Predictions of a Chinese banking system bailout are going mainstream.
What was once the fringe view of permabears and short sellers is now increasingly being adopted by economists at some of the world’s biggest banks and brokerages. Nine of 15 respondents in a Bloomberg survey at the end of last month, including Standard Chartered Plc and Commonwealth Bank of Australia, predicted a government-funded recapitalization will take place within two years. Among those who provided estimates of the cost, a majority said it will exceed $500 billion.
While a bailout of that size would be a far cry from the $10 trillion forecast of U.S. hedge fund manager Kyle Bass in February, the responses reflect widespread concern that Chinese lenders will struggle to cope as bad loans surge. Even as some analysts said a state recapitalization would put the banking system on a stronger footing, 80 percent of respondents predicted news of a rescue would weigh on Chinese markets — dragging down bank stocks and the yuan while pushing up government borrowing costs and credit risk.
“A recapitalization will happen after the Chinese government comes clean with the true nonperforming loan figure,” said Kevin Lai, the Hong Kong-based chief economist for Asia ex-Japan at Daiwa Capital Markets. “That will require a lot of money creation.”
At CBA in Sydney, analyst Li Wei said the Bloomberg survey was the first time he’d estimated the timing and cost of a recapitalization. The topic became more prominent after an article calling for the nation to tackle leverage and bad debt appeared in the People’s Daily, the mouthpiece of China’s ruling Communist Party, in May. That same month, Societe Generale SA issued a 48-page report wargaming restructuring options for China’s state-owned enterprises and banks.
Chinese lenders are grappling with a growing mountain of bad debt after flooding the financial system with cheap credit for years to prop up economic growth. Non-performing loans jumped by more than 40 percent in the 12 months ended March to 1.4 trillion yuan ($210 billion), or 1.75 percent of the total, according to government data. The figures are widely believed to understate the true scale of the problem, with CLSA Ltd. estimating NPLs were probably closer to 11.4 trillion yuan at the end of last year.
The People’s Bank of China and the China Banking Regulatory Commission didn’t reply to faxed requests for comment.
Chinese banks will be able to maintain relatively high capital levels even if they’re hit by severe shocks, the central bank said in its 2016 financial stability report last month. A stress test of 31 large- and mid-sized Chinese banks showed their aggregate capital-adequacy ratio falling to 10.97 percent from 13.32 percent in a worst-case scenario, the PBOC said. China will require systemically-important banks to have a ratio of 11.5 percent by the end of 2018.
Some economists are less sanguine, predicting that Chinese banks will need state help as loan losses erode capital buffers. A majority of the survey respondents said policy makers will use a mix of foreign reserves, state assets sales, sovereign bond issuance or money printed by the central bank to fund a recapitalization. Most of the economists who estimated a tab for a bailout said it will cost at least $500 billion, with forecasters from CBA and Hamagin Research Institute saying it could climb to as much as $3 trillion.
It wouldn’t be the first time China’s government has stepped in to support its banks, most of which are still majority-owned by the state. When the country’s NPL ratio climbed to as high as 40 percent in the late 1990s, policy makers sold special bonds to recapitalize the four biggest lenders and set up state-run bad banks to buy 1.4 trillion yuan of soured loans at face value. The effort was largely a success, setting the stage for more than a decade of breakneck growth that turned China into the world’s second-largest economy and helped many of its biggest companies tap into global capital markets.
A government bailout “will help write off bad debt and help banks clean up their balance sheets,” said Ding Shuang, the head of Greater China economic research at Standard Chartered in Hong Kong. “It’s a positive thing if it really happens.”
Of course, some analysts argue that a bailout by the government won’t be necessary. Iris Pang of Natixis SA says lenders can replenish their capital by selling bonds and equity.
Others foresee more extreme scenarios. Bass, the Dallas-based founder of Hayman Capital Management, says a large devaluation of the Chinese currency will be the centerpiece of a government response that may also include cutting interest rates to zero. The yuan will fall in excess of 30 percent against the dollar, Bass predicts, helping to boost export competitiveness and “reset” the economy.
“China will save its banks, and the renminbi will be the valve for normalization,” Bass told investors in a February letter, referring to another name for the yuan.
In May report called “Restructuring China Inc.,” Societe Generale analysts said losses in the banking system could reach $1.2 trillion. They advised avoiding shares of lenders until after a debt restructuring in coming years, and said if government bond sales surged as part of funding a recapitalization, sovereign borrowing costs could rise by 100 basis points or more across all maturities.
Chinese markets are already signaling anxiety over losses in the banking system. The nation’s four biggest lenders trade at an average 32 percent discount to net assets in Hong Kong, suggesting investors are braced for big writedowns, a recapitalization that dilutes their equity stakes, or some combination of both. The yuan just capped its biggest quarterly decline since China unified the official and market rates in 1994, while market perceptions of the nation’s default risk have almost doubled since late 2014.
“The government appears to still be in the process of working out how to restructure,” Yao Wei, China economist at Societe Generale, said in the report. “This is the root of the uneasiness — the excruciating time spent waiting before the government takes action.”
By Bloomberg News