Category Archives: Banking

Evergrande Worries The US Fed After All

THE US FEDERAL RESERVE’S latest semi-annual financial stability report comes with an uncommon warning about China’s financial stresses, not the sort of thing it typically comments on.

Its concern is that the stresses in China’s real estate sector could strain the Chinese financial system, with possible spillovers to the United States:

In China, business and local government debt remain large; the financial sector’s leverage is high, especially at small and medium-sized banks; and real estate valuations are stretched. In this environment, the ongoing regulatory focus on leveraged institutions has the potential to stress some highly indebted corporations, especially in the real estate sector, as exemplified by the recent concerns around China Evergrande Group. Stresses could, in turn, propagate to the Chinese financial system through spillovers to financial firms, a sudden correction of real estate prices, or a reduction in investor risk appetite. Given the size of China’s economy and financial system as well as its extensive trade linkages with the rest of the world, financial stresses in China could strain global financial markets through a deterioration of risk sentiment, pose risks to global economic growth, and affect the United States.

Was it just two months ago that Fed Chair Jerome Powell said that the risks from Evergrande’s troubles seemed very particular to China?

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A Trail Of Hidden Debt Along The Belt And Road

A REPORT ON Belt and Road Initiative (BRI) funding crosses our desk. It comes from AidData, a development aid research centre at the US university William and Mary, which has compiled a database of China’s international development finance covering 13,427 projects approved between 2000 and 2017 worth $843 billion across 165 countries, of which some 140 have signed onto the BRI.

Among its findings are that China has used debt rather than aid to establish a dominant position as a provider of international development finance, and the political sway that comes with it. That is less of an eye-opener than the estimates that the loans extended to recipient countries — primarily low- and middle-income nations — are far more extensive than generally realised, to the tune of $385 billion of ‘hidden debt’.

The reason for this hidden debt — hidden in the sense that it is not captured by institutional debt monitoring mechanisms such as the World Bank’s Debtor Reporting System (DRS) — is that Beijing’s loans are increasingly going to state-owned companies, banks or other entities that benefit from implicit or explicit, host government guarantees. 

Thus the debt does not show up in counts of sovereign debt, yet the liabilities for the recipient governments do not magically disappear.

The true magnitude of the debt is one concern. By AidData’s estimates, 42 low and middle-income countries now owe China the equivalent of more than 10% of their GDP.

Factoring in their hidden debt could cause reassessments of credit ratings, potentially raising borrowing costs.

A third concern is that hidden dent complicates debt management. Recipient governments may not have a good handle on their debt service requirements. That may complicate making the interest payments and debt restructuring where necessary.

Five key points emerge from the report:

  • the sheer growth of China’s overseas development finance since 2000, outspending traditional Western and multilateral providers by 2-to-1 or more (an average of $85 billion a year for China against the United States’ $37 billion, for example), and doing so with semi-concessional and non-concessional debt rather than aid;
  • a transition from direct sovereign lending pre-BRI to lending to state-owned companies, state-owned banks, special purpose vehicles, joint ventures, and private sector institutions, which, as already noted, keeps the loans off the balance sheets of the governments in the recipient countries but still provide explicit or implicit host government guarantees;
  • the increasingly central role of China’s state-owned commercial banks — including Bank of China, the Industrial and Commercial Bank of China, and China Construction Bank — have played in the transition, including organising lending syndicates and other co-financing arrangements that make it possible to undertake BRI mega-infrastructure projects (financed with loans worth $500 million or more);
  • the growing use of collateralisation to offset increasing credit risk, allowing Beijing to pursue a high-risk, high-reward credit allocation strategy to secure energy and natural resources, with the loans secured against future export receipts, or, for infrastructure loans, physical assets; and 
  • masking from international institutional monitoring, eg, the DRS, the extent of Chinese debt burdens on some recipient countries, estimated to be underreported by an average equivalent to 5.8% of their GDP, which is complicating international debt restructuring talks, which have become as much competitive as collaborative between China and Western donors and creditors of late as Chinese state-owned policy banks can restructure loans on their own terms outside the well-established forums of sovereign debt renegotiations.  

Nor do China’s loans come cheap. The average interest rate is 4.2%, with a repayment period of less than ten years, AidData says. By comparison, a lender like Germany, France or Japan would typically charge 1.1% with a repayment period of 28 years.

A further intriguing point to emerge is that more than a third of BRI infrastructure projects have encountered significant implementation problems—corruption scandals, labour violations, environmental hazards, public protests and the like. In contrast, non-BRI infrastructure projects are less troubled, as are BRI projects undertaken by the host country rather than China. That fits with widespread anecdotal evidence of local resentment when China ships in everything from raw materials to labour.

