Aworrying report out this week from HSBC on the health of the Chinese banking sector is worth a mention – particularly given our recent Talking Point on the dangers posed by the local government financing vehicles (see WiC110).
Published by Yi Hu and Devendran Mahendran, “China Banks: Revelations from the Bond Markets” takes a bearish tone, with the two analysts aiming to gauge China’s banking health by looking at the latest data from the domestic corporate bond market.
That’s because the banks either have a direct exposure to the sector (they have bought a little over half of the bonds themselves) or are tied to some form of guarantee as underwriters of the original debt. Additionally, bond issuers are obliged to disclose a fuller range of information, allowing for a more detailed snapshot of their financial condition.
Hu and Mahendran estimate that 723 corporate bond issuers had a total of Rmb3.1 trillion of debt outstanding ($475 billion) at the end of May 2011. But the total exposure for the banks is actually greater, they say, as the same group also borrowed Rmb11.7 trillion in loans from the banks last year.
So how likely is it that the banks will get their money back?
We get the better news first. Bonds from the largest five issuers make up 30% of long-term debt, with the Ministry of Railways by far the largest issuer. As this group is state-owned, it has a relatively strong credit profile.
But then the narrative turns gloomier. When the HSBC pair begin to plough through the financial information of the companies in question, they discover that many have also provided financial guarantees to third parties.
Factor these into a fuller assessment of their liabilities, and many could be more indebted than it first appears.
For example, add up the guarantees granted by Shaanxi Provincial Expressway Construction Group and another 75% of potential debt tots up on top of the formal loan commitments.
Another concern noted in the report: that a lot more bonds and loans have ended up in property than hitherto thought.
According to data from the central bank, only 8% of corporate loans were granted to property developers last year. But when HSBC digs into the details, it finds that a quarter of bond issuers say in their financial statements that property or land management is a core business. That makes it look like exposure to the property sector is being understated in the debt data in general.
Next up, the two analysts turn to repayment capability, asking whether credit has been extended to weaker firms. And their conclusion is that it probably has: in fact, they calculate that 37% of the issuing group have returns on capital lower than last year’s benchmark lending rate of 5.31%.
The report concludes with a look at the chunk of debt at the local government financing vehicles. And the danger here, say Hu and Mahendran, is that many of these entities are not in position to make interest payments on their loans or bonds. From their sample of local government vehicles, they estimate that a third do not have the cashflow to repay their loans.
The People’s Bank of China reckons local government financing platforms have run up debts of up to Rmb14 trillion. So, if HSBC’s percentage (i.e. 33% won’t repay) is representative, it could imply that as much as Rmb4.6 trillion won’t be serviced, leaving the banks with $714 billion of non-performing loans. Little wonder the report is called ‘Revelations’.
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