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Banks
www.fitchratings.com 14July2010
ChinaSpecial Report
Chinese Banks
Informal SecuritisationIncreasingly DistortingCredit Data
Summary
In the wake of the 2009 credit boom, trends in Chinese bank loan growth have beenincreasingly under the spotlight. Bank credit rose 33% in 2009 (to 140% of GDP atyear‐end), and is on pace for another brisk year in 2010. With GDP growth now backin double‐digits, Chinese policymakers have been grappling with how to rein in thecredit‐fuelled stimulus before it leads to overheating, without overshooting.Against this backdrop, the reported decelerationin lending in H110 (Chart 1) has received muchattention. The slowdown is cited as evidence thatrecent administrative tightening is working, andthat China’s banks and economy are normalisingafter the shock of 2008‐09. While the creditenvironment is less frenzied than in H109, FitchRatings cautions that lending has not slowednearly as much as official data suggests, due tothe increasing amount of credit being shifted offof Chinese banks’ balance sheets via informalsecuritisation (ie the re‐packaging of loans intoinvestments products for sale to investors).Fitch believes the vast majority of these transactions are not publicly disclosed byChinese banks, and few, if any, traces of the loans remain in financial statements.The growing popularity of this activity is increasingly distorting credit growthfigures at an institutional and system level, resulting in pervasive understatementof credit growth and credit exposure. Consequently, Chinese banks’ loan lossreserves and capital are more exposed to credit losses than current data suggests.Adjusted for informal securitisation activity, Fitch estimates that the net amount ofnew CNY loans extended in H110 was closer to CNY5.9trn, or 28% above the officialfigure of CNY4.6trn. While this difference may seem small when compared to thetotal stock of CNY loans for banks involved in this activity (roughly CNY34trn at end‐June 2010), on a flow basis the volume of credit being shifted off balance sheets inrecent times has been large and rising. Activity also is largely concentrated amongjust a few dozen banks, and institution‐specific exposure is often much higher.A key misconception about this activity is that as long as the quality of theinvestment products’ underlying assets remains strong, there is nothing to worryabout. While asset quality is a key issue, Fitch’s greatest concerns currently centreon liquidity risk, and the growing potential liabilities Chinese banks are taking on inthis activity. Credit‐backed investment products are frequently marketed assubstitutes for bank deposits, and investors commonly believe there is an implicitcommitment from banks to repay investors upon the products’ maturity. However,these obligations are not included anywhere in financial statements, and hencerepresent a hidden call on liquidity. While China’s large, highly liquid banks may beable to manage these obligations, smaller banks could encounter strains.
Analysts
Charlene Chu+8610 8567 9898 x112charlene.chu@fitchratings.comChunling Wen+8610 8567 9898 x105chunling.wen@fitchratings.comHiddy He+8610 8567 9898 x108hiddy.he@fitchratings.com
Related Research
·
Macro‐Prudential Risk Monitor
(June 2010)
·
EM Banking System Datawatch
(April 2010)
·
China
(January 2010)
·
Chinese Banks: Annual Review and Outlook
(December 2009)
·
Chinese Banks: Soaring Credit Amid WeakCorporate Climate A Concern
(May 2009)
·
Chinese Banks: Asset Quality Under Pressure As Credit Cycle Turns
(January 2009)
04008001,2001,600
2 0 0 5 2 0 0 6 2 0 0 7 2 0 0 8 2 0 0 9 2 0 1 0
010203040New loans/mo. (3mma, LHS)CNY loans (yoy, RHS)
Chart 1: CNY Loan Growth
(CNYbn)Source: Bloomberg, PBOC(%)
Banks
Chinese Banks ‐ Informal Securitisation Increasingly Distorting Credit DataJuly 2010
2Recent Developments in Regulation andDisclosure