Whether such concerns amount to a tipping point in a BRI backlash is moot, and may provide only a slither of an opening for the two new Western counters to the BRI, the United States’ Build Back Better World Initiative and the EU’s Global Gateway Initiative.

China may well now have a sufficiently firm foothold in development finance that it will not be dislodged by rival and not necessarily wanted offers of sustainable and transparent financing and good governance. A tweak to Beijing’s messaging,already being rehearsed — no vanity projects and cleaner and greener projects — may suffice.

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Evergrande, Still Breathing Hard, Resumes Construction

BELEAGUERED PROPERTY DEVELOPER Evergrande dodged its October 23 debt default deadline, making an $83.5 million payment to its international bondholders due on September 23, just before the 30-day grace period expired.

That was the first of five coupon payments it has missed on their due dates, totalling a combined $275 million.

It is unclear where Evergrande got the $83.5 million from, but it has bought another week of breathing room, although the company will still be breathing hard under the weight of its more than $300 billion in liabilities.

One place the funds for the coupon payment did not come from was the hoped-for sale of control of its core property business, Evergrande Property Services. Talks to sell a 51% stake of Evergrande Property Services to Hong Kong-listed Chinese property developer Hopson Development fell through.

Trading of shares in Evergrande Property Services resumed on Thursday on the Hong Kong stock exchange, having been suspended since October 4 pending a possible general offer for its shares. Evergrande said the day before that there had been no material progress in asset sales. The last significant disposal was a 20% stake in Shengjing Bank to an agency of Shenyang city’s government.

However, the company has restarted work on up to 10 projects in six cities, including Shenzhen. On August 31, it had acknowledged that delays in paying suppliers and contractors had forced the suspension of some projects. However, its statement on Sunday on WeChat announcing the resumptions did not disclose on how many of its 1,300 developments across China it had halted work.

Last week, People’s Bank of China Deputy Governor Pan Gongsheng reiterated that the risks from Evergrande are controllable, property sector financing is returning to normal, and that the bank will protect households and suppliers.

Not many investors in financial markets share the central bank’s sanguinity. First, there is the ever-present risk of default. Each grace period is starting to feel like a round of Squid Game for Evergrande.

Second, the speed and depth of the slowdown of China’s property market that the crisis has triggered are raising concerns about the extent to which they will weigh on GDP and whether authorities can balance reducing the cost of living by making housing more affordable with managing decelerating growth.

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Contagion Fears Will Intensify As China’s Property Debt Woes Widen

A THIRD WEEK; a third round of missed bond payments by beleaguered property group Evergrande.

Reports say the group missed coupon payments totalling $148 million due today. That follows two sets of payments missed in September. The clock is ticking down on the 30-day grace period on the first of them before a default must be declared.

The developer has more than $300 billion in liabilities.

The fear is of the debt crisis spreading to other developers. A total of $92.3 billion of bonds issued by Chinese developers fall due over the next twelve months. Developers with weak credit ratings are already finding refinancing their debt next to impossible.

Fantasia Holdings, a mid-sized developer based in Shenzhen, has already defaulted on $206 million in payments due. Sinic Holdings, which develops residential and commercial property across China, told the Hong Kong Stock Exchange on October 11 that it would likely default on a bond payment due on the 18th of this month. Beijing-based Modern Land is asking its bondholders to extend payment-due deadlines by three months.

If the sector’s liquidity problems do not improve, further defaults seem inevitable. The question would then become how much contagion there would be in the rest of the economy, of which real estate accounts for a quarter.

Managing a soft landing for the sector’s most troubled companies without making an overt bailout remains a high priority for authorities. More measures at the municipal and provincial level to support developers, such as Harbin’s release of presale funds held in government escrow accounts to ease cash flows, are likely.

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China’s Property Sector Teeters

THE DOMINOES in China’s property market are teetering, even if the first has yet to fall.

Fantasia Holdings, a mid-sized developer based in Shenzhen that the rating agency S&P downgraded to triple C last week, suspended trading in its shares on the Hong Kong exchange on Tuesday after announcing that it had defaulted on a $206 million bond the day before.

It has a further $1.9 billion of offshore bond payments a d $992 million of onshore bond payments due by year’s end. Last month, the company had told investors that it did not have a liquidity issue.

Stress is clearing rising in China’s property sector and the high-yield bonds that underpin it. Fantasia joins beleaguered Evergrande in suspending its shares. In addition, rating agency Fitch has cut its grading of another developer, Shanghai-based Sinic Holdings, to C from triple C. There is only one further cut left, to D for default.

Evergrande, which is selling assets where it can to prevent being dragged under by total liabilities of more than $300 billion, is expected to announce that it has sold 51% of its property service business, which is listed in Hong Kong, to Hopson Development for $5 billion. Evergrande missed an interest payment on an offshore bond on September 23, triggering a 30-day grace period before a formal default.

