The China Credit Spotlight is a flagship series of China research that brings together our views on China's economic and credit trends, and examines the credit conditions for China's top corporates and banks, key sectors, local and regional governments, and structured finance.
The Ties That Bind Banks And Insurers
Linkages between China's banks and insurers are strengthening. Major banks are set to raise large amounts of capital over the next 18 months. Insurers are natural buyers of their capital instruments, which offer yield, duration, and supportive regulatory settings. While the relationship has mutual benefits, S&P Global Ratings thinks growing cross-holdings in the financial sector could multiply systemic risk.
- We believe the bank-insurer relationship is one of mutual benefit. In the event of a bank failure or crisis, however, systemic risks would multiply.
- Another complication is that most Chinese banks and major insurance companies are government-owned. This means they benefit from state support, but also face obligations to carry out broader economic goals.
Securitization Enters Its Awkward Adolescence
Chinese reforms are having a profound impact on the country's securitization industry, which we project to grow 6% in 2019 to US$310 billion in issuance. However, S&P Global Ratings expects institutions will find their underwriting standards tested as the industry ventures into new territories involving new originators.
- Regulators are approving more transactions, while an economic rebalancing to domestic consumption and China's deleveraging are pushing more institutions to consider securitization.
- We see this market as going through a kind of adolescence with lots of growth and potential. But there's also experimentation with new practices that could expose the industry to greater risk.
The Coming Exit of Struggling Banks
China's biggest banks remain resilient, while some smaller and weaker institutions are getting weaker. S&P Global Ratings has been regularly writing about this "Matthew Effect," a polarization brought home this year with the Chinese government's takeover of Baoshang Bank in May and a coordinated effort to bolster the troubled Bank of Jinzhou in July. We anticipate more difficulties will likely surface over the next year, and some problem banks will exit the market.
- Credit divergence will intensify, in our view, because some small and midsized banks (SMB) are less equipped to deal with a slowing and rebalancing economy and tightening financial regulations.
- Within the SMB niche, markers for vulnerability include geographic base; high exposure to riskier credit; or governance issues, often indicated by ownership structures and failure to file financial reports in a timely manner.
Catching The Mice In Mixed-Ownership Reform
It's been four years since China announced a key initiative to inject private capital and management expertise into state-owned enterprises (SOEs). Yet most SOEs continue to be controlled or dominated by government bodies, and this year we've seen more of the reverse trend, with SOEs investing in or rescuing private companies. This show that progress of "mixed-ownership reform" has been slow. Nonetheless, S&P Global Ratings believes the initiative's success shouldn't be measured on ownership patterns alone.
- Mixed-ownership is one of several reforms aimed at transitioning China from its rapid, catch-up growth phase to a more balanced and productive output model.
- Wider and more independent shareholding structures can reduce wasteful spending at the corporate level, enhance governance, and boost returns on investment.
The Staying Power Of A US$3 Trillion Local Government Problem
China's push to end local governments' reliance on off-budget debt has so far been ineffective, with state-owned entities (SOEs) continuing to bury liabilities. S&P Global Ratings estimates this is a Chinese renminbi (RMB) 20 trillion (US$3 trillion) problem, with local government hidden debt equal to about one-quarter of Chinese GDP.
- Authorities want local governments to stop hiding debt. But it also wants the governments to keep borrowing to fund projects that promote fixed-asset investment targets and GDP growth.
- China's local governments need debt more than ever, to plug deficit holes, meet GDP targets, and fund infrastructure. The composition of local government debt is reshaping as these dynamics play out.
Restructuring Won't Fully Unlock Infrastructure Debt Traps
China's massive infrastructure program lies at the heart of crushing debt problems. It's not clear just how much local and regional governments (LRGs) have borrowed to support their capital-hungry projects since not all of it appears on their balance sheets. Most debt--some in the form of wealth management products--is channeled through local government financing vehicles (LGFVs) and have implicit government guarantees. Far more debt could be hidden in this way than disclosed in official LRG borrowings. We do know that China faces a maturity wall of LGFV onshore bonds in 2019-2021 that could be as steep as Chinese renminbi 3.8 trillion (US$560 billion). But can it be cleared?
- LGFVs won't be able to dig their way out of the hidden debt pits without assistance. The industry could face a liquidity crunch should policy and financing conditions turn against them.
- Regulators require debt held in asset management products to be resolved by the end of 2020. There's been limited visibility over how the LGFVs will repay these debts or swap them into bank loans.