In early July, alarmed at the increasing amount of credit leaking out of the bankingsystem through this channel, the China Banking Regulatory Commission (CBRC)ordered trust companies, which play a vital role in these transactions, totemporarily halt all informal securitisation deals with banks. Whether the ban willultimately become permanent and what, if any, forms of activity will be exempt haveyet to be officially decided. The CBRC is likely to face opposition to the ban frombanks and trust companies, and, as with previous rules aimed at curbing these deals,the final regulations could be much less stringent than those initially announced.In Fitch’s view, a prohibition on this activity would be a positive step towardspreserving financial sector stability, but in practice could be difficult to executeand carries potential negative implications for growth over the short‐run. Therecovery in China’s GDP growth is more credit‐dependent than most observersrealise, and the need to maintain loose credit while preserving the strength of bankbalance sheets is one reason why these deals have been permitted to continue.From a practical viewpoint, even if a blanket ban were put in place,implementation would not be a simple task, and Fitch believes Chinese banks wouldcontinue to face significant risks from this activity for at least another year. While aban may effectively stop new transaction flow, to the extent that banks have beenpaying maturing investors with new monies raised (which is not uncommon), theban itself could lead to difficulties in meeting repayment obligations at someinstitutions. Of the estimated CNY2.3trn in outstanding products at end‐H110, morethan 40% of products will mature in H210 and another 25% in H111.Meanwhile, dealing with the large stock of loans already transferred off‐balance‐sheet and re‐packaged into investment products also could be a challenge. In caseswhere the maturity of the underlying assets exceeds that of the products (whichhas become increasingly common), these loans will likely have to be brought backon‐balance‐sheet if new products cannot be issued. This re‐incorporation of such alarge amount of credit could strain capitalisation and loans/deposits ratios for someinstitutions, in turn necessitating another sizeable round of capital raising.Past experience also suggests that so long as there is demand for this activity —either from banks looking to adjust their asset structure, or from investors in searchof higher returns — shutting it down completely could be difficult.
Minimal Impact on Transaction Flowfrom December Guidance
Informal securitisation has developed largely on an ad hoc basis in China, and hencethere is no comprehensive legal framework or standardised disclosure requirementsgoverning activity. Thus far, regulators have focused most of their attention ondirecting specific aspects of transactions. Prior to the temporary ban in early July,the most recent changes in guidelines occurred at end‐2009 and included:
·
requiring that full ownership of loans be transferred to trust companies in eachsale;
·
prohibiting banks from engaging in under‐the‐table repurchase agreements tobuy back loans that had been previously sold;
·
banning banks from selling credit‐backed wealth management products (CWMPs)built around their own loans; and
·
encouraging more liquidity and diversity of the assets underlying CWMPs built aroundmultiple loans, whose maturities often differfrom each other and the CWMP.In response to the December 2009 rules, Chinese banks and trust companies made anumber of adjustments to deal structures in H110, typically involving somevariation of enlisting other banks to sell the products or act as intermediatepurchasers of the loans, or arranging for trust companies to step into the role ofloan originator or product distributor (see Chart 2 to the left). The final net effect
Bank A Trust Co.Investors
123
Prior to 2010: Typical LoanRe‐packaging Transaction
Chart 2: Flow Diagrams of theLoan Re‐Packaging Process
Post‐2010: A Second BankBecomes Involved In The Deal
Bank ATrustCo.InvestorsBank B
1 234
Type 2 – Bank B Assists Bank A inSelling the Loan, Enabling Bank Ato Distribute the Product
MATCHED BY
Type 1 – Banks Sell Each Others’Products
Bank A Bank BInvestorsTrustCo.
1 23
Bank A Bank BInvestorsTrustCo.
2 13
Post‐2010: Trust Company PlaysA More Active Role
1. Trust Company signs a loanagreement with a borrower2. Trust Company creates a trustproduct that it or a bank pre‐sells to investors (sometimesthe bank is the investor, andthe purchase is booked in itsinvestment securities portfolio)3. Monies raised in pre‐sale arepassed on to the borrower
Bank A Bank BTrustCo.
1 2
Type 1 – Trust Company Sellsthe ProductType 2 – Trust Company Originatesthe Loan
Bank A Trust Co.Investors
123
Prior to 2010: Typical LoanRe‐packaging Transaction
Bank A Trust Co.Investors
123
Prior to 2010: Typical LoanRe‐packaging Transaction
Chart 2: Flow Diagrams of theLoan Re‐Packaging Process
Post‐2010: A Second BankBecomes Involved In The Deal
Bank ATrustCo.InvestorsBank B
1 234
Type 2 – Bank B Assists Bank A inSelling the Loan, Enabling Bank Ato Distribute the Product
MATCHED BY
Type 1 – Banks Sell Each Others’Products
Bank A Bank BInvestorsTrustCo.
1 23
Bank A Bank BInvestorsTrustCo.
