Two weeks ago, using Macquarie data, we found something disturbing at China's micro level: not only are a quarter of Chinese firms with debt unable to cover their annual interest expense currently...
.... but when just looking at the commodity sector, roughly half of all companies are in the same dire straits, as a result of the collapse in commodity prices which translates into a drop off in cash flow which makes just the annual all-in cash interest payment impossible .
Over the weekend, Hong-Kong based CLSA decided to take this micro-level data and look at it from the top-down. What it found was stunning.
According to CLSA estimates, Chinese banks' bad debts ratio could be as high 8.1% a whopping 6 times higher than the official 1.5% NPL level reported by China's banking regulator!
As Reuters reports, the estimate is based on analysis of outstanding debts for more than 2700 A-share companies (ex-financials) and their ability to repay loans. Or in other words, if one backs into the true bad debt, not the number given for window dressing purposes by Chinese "regulators", based on collapsing cash flows, what one gets is a NPL that is nearly 10% of all outstanding Chinese debt.
Reuters has some more details on the methodology:
- Two consecutive years of a co's interest coverage (EBITDA/interest expense) below 1x or losses for two successive years qualifies for debts to be treated as "bad" in CLSA's analysis.
- By these measures, wholesale & retail and manufacturing sectors boast the highest implied NPLs at 21.1% and 15.8% respectively, taking into account total debt
- While China's real estate sector has been the most aggressive in adding debt, profitability at developers in tier-1 cities has held up well, muting the overall NPLs for the sector
- Developers in tier-2 and tier-3 cities, however, show high implied NPLs
- As bad debts rise, burden falls on PBOC to ensure sufficient liquidity so that Chinese banks can gradually absorb the credit costs, CLSA says.
Yes, the PBOC's burden most certainly rises, and what a burden it is: here's why.
The chart below shows the history of total Chinese bank assets: as of the latest official data, the number is roughly $30 trillion.
If one very conservatively assumes that loans are about half of the total asset base (realistically 60-70%), and applies an 8% NPL to this number instead of the official 1.5% NPL estimate, the capital shortfall is a staggering $1 trillion.
In other words, while China has been injecting incremental liquidity into the system and stubbornly getting no results for it leading experts everywhere to wonder just where all this money is going, the real reason for the lack of a credit impulse is that banks have been quietly soaking up the funds not to lend them out, but to plug a gargantuan, $1 trillion, solvency shortfall which amounts to 10% of China's GDP!