viernes, 17 de agosto de 2018

viernes, agosto 17, 2018

Regional lenders: China’s most dangerous Banks

In the second part of an FT series, Gabriel Wildau and Yizhen Jia explain how reliance on short-term funding and exposure to the industrial economy have put some lenders at risk

Gabriel Wildau and Yizhen Jia in Shenyang


© Shenyang Machine Tool Group has received loans from Bank of Shengjing, one of a group of regional lenders who are exposed to loss-making enterprises. FT montage; Bloomberg


At dusk under a smoggy sky, in the heart of north-east China’s rust belt, workers in beige uniforms file out of Shenyang Machine Tool, a lossmaking state-owned enterprise that is a pillar of the regional economy.

It looks like the end of any day in the company’s 35-year history, but workers know the factory’s best days are behind it. The manufacturing and construction boom that powered China’s economy, fuelling demand for heavy machinery, is winding down, and Shenyang Machine has posted losses every year since 2013, once government subsidies — of between Rmb29m and Rmb53m ($4.3m to $7.8m) — are excluded.

“They’ve been talking about reform for 10 years, but personally I haven’t seen much change here,” says one worker who only gives his surname, Kong, who does aftersales service for Shenyang Machine and has worked there for 30 years. “People aren’t using geared lathes any more. We’re being forced out of the market.”

The workers are oblivious to the company’s $78m loan from Bank of Shengjing, the largest regional lender in Liaoning province, whose capital city is Shenyang. But the nexus between lossmaking companies and regional banks has emerged as a key risk to China’s economy, where an explosion of debt since the global financial crisis has sparked warnings from the IMF and other watchdogs.

Map: Shadow loans are concentrated in economically-distressed northeast China
Map: Shadow loans are concentrated in economically-distressed northeast China


For the bank, whose name in Chinese means “prosperous capital”, the problem goes beyond Shenyang Machine. Bank of Shengjing is highly exposed to the broader economy of Liaoning, where average annual growth was the weakest of any Chinese province between 2014 and 2017. ´
Adjacent to the Shenyang Machine factory complex are several other struggling state-owned industrial groups that according to Economic Daily, a state-controlled media outlet, have also received loans from Bank of Shengjing, including Northern Heavy Industries and Shenyang Blower Works.

Over the past 18 months, regulators have unleashed a “ windstorm” against Chinese banks, with rules to prevent out-of-control lending growth and risky funding practices that are especially prevalent among regional players.

The forcefulness of the campaign, which has inflicted significant pain on weak corporate borrowers by denying them access to credit, reflects policymakers’ concerns that if left unchecked, problems at regional banks could spark contagion across the financial system.

Chart: Recognising shadow loan defaults would wipe out capital in some Chinese banks

The connection between weak regional economies and local banks has also drawn the attention of investors such as Alexander Campbell, chief executive of Black Snow Capital, a New York-based hedge fund that has placed a bearish bet on Bank of Shengjing and other publicly traded regional lenders.

In February, Brandon Emmerich, founder of Granite Peak Advisory, a research company based in New York, co-authored with Mr Campbell a ranking of “China’s worst banks” based in part on the stability of a bank’s funding sources and its exposure to various regional economies. Those in Liaoning were clustered near the top.

“If and when China’s economic growth begins to sputter, problems will surface first in the set of small banks with fragile balance sheets and lending exposure to anaemic regional economies,” says Mr Emmerich.


Zhang Yukun, then chairwoman of Shengjing Bank, at the company's listing ceremony in December 2014 © Bloomberg


Several regional banks have already gone bankrupt in all but name before being bailed out and restructured by local authorities. Others have become piggy banks for local governments or politically-connected tycoons with an outsized influence over local banks.

These lenders are largely not permitted to operate outside their home territory and are therefore highly dependent on local governments, state enterprises and entrepreneurs to support their businesses. An institution that refuses to lend to a local champion, even if doing so is risky, could find itself shut off from other, more profitable, projects.

“The further out towards the tail you go, the sketchier it looks,” says Mr Campbell.

