have to devalue its currency in order to inflate away what is fundamentally an excess debt problem as the alternative is unleashing a massive debt default tsunami and "admitting" to the world just how insolvent China's state-owned banks truly are, not to mention leading to the layoffs of tens of millions of workers by these zombie companies.  

However, China now appears to be taking a surprisingly different track, and according to a Reuters report China's central bank is preparing regulations that would allow commercial banks to swap non-performing loans of companies for stakes in those firms. Reuters sources said the release of a new document explaining the regulatory change was imminent.

According to Reuters, the move would represent, "on paper, a way for indebted corporates to reduce their leverage, reducing the cost of servicing debt and making them more worthy of fresh credit."

It gets better.

It would also reduce NPL ratios at commercial banks, reducing the cash they would need to set aside to cover losses incurred by bad loans. These funds could then be freed up for fresh lending for investment in the new wave of infrastructure products and factory upgrades the government hopes will rejuvenate the Chinese economy.

It is certainly possible that this is merely a trial balloon, one which as was the case repeatedly during Europe's crisis uses Reuters as a sounding board to gauge the market's reaction, however the reality is that China may truly be desperate enough to pursue this option.

Because what is lacking in the Reuters explanation is that this proposal entails nothing short of a nationalization on a grand scale, one which gives China's impaired commercial banks - all of which are implicitly state controlled - the "equity keys" to the companies to which they have given secured loans, loans which are no longer performing because the underlying assets are clearly impaired, and where the cash flow generated can't even cover the interest payments.

In effect, the PBOC is proposing the biggest debt-for-equity swap ever seen. What it also means is that since the secured lender, which is at the top of the capital structure will drop all the way down, it wipes out the existing equity and unsecured debt, and make the banks the new equity owners, and as such China's commercial banks will no longer be entitled to interest payments or security collateral on their now-equity investment.

Finally, while this move does free up loss reserves, it essentially strips banks of their security and asset protection which they enjoyed as secured lenders.

So why is China doing this?

As Reuters correctly noted, by equitizing trillions in bad loans, it frees up the corporate balance sheets to layer on fresh trillions in bad debt, the same debt that pushed these zombie companies into insolvency to begin with.

What this grand equitization does not do, is make the underlying business any more profitable or viable: after all the loans are bad because the companies no longer can generate even the required cash interest payment - as a result of China's unprecedented excess capacity and low commodity prices which prevent corporate viability. It has little to do with their current balance sheet.

That, however, is irrelevant to the PBOC which is hoping that by taking this step it can magically eliminate trilliions in NPL from commercial bank balance sheets in what is not only the biggest equitization in history, but also the biggest diversion since David Copperfield made the statue of liberty disappear, as instead of keeping the bad loans on the asset side as NPLs, thus assuring at least some recoveries, the banks are crammed down and when the next NPL wave hits, their exposure will be fully wiped out as mere equity stakeholders.

So why are banks agreeing to this? Because they know that as quasi (and not so quasi) state-owned enterprises, China's commercial banks are wards of the state and when the ultimate impairment wave hits and banks have to write down trillions in "equity investments", Beijiing will promptly bail them out.

Essentially, in one simple move, Beijing is about to "guarantee" trillions in insolvent Chinese debt.

In short, as pointed out earlier, what the PBOC has proposed is the biggest "shadow nationalization" in history, one which will convert trillions in bad loans in insolvent enterprises into trillions in equity investments in the same enterprises, however without any new money actually coming in! Which means it will be up to new credit investors to prop up these failing businesses for a few more quarters before the reorganized equity also has to be wiped out.

Going back to the Reuters, it reports, that "the new regulations would be promulgated with special approval from the State Council, China's cabinet-equivalent body, thus skirting the need to revise the current commercial bank law, which prohibits banks from investing in non-financial institutions."

Of course the reason why commercial bank law prohibited banks from investing in non-financial institutions is precisely because it is a form of nationalization; only this time it will be worse - China will be nationalizing its most insolvent, biggest zombie companies currently in existence.

Reuters also observes that in the past Chinese commercial banks usually dealt with NPLs by selling them off at a discount to state-designated asset management companies. "The AMCs would turn around and attempt to recover the debt or resell it at a profit to distressed debt investors." That China has given up on this approach confirms that there is just too much NPL supply and not nearly enough potential demand to offload these trillions in bad loans, hence explaining what may be the biggest nationalization in history. 

