It’s China, it’s bad loans, and it’s securitisation

It’s China, it’s bad loans, and it’s securitisation

David Keohane

| Sep 13 08:33 | 3 comments | Share

What could possibly go wrong? It looks increasingly likely that China is gearing up for another round of bad-loan cleansing with asset management companies seemingly being prepared for some more NPL absorption and a move towards what might be loosely termed market-based approaches to restructurings. It looks like this will include securitisation, which Chinese authorities have been dipping their toes back into since a Lehman-burning, according to SocGen’s Wei Yao (with our emphasis):

China’s credit asset securitisation (CAS) got off to a meaningful start in 2005 when the government accelerated policy initiatives to set up the regulatory framework. Domestic issuance of asset-backed securities (ABS) took off, rising from almost zero to nearly CNY70bn by 2008. However, as soon as the Lehman crisis hit, policymakers suspended the trial programme and only cautiously resumed it in 2011 with six deals totalling CNY22bn, which were subsequently followed in 2012 by a second trial of CNY50bn. Entering 2013, the reluctance has continued to thaw and interest has continued to rise.In August, the State Council announced to steadily push ahead with the pilot scheme for securitisation. A new round of CNY300bn is widely expected to kick off soon.The renewed interest in securitisation echoes the government’s new policy guideline of “better utilisation of the stock,” as the liquidity transformation function [of securitisation] suits the purpose well. This tool is clearly intended to alleviate the debt roll-over burden on banks, thus freeing up their capital for new lending. In particular, infrastructure loans have been singled out as favoured underlying assets for securitisation and China’s Development Bank – the biggest infrastructure lender – is said to be ready to take up two-thirds of the quota in the upcoming programme.

China is obviosuly not new to the securitisation game but it has been largely informal with the help of the interbank markets and shadow banks. Yao points to the sudden and sharp increase in banks’ net claims on non-bank financial institutions (NBFIs) where the suspicion is that some of the claims could be disguised lending from formal banks.

The scale of off-balance-sheet lending via the interbank market is estimated to have surged to CNY4tn from practically zero in less than four years times, which is probably another reason for the sense of urgency to push ahead with CAS. If the financial regulators were to introduce tighter rules to discourage these informal practices while broadening the formal channel, this could help to mitigate the risk in the financial system in the short term.

Anyway, the point here is that although the government has emphasised that only assets of good quality will be targeted for securitisation, Yao thinks the mention of infrastructure loans as a priority naturally suggests that policymakers may also aim to use this financial market tool for NPL restructuring.

Others are more fundamentally sceptical. Fitch, for example, said: the measures will not “facilitate any meaningful risk transfer from the banking system. Unless quotas are lifted dramatically, the small size of China’s securitisation market (less than 0.1% of total assets) means any attempt at “cleaning up” the country’s banks by a large-scale transfer of NPLs could be problematic – given problems with pricing such assets and the potential for overwhelming what is a fledgling market.”

But as Yao notes, China has tried this before — in 2004, the Industrial and Commercial Bank of China securitised a batch of NPLs with a face value of CNY2.6bn into CNY820m notes via a special purpose vehicle. Scale is a good point though.

A final chunk from Yao’s note:

In the aftermath of the 1997 Asian crisis, a number of Asian economies also looked to securitisation with the hope that its risk transformation function would help deal with the huge piles of NPLs left over from the financial turmoil. However, before the securitisation process the NPLs were always written down and transferred to bad banks at big discounts. In additions, there were two other issues. First, the available pools of debt collaterals were less diversified than those in developed markets; and second, investors were justly wary of the uncertainty surrounding potential default processes. As a result, the equity tranche, especially for NPL securitisations, had to be much bigger – sometimes 10-20% – than would otherwise be necessary and the originators – often banks – usually ended up holding the entire tranche.

This may well happen to China’s experiment as well. At the moment, the banks hold nearly 70% of the outstanding ABS and the trading volumes have been fairly muted. In order to address these problems, the upcoming securitisation trial is said to expand the list of eligible investors to include insurers. They have CNY7tn in assets under management, of which two-thirds are controlled by four big state insurers. Besides, one-third of insurance money is in bank deposits. There should be no problems keeping a few more rounds of trials going, but questions remain as to whether the risks will be properly priced and whether non-performing assets will be let go.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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