Problems at small banks matter because their role in China’s financial system is growing. The country last year surpassed the eurozone to become the world’s largest banking system by assets. Meanwhile, small and mid-sized banks have more than doubled their share of total Chinese banking assets to 43 per cent in the past decade.

And their role is set to grow further. Some 17 regional lenders are seeking approval for initial public offerings on the Shanghai or Shenzhen exchanges.

“Once these former rural credit co-operatives were able to get real banking licences, you can’t imagine how happy they were. While the big players were more conservative, the small ones expanded as fast as they could, and now they’ve become a substantial part of the system,” says Han Hanjun, an economist at the Shanghai Academy of Social Sciences. Bank of Shengjing and Shenyang Machine both declined to comment for this article.



Mr Campbell has never been to Liaoning, but when he looks at balance sheets of the region’s banks, he has a feeling of déjà vu. In 2008, as a proprietary trader of bank shares at Lehman Brothers, he witnessed first hand how banking crises unfold. For him and other observers, the risk posed by regional lenders comes not only from their exposure to weak companies such as Shenyang Machine but also from the way these banks obtain funding to make these loans.

Traditional banks rely on deposits from households and companies to fund their lending. Banks in which deposits comprise a large share of total liabilities are viewed as safe because deposits are unusually “sticky”. In the UK, for example, the average retail account holder stays with their bank for 17 years, longer than with their spouse at 12 years.

“As an investor, you’d love to see a bank that’s completely deposit-funded. Once you see banks levering up through non-deposit sources, the cost of funds increases and you develop the potential for an interest rate shock or a liquidity shock,” says Jason Bedford, executive director for Asian financial institutions research at UBS in Hong Kong.

“Interbank funding is very short term. It can be here today and gone tomorrow,” he adds.



In China, regional banks struggle to attract deposits because regulators rarely allow them to open branches outside their home provinces.

Yet they have displayed a voracious appetite for growth. In a country where licences for tightly-regulated sectors like banking are a scarce commodity, entrepreneurial managers of regional banks viewed their upgrade from rural co-operatives as a golden ticket.

“To rise from a small local lender to achieve the size and stature we are today — it took incredibly hard work. You can’t even believe the challenges we’ve overcome,” says an executive at a regional lender in north-east China.

With modest deposit growth unable to satisfy their appetites for balance-sheet expansion, small banks turned to volatile, wholesale borrowing from other banks. The share of deposits in total liabilities at regional banks fell from 73 per cent to 64 per cent between 2013 and 2017, according to Mr Bedford’s data from 244 Chinese lenders.

For the institutions that have grown most aggressively, the share of deposit funding is even lower. At Bank of Shengjing, it was 48 per cent at the end of 2017, while at Bank of Jinzhou, another Hong Kong-listed bank in Liaoning, it was 52 per cent. Bank of Jinzhou said in an emailed statement that its “risks are controllable”. At Wells Fargo, the largest pure commercial bank in the US, deposits were 77 per cent of total liabilities last year.

“A lot of regional banks only care about short-term profits. They just grab what is right in front of them but don’t consider a long-term development strategy,” says Mr Han.



The state-owned and subsidised Shenyang Blower Works © Getty


In addition to exposure to weak regional economies and reliance on volatile funding sources, a third element adds to risks at these banks: the use of complex financial engineering and creative accounting to expand lending beyond regulatory limits.

A decade ago, much as bank liabilities were mostly customer deposits, banks’ asset portfolios were also simple and transparent, comprised mainly of corporate loans and home mortgages. But breakneck growth pushed banks up against lending limits set by the People’s Bank of China.

In order to keep loans flowing without directly violating central bank quotas or rules on capital adequacy and loan-loss provisioning, regional banks resorted to financial innovation. By partnering with non-bank financial institutions like trusts, securities companies, and fund managers, they were able to transform loans into assets recorded on their balance sheets as “ investment receivables”.

“If my assets are increasing by Rmb17bn in a year, but my loans are only allowed to grow by Rmb8bn, then I have no choice but to move the rest of those loans into another category on my reports,” says the north-east China bank executive. “So we shift them over into the investment receivables item.”