Finally, Reuters concludes that "the sources did not have further detail about how the banks would value the new stakes, which would represent assets on their balance sheets, or what ratio or amount of NPLs they would be able to convert using this method." Which is to be expected: in this grand diversion the last thing China would want is to reveal the proper math which would show how both China's commercial banks, and the government itself, are about to guarantee trillions in insolvent assets.

While this is surely good news for the very short run, as it allows the worst of the worst in China's insolvent corporate sector to issue even more debt, in the longer run it means that China's total debt to GDP, which is already at 350% is about to surpass Japan's gargantuan 400% within a year if not sooner.

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
DirkDiggler11's picture

This "solution" by the Chicom's is total bullshit. The only thing worse than lending a crap company money is leading the crap company money and then having "stock" in the same crap company.

You can polish a turd all you want, but deep down it's still shit, just like their non-performing loans...

Money Counterfeiter's picture
Money Counterfeiter (not verified) DirkDiggler11 Mar 10, 2016 6:10 AM

Once a communist always a communist.  Obviously a genetic characteristic.

Manthong's picture

Well, the good news is that there will be a target rich environment for Chinese Financial Zombies.

bania's picture

What a great read. This must be the super smart Tyler. Going to read it again.

Harlequin001's picture

Oh yeah, forgot about that. How much is that worth again?

NoDebt's picture

It's worth whatever number the Ponzi requires.

Stainless Steel Rat's picture
Stainless Steel Rat (not verified) NoDebt Mar 10, 2016 8:50 AM

"Hostile Government Bailout"!!!

BuddyEffed's picture

And these non performing and structurally challenged Chinese business models are based on some of the cheapest labor in the world.

That's pretty sad and pretty bad and egad too.

pods's picture

I'm sure that banks, who weren't smart enough to judge credit risk, will fully be able to run the underlying companies.


SWRichmond's picture

China gets to keep the productive capacity they built using US consumers' money, which China then lent back to us at interest.

Acting surprised that most people don't see this in 3...2...1...

Son of Loki's picture

Mugabe eager to nationalize Zimbabwe's diamond industry



“If you want to keep your diamonds, you can keep your diamonds. That’s a promise!”

CheapBastard's picture
Fake trade invoicing in China is back, this time to get money out of the country


Theosebes Goodfellow's picture

~"China Proposes Unprecedented Nationalization Of Insolvent Companies"~

What a bunch of communists! Wait..., never mind.

Uchtdorf's picture

Remember there's nothing backing gold. But, hey, the US Dollar? Well, that's backed up by the US government so it's good to go.

BarkingCat's picture

In reality it is backed by world's largest and most active military.

MaxMax's picture

In reality it is backed by world's largest and most active military.

Right.  People seem to forget that currency / debt ultimately requires the threat of force to work.  There is a good book on this written by David Graeber called Debt: The First 5,000 Years.  Currency, debt, slavery, marriage and controlling other people are all closely linked.

While I have lots of problems with US monetary policy, without the USA threat of force, it would be a completely different situation.  Try not paying your property taxes.  They will start with letters and additional fines, and ultimately end up with a Sheriff and gun at your door forcing you to leave or getting arrested. 

Miffed Microbiologist's picture

My question is what percentage of telecommunications equipment and semiconductors used in the US military is made in China.


TheReplacement's picture

A slightly better question would be what percent of US military equipment relies on Chinese made SCs.  100% of equipment having just 1% Chinese stuff is far worse than 1% of equipment having 100% Chinese stuff.

Keyser's picture

The Chinese are starting to nationalize their industries and will print to cover the liquidity gap... Look for something similar with a different name in the west, beginning with the banks... 

NoDebt's picture

They were effectively nationalized from inception.  Now they're just admitting to it.

Arnold's picture

In our case it seems 'industry' owns the government.

I'm not implying manufacturing by my quotes.

TheReplacement's picture

In our case industry is heavily indebted to someone else.  Ultimately that someone else is the same entity (or group thereof) that we and .gov are indebted to. 