2 13
Post‐2010: A Second BankBecomes Involved In The Deal
Bank ATrustCo.InvestorsBank B
1 234
Type 2 – Bank B Assists Bank A inSelling the Loan, Enabling Bank Ato Distribute the Product
MATCHED BY
Type 1 – Banks Sell Each Others’Products
Bank A Bank BInvestorsTrustCo.
1 23
Bank A Bank BInvestorsTrustCo.
2 13
Post‐2010: Trust Company PlaysA More Active Role
1. Trust Company signs a loanagreement with a borrower2. Trust Company creates a trustproduct that it or a bank pre‐sells to investors (sometimesthe bank is the investor, andthe purchase is booked in itsinvestment securities portfolio)3. Monies raised in pre‐sale arepassed on to the borrower
Bank A Bank BTrustCo.
1 2
Type 1 – Trust Company Sellsthe ProductType 2 – Trust Company Originatesthe Loan
Post‐2010: Trust Company PlaysA More Active Role
1. Trust Company signs a loanagreement with a borrower2. Trust Company creates a trustproduct that it or a bank pre‐sells to investors (sometimesthe bank is the investor, andthe purchase is booked in itsinvestment securities portfolio)3. Monies raised in pre‐sale arepassed on to the borrower
Bank A Bank BTrustCo.
1 2
Type 1 – Trust Company Sellsthe ProductType 2 – Trust Company Originatesthe Loan
Banks
Chinese Banks ‐ Informal Securitisation Increasingly Distorting Credit DataJuly 2010
3
07501,5002,2503,0003,750Q107 Q207 Q307 Q407 Q108 Q208 Q308 Q408 Q109 Q209 Q309 Q409 Q110 Q210WMP loan‐only WMP mixed* Trust loan‐only Trust credit‐equivalent
Chart 3: No. of Loan‐Related Investment Products Outstanding
* The CBRC has been encourating banks and trust companies to create mixed‐asset products, with loans comprising aslittle as 70% of underlying assets. Other common components are government, policy bank, and corporate bondsSource: Wind, Fitch
has been much more convoluted transactions that are harder for regulators andanalysts to track, and in turn more difficult to unwind in the event of default.
Already Weak Disclosureis Getting Even Worse
Data on the sale and re‐packaging of loans into CWMPs has always been sparse, but,historically, observers have been able to track activity by the number of CWMPsissued each month using information collected by small third‐party data providers.However, as public scrutiny of informal securitisation has risen, Fitch has observeda noticeable worsening of Chinese banks’ already poor disclosure of this activity.Some banks very actively engaged in transactions last year are showing up in 2010data as minimally involved, yet the bank’s own salespeople (responding to Fitch’senquiries) state that business remains as strong as ever. Meanwhile, privateplacements of products to institutional investors are becoming more commonplace,most of which are never disclosed to any entity but the CBRC. Because of thisworsening in disclosure, data from third‐party providers is capturing less and lesstransaction flow, with as much as 40% of deals in H110 going uncaptured, versusless than 10% prior to end‐2009.Fitch has made two important changes to its analysis of informal securitisation in2010. First, at least for the time being, the agency has ceased publishinginstitutional‐level figures due to large variations in the levels of disclosure anddistortions arising from the new trend of Chinese banks’ selling each others’products. Second, reflecting the rapid growth of the trust sector in China, trends intrust companies’ issuance of credit‐backed and credit‐equivalent trust products(CTP) has been incorporated into issuance data.Although the distributors and investors in CTPs often differ from CWMPs, trackingtrends in trust product issuance is important in gauging the extent of creditunderstatement at a system level. Chinese banks are not exposed to losses on CTPsto the same degree as CWMPs, but may not be entirely immune either, given that alarge share of trust product loans were either arranged by or initially extended bybanks, and that a large share of trust products are distributed through banks.
Informal Securitisation Activity Accelerating
Volume of Credit Being Re‐packagedonthe Rise
Data on the number of outstanding CWMPs and CTPs shows net issuanceaccelerating in H209 as credit conditions tightened, followed by a flattening out inH110 (Chart 3). While the recent moderation in part reflects the looser creditenvironment in H110, the significant worsening in disclosure in 2010 also has been amajor factor distorting recent data. Indeed, when historical figures are adjusted tostrip out the entity that most conspicuously dropped out of issuance figures in 2010,net product issuance swings from −7% to +1% in H110.
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