Bailed out Baoshang bank




Baoshang Bank Following the abduction of billionaire Xiao Jianhua from Hong Kong last year by mainland agents, Mr Xiao is working with authorities to sell assets from his conglomerate, Tomorrow Group. According to Caixin, the financial news outlet, Tomorrow Group is seeking a buyer for half of the group’s 70 per cent stake in Baoshang Bank, based in Baotou, Inner Mongolia. But Tomorrow Group is not just a shareholder in Baoshang, it is also apparently the bank’s biggest client.

Baoshang’s disclosures state that exposures to one borrower of shadow loans equalled 122 per cent of net assets — far higher than the banking regulator’s 15 per cent limit, which applies only to a bank’s formal loan book. Though this borrower is not named, its description matches reporting by Caixin, which quoted an unnamed source describing Baoshang as a “piggy bank” for Tomorrow Group. Baoshang declined to comment, and Tomorrow Group could not be reached.



Disguised loans took the form of financial products with exotic names such as “trust beneficiary rights” and “targeted asset management plans”. These products are loans in all but name, but they allowed banks to abide by formal loan quotas and lower risk-weighted assets, which are used to measure capital adequacy.

At Bank of Shengjing, formal loans comprised only 26 per cent of total assets at the end of last year, while shadow lending was 54 per cent. At Bank of Jinzhou, shadow loans are 56 per cent of total assets.

“These banks are quite vague and blurry when it comes to investment receivables,” says a private fund manager that specialises in banks. “There’s so much massaging of the balance sheet, and they won’t tell you about their internal manoeuvrings.”


Bailed out Bank of Fuxin




Bank of Fuxin The gross domestic product of Fuxin city in Liaoning province shrank by 12.2 per cent in 2016, according to official data, although the reported decline probably reflects recognition of inflated GDP figures in previous years.

That same year, the provincial government arranged a bailout of Bank of Fuxin that involved sales of non-performing loans worth Rmb11bn — or 22 per cent of the bank’s total loan book — at face value to a group of five state-owned institutions. But there was a catch: about a third of these NPLs were apparently packaged into special purpose vehicles in which the bank itself then invested, says Jason Bedford, a UBS Asia financial institutions analyst. The arrangement means that the bank remains exposed to bad loans that the clean-up was ostensibly designed to erase.


Despite the risks, most analysts do not expect problems at small Banks to erupt into systemic crisis. The central government has the financial resources and technocratic expertise to extinguish small fires before they blaze out of control, and several small banks have been quietly bailed out with minimal systemic impact or even public awareness.

“I’m not worried about systemic risk. Right now the system is safer than it has been since 2010 because of the competence of the regulatory authorities,” says Mr Bedford. “The processes around management of contagion risks are extremely good in China.”

Still, small banks are expected to face significant turmoil as they adapt to new regulations intended to curb their risky behaviour. Banks lobbied fiercely to dilute a draft framework, published in November, that would limit their ability to transform loans into “investments”, but the final version was largely unchanged apart from extending the phase-in period to the end of 2020.


Bailed out Bank of Dalian




Bank of Dalian Based in the provincial capital of economically distressed Liaoning province, Bank of Dalian underwent two bailouts in 2015 and 2016. Six board directors and five senior executives were replaced. China Orient Asset Management, one of the country’s dedicated bad loan banks, acquired 21 per cent of its loan book in exchange for a 50.3 per cent stake in the lender.


Last year, the China Banking Regulatory Commission also capped the share of interbank borrowing in total liabilities at 33 per cent. As a result, the share of deposits in total liabilities for the overall banking system increased by four percentage points to 72 per cent, though it is still below 79 per cent at the end of 2013, according to Mr Bedford’s data analysis. At the same time banks’ asset structure is also improving, with banks’ reducing their partnerships with non-bank financial institutions that helped them invest in disguised loans.

“The theme underlying these various moves is a push for banks to return to their traditional business model of taking deposits and making loans, and to reduce their use of investment products,” says Chen Long, an economist at Gavekal-Dragonomics, a Beijing-based research company.

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