It is always the bankers in the end.

roddy6667's picture

Being a socialist country with 55% of their country being State Owned Enterprises, this is not a big deal. The can try to make the collateral business profitable, they can pay back a certain percentage vs . nothing, they can pay back the people who loaned the money with gov't bonds with a future redemption date, etc. There are lots of options.

TheReplacement's picture

I've said for some time that "they" are buying everything.  By they I mean TPTB.  By everything I mean the rope with which they mean to hang us.

Cognitive Dissonance's picture

It's the old 'In for a penny, in for a pound' thinking that always throws "good" money after bad. Then again, desperate people do desperate things.

new game's picture

Is this much different than the 800b tarp rollout and the fed putting mbs on there balance stmnt? not to mention propping up(instant fed injections) numerous other distressed corporations around the world, Ge most notable? China learned from the fed and is one upping the fed and getting in front of their massive malinvestment.

no way this goes good, but buys tyme..pun intended

tic toc

FreeMoney's picture

At 20% of Chinas $35T that is $7T.  Sounds about the same number as the FED and ECB have monetized in soverign debts.  

Element's picture

Commies nationalising stuff? What next?

Oh I get it, the foreign technology factories need 'liberating' of their technology and tooling.

RaceToTheBottom's picture

Commies are acting just like our "Capitalists".  

Oh the horror!!!

At least some of their criminals get killed.  Our Communist/Capitalists get Billions in addition to the bailout/backstop...

TheReplacement's picture

I'd venture a guess that the only criminals killed in China are the ones who got caught stealing from the criminals above them who are stealing from everyone.

Don't steal.  Government hates competition.

NoDebt's picture

If that's not worth 500 Dow points and $10/bbl more for oil, I don't know what would be.

Crank up the China Ponzi again, we're going to Commodityville!

Dr. Engali's picture

Build moar empty cities. Moar, moar, moar, you fuckers!

NoDebt's picture

"It works everywhere it's been tried."

new game's picture

just what the world needs moar of: steel, container ships, aluminum and state sponsored private equity money. exactly when the world is saturated in debt and slowing down. not to mention massive amounts of demand brought fwd. it is an epic waste of resources, and china will be remembered as the short term experiment that purged 1 billion people from the face of the earth.

deflation with no bounds has to happen, just cant see it any other way, then hyperinflation to follow as history repeats...

NoDebt's picture

What part of "we're going to recapitalize the entire Chinese economy with printed money" is it that you find so offensive?  I predict you will get past whatever objections you have when you see your brokerage statement at the end of the year.  

You're gonna be rich, dude!  What's your beef with that?


new game's picture

i have zero money in the system except what is in my bank to pay monthly bills.

i am objective, with the exception of my wifes small pension and of course s.s. if that doesn't go caput.

NoDebt's picture

More's the pity.  You should buy some stawks.

back to basics's picture

Actually that is US and EU style capitalism they are copying where no one is allowed to fail. The Chineses are going down this route because it's the only route the have when the losses are so massive.

Mike in GA's picture

I give em credit for a massive, massive, unexpected new way to disappear losses/NPLs.  What it makes me think is, given the fact that the world economy is nowhere near recovery, Act II when the Debt/GDP is > 400% is gonna be boiling shoe soles and calling it soup. Flavoring could be supplemented by  the heads that roll when the peasants come to town.

Arnold's picture

Fishing for pigs at the river.

averagemong's picture

the losses are never disappeared instead they are born by voiceless faceless worker slaves living a shitty life

roddy6667's picture

You should visit China sometime. Life is pretty good here. Where do you get this "information" about life in China?

DragonWings's picture

yes and at least the pay the cake and eat it too, unlike US where the state pays for the cake... and the bakers keeps eating it...


Kirk2NCC1701's picture

Uncontrolled Capitalism ('Freedom') is what you want when you want to climb the Totempole.

Controlled Capitalism (Control) is what you want when you've climbed the Totempole.

Likewise, when you want market share, you want a level field.

When you have market share, you do NOT want a level field, to have to keep fending off would-be competitors.  You want to fence them out with 'laws' and regulations.  Duh!


Anything about this bit of Human Nature that is not clear?  Give it 5-10 and we'll be 'Merican Chicoms. In fact, thanks to the Chicago Gang, we already are Chicoms.