Evergrande has said nothing formally beyond an exchange filing that it was suspending trading in advance of a ‘possible general offer’ for its Hong Kong-listed shares. Any such offer could be imminent or could not come for some time, with Evergrande’s shares, which had fallen 80% this year, remaining suspended in the interim.

Beijing has also been officially silent on the sector’s problems, even if authorities are orchestrating as soft a landing as they can behind the scenes. Spoiler alert: it will still be pretty bumpy, especially for bondholders.

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Evergrande Sells More Assets As Backdoor Bailout Continues

EVERGRANDE’S SALE OF a 20% stake in Shengjing Bank to an agency of Shenyang city’s government provides a snapshot of how the beleaguered property group is being bailed out.

Shenyang Shengjing Finance Investment Group will pay 10 billion yuan ($1.55 billion) for the stake, but the proceeds will be used to offset Evergrande’s liabilities to the bank. Evergrande retains a 14.6% stake in the bank.

Cash-strapped Evergrande has already shed various assets, including 25 billion yuan worth of property and an earlier 2% stake in Shengjing Bank that raised 1 billion yuan.

More such asset sales are likely, as authorities actively nudge the restructuring of the group’s debt. They have moved to limit contagion from Evergrande spreading after the company missed several interest payments this month to lenders, contractors and suppliers, as well as an $83.5 million coupon payment due on a dollar-denominated offshore bond and concocted a palliative deal with its onshore bondholders.

More deadlines are approaching on its local and offshore bond obligations, including a $45 million bond payment due today, on which Evergrande is likely to invoke its 30-day grace period to make payment. The rating agency Fitch cuts its rating for Evergrande to a ‘C’ today, which signifies a company in ‘near default’. It is Fitch’s fourth downgrade of the group since June 22.

Evergrande has outstanding international debts of about $20 billion and total debt of around $300 billion. More than 100 Chinese banks have lent money to Evergrande, and 1.4 million new housing units have been sold but not completed.

The restructuring will prioritise homebuyers, then contractors and suppliers owed money, followed by domestic investors in Evergrande’s financial products. Foreign investors will be at the back of the queue.

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Evergrande Poses Critical Test For China’s Policymakers

Screenshot of Evergrande Group web site home page captured September 20, 2021

AUTHORITIES BEGAN TO tighten their regulation of China’s property sector last year, fearing real estate developers’ debt was the country’s most significant systemic financial risk.

A slowing economy has only further exposed the property bubble and the extent of its over-leverage. The sector now faces a crisis that is coming to a head with the fate of one of its largest property developers, Evergrande, which has been offloading its properties at firesale prices to meet the new regulatory requirements. 

According to the National Bureau of Statistics, home sales (by value) fell 20% year-on-year in August, while new homes prices rose at the slowest rate this year. 

Evergrande, which faces defaults on some of its $300 billion of debt owed to its bankers this week, is widely considered on the verge of bankruptcy. Its scramble to sell assets fast enough to raise the cash to avoid defaults only pitches the property market into a vicious cycle of falling prices that risks bring down even more developers.

Evergrande’s share price has fallen by approaching 90% in the past six months, and global credit rating agencies have downgraded the firm’s bonds deep into junk territory. Yet Evergrande is ‘too big to fail’ both economically and politically. 

A bailout of some kind is all but inevitable. The open questions are how it will be dressed up to reduce moral hazard and assuage widespread outrage — beyond the collapse in home values, more than a million people face losing deposits on unfinished homes — and who will foot the bill? 

Secured creditors like bondholders account for one-third of Evergrande’s liabilities. Of the remainder, It owes about $147 billion in trade and other payables to suppliers. The risk of the impact rippling through the real economy is significant. Authorities may still be grabbling with quite how extensive and risky those supply chain linkages are.

A way will be found to move Evergrande’s bad debt into official hands, albeit, to mix metaphors, through gritted teeth. The scale of the required rescue is greater than anything experienced with Anbang and other over-extended corporate casualties. The political will also feels weaker, though it will be stiffened as needs be.

Authorities will also have to adjust the expectations of those who invest their savings in a home in the belief that property values never go down.

This all has some of the feeling to it of both the collapse of Japan’s property bubble in the 1980s and the Lehman Brothers bankruptcy in the United States in 2008. Evergrande is systemically important, and its failure would reverberate across the economy with unintended consequences, perhaps for years.  

The policy decision to be made is a very high-stakes one. Beyond avoiding a corporate credit crunch, there is the question of whether the potential impact on local authorities is fully understood. Is there reliable data on which to make that assessment?

This Bystander expects a cautious forced restructuring with the bad debt being buried, not resolved. Some executives will undoubtedly be labelled corrupt, official fingers of blame will be pointed at ‘speculators’ and punishments, arbitrary or otherwise, doled out. 

Other official fingers will be tightly crossed, hoping to get through the crisis without triggering the economic conditions that befell Japan in the 1990s or the political tensions in the United States that have followed the 2008 global financial crisis.

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China’s Central Bank Eases Towards And End To Easing

AS EXPECTED, THE People’s Bank of China (PBOC) has made a modest reduction to the amount of cash that banks must hold in reserve in an effort to boost lending to small businesses.

The central bank will cut the reserve requirement ratio by half a percentage point, effective from July 15, taking the requirement to 12% for large banks, 10% for smaller banks and 5.5% for rural commercial banks.

The easing will inject around 1 trillion yuan ($154 billion) of long-term liquidity into the economy. It may also be a sign of concern that the recovery is faltering.

Rising commodities prices and supply chain interruptions are increasing input costs for manufacturers while local lockdowns to counter occasional Covid-19 outbreaks and still-subdued consumer spending have hit the services sector.

Second-quarter GDP figures due next week may confirm that. Consensus forecasts are for 8% year-on-year growth, down from the first quarter’s 18.3% growth, although the comparison means little because the first quarter last year was the first to be hit by the pandemic and contracted 6.8%.

As first into the pandemic, China has been first into recovery with the PBOC leading its peers in scaling back stimulus and now starting to tighten monetary policy, albeit ever so slightly and even while insisting there has been no change of stance.

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Broad Regulatory Corruption Revealed Behind Baoshang Bank Failure

THE SCALE OF the corruption among bank regulators in Inner Mongolia that was instrumental in the collapse of Baoshang Bank is breathtaking, according to the Central Commission for Discipline Inspection (CCDI).

Five former officials of the regional branch of the now-disbanded China Banking Regulatory Commission (CBRC), including its former head, Xue Jining, pocketed 700 million yuan ($109 million) between them, according to a report released by the CCDI on May 27. The five are said to have taken bribes including, cash, gifts, apartments and sex for approving new businesses and loans, project construction authorisations and personnel appointments between 2002 and 2015.

Four-fifths of the corrupt dealings involved Baoshang Bank, a local lender that failed and was taken over by the state in 2019 after been deemed a systemic risk. The CCDI report lays out in some detail how the CBRC officials in Inner Mongolia overlooked warning signals about the bank’s financial condition in their inspections and also misrepresented the health of its loan book in their reports.

Baoshang was the first Chinese lender to be taken over by the state in two decades. The founder of the bank’s parent company, Tomorrow Holding, the billionaire Xiao Jianhua, was placed under investigation by anti-corruption authorities in 2017. The newly released findings were compiled by a special task force at the CCDI looking into the bank’s failure.

More than half the bribes were allegedly taken by Xue. He as expelled from the Party in January and is on trial on corruption charges to which he has pleaded guilty. The CBRC was replaced by the China Banking and Insurance Regulatory Commission (CBIRC) in 2018, for which the report will be used as a salutary tale.

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Beijing Doubles Down On Crypto

CHINA HAS AGAIN put the boot into cryptocurrencies.

Vice Premier Liu He issued a statement saying that tighter regulation of crypto is needed to protect the financial system and hinted at prosecutions of illegal financial activities. This doubles down on the warnings earlier in the week issued by three financial self-regulatory bodies — the National Internet Finance Association of China, the China Banking Association and the Payment & Clearing Association of China — about the investment and legal risks involved in trading in virtual currencies.

News of the statement sent bitcoin and other cryptocurrencies into a further swoon. It also fuelled speculation that Beijing plans a further crackdown on crypto.

Trading in virtual currencies already violates several laws and regulations, including exchanging legal currencies for cryptocurrencies and exchanges between different virtual currencies. The prohibition on exchanging crypto for physical money means that the only channel for virtual currency exchanges is the exchanges’ over-the-counter (OTC) trading.

The snag there is that OTC transactions can be used for money laundering, which runs slap bang into the anti-corruption campaign. OTC traders can require buyers to provide documentary evidence that they are not money laundering, but convincing authorities is another matter.

As well as closing off opportunities for individuals to convert cryptocurrencies, authorities can crackdown on financial institutions for providing crypto-related services. Banks have already been warned of the risk of violating laws and regulations when they are involved in any virtual currency-related businesses.

However, this is more by way of a warning not to take advantage of loopholes in the rules on virtual currency-related business than closing the loopholes.

That, though, will likely come with more and more specific violations being codified. Meanwhile, the ban on financial institutions being indirect involved in crypto-related business provides a catch-all compliance obligation that regulators can impose as strictly as they feel they need to.

That, in turn, can be dialled up or down to reflect how firmly authorities feel they have crypto under their thumb. Private crypto will not be allowed to compete with the People’s Bank of China’s digital yuan, which is a key component of authorities’ broader plan to maintain control of a rapidly digitising economy. 

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