one big thing
1. A master plan for cleaning up the banks
With bad loans set to surge and loan issuance having increased to deal with the pandemic, banks are going to have to raise more capital.
They need a plan. Perhaps even a Master Plan.
- Well…apparently, there is one– and Caixin has seen it!
On Friday, Caixin was kind enough to share what it found out. The plan’s details are still being fleshed out by the banking and securities regulators, central bank, Ministry of Finance, state auditor, and the National Development Reform Commission, but here’swhere things stand:
- Local authorities will be expected to take responsibility for restructuring and recapitalizing banks in their jurisdictions.
- There’s “no universal model” for dealing with bank distress. Every bank will be dealt with on its own terms.
- Local authorities should encourage market-oriented mergers.
- Central financial institutions – a group that may include policy banks and the Big 4 asset management companies – will be encouraged to invest in small banks.
- Provincial-level banks that pose a risk to regional financial stability and can’t raise sufficient capital themselveswill be allowed to apply for special loans from the central bank.
- For seriously problematic banks, the guiding principle should be to “sell those that can be sold, and let those that should go bankrupt go bankrupt.”
One detail we found particularly interesting was in regard to the RMB 200 billion worth of special purpose bonds the finance ministry had set aside for recapitalizing small banks.
- Banks can only tap those funds once they’ve cut dividends, sold shares in private placements, and tried to introduce strategic investors.
Get smart:China’s regulatory authorities have been signaling for the past month that things are about to get rough for the country’s banks.
Get smarter: The authorities aren’t in panic mode. This is an attempt to ensure that if local authorities aren’t up the task of dealing with bank distress, there are channels to escalate the problem to higher levels of government.
2. Lou Jiwei on China’s fiscal position
China’s fiscal deficit in 2020 is much larger than you think, but even this unprecedented support won’t lead to a v-shaped recovery.
Don’t take our word for it – that’s all according to Lou Jiwei, a former Chinese finance minister and current director of the Foreign Affairs Committee at the Chinese People’s Political Consultative Conference.
Lou’s math is simple:
- The central government outlined a general public budget deficit of 3.6% of GDP (or more) at the Two Sessions in May.
- The additional RMB 1 trillion in special treasuries bonds (STBs) that were issued adds 1 percentage point to that number.
- The RMB 1.5 trillion increase in local special project bonds (SPBs) over the 2019 level adds another 1.5 percentage points.
- That puts the real fiscal deficit for 2020 at 6.1%, at least.
Some context: Chinese authorities typically only count the general public budget deficit when tallying up the official budget shortfall each year. However, they use something called the government-managed funds budget to issue more debt, while keeping the official balance sheet relatively clean.
More context: Since the central government is ultimately responsible to pay out on STBs and SPBs, especially if things go sideways, lots of economists – including Lou – think this debt should be included in the deficit.
Even more context: For years, the IMF and others have argued that China’s actual fiscal deficit has been running in the high-single or even low-double digits. So Lou’s comments aren’t exactly a shocker.
Why it matters: Lou’s key point is that even with all the fiscal firepower China has rolled out, the country won’t see a v-shaped recovery because of geopolitical tensions and a weak global recovery.
Get smart: We recently outlined why China’s fiscal bazooka is firing blanks, so we’d concur with Lou.
- After a solid Q2 jump, economic momentum is set to level off through the end of the year.
Go deeper: Lou’s entire speech is pretty solid – it’s worth a read.
3. China imposes new export restrictions, putting TikTok sale in doubt
Chinese regulators look to be throwing a spanner in the works for the sale of TikTok’s US operations.
The latest:On Friday, the Ministry of Commerce (MofCom) and the Ministry of Science and Technology (MoST) released a revised export controlcatalogue.
Some context: The catalogue was revised from its 2008 version, and 23 new technologies were added to the list of prohibited exports.
Among the technologies subject to new export control restrictions, a few jumped out:
- AI interface technology
- Personalized push notification algorithm technology for mobile apps
- Laser technology
- Drone technology
Hmmm…those first two will directly impact the TikTok sale.
More context:Companies– like TikTok owner ByteDance, for instance – are required to take two approval steps when exporting restricted technologies,both before negotiating deals and after signingexport contracts.
- Each approval process can take up to 15-30 working days.
Get smart: The need for pre-approval to negotiate technology sales will obviously upend the ongoing TikTok talks immediately.
Get smarter: If Chinese regulators slow roll the approvals, it would push a potential dealpast the September 15 deadline that US President Trump has set for the sale.
The bottom line: While China is looking to play nicer with the US, in general, Chinese officials aren’t thrilled with the idea of the forced sale of TikTok, and they want to weigh in.
What to watch: China is looking to call Trump’s bluff, will he blink on the deadline?
4. Big four banks trade profits for provisions
The effect of the pandemic on the banks is getting real.
China’s big four banks posted first half profits over the weekend. They recorded their sharpest decline in over a decade.
- Industrial and Commercial Bank of China’s (ICBC) net profit declined 11.4% in the first half compared with a year earlier.
- China’s Construction Bank (CCB) saw its net profit drop 11.0%.
- Bank of China (BOC) posted a 11.5% decline.
- Agricultural Bank of China’s (ABC) net profit fell 10.4%.
The decline was driven by big increases in loan-loss provisions – reserves put aside to write down nonperforming loans– which jumped between 27% and 97% (Bloomberg).
Get smart:China’s banks are battening down the hatches – and the big four are leading by example. With the authorities warning of an imminent surge of NPLs, it’s time to make preparations.
Get smarter: Not all banks are going to be able to ramp up provisions – or capital – as easily. Consequently, the regulators are making contingencies (see entry #1, above).
Further reading:If you’re interested in learning more about how Beijing is preparing to deal with a sharp increase in bad loans, check out our piece fromAugust 27, The Coming Surge in Nonperforming Loans.
5. CBIRC sets out plan to curb poorcorporate governance
Regular CMD readers will know that for the past few months, senior financialofficials have been stressing the importance of corporate governance in the financial sector.
Now it’s time to get serious:
- On Friday, China’s banking and insurance regulator (CBIRC) released its three-year action planfor improving corporate governance in the bankingand insurance sectors.
The CBIRC pointed out that obscure shareholder structures and misconduct by large shareholders have been the root causes of chaos within financial institutions in recent years.
To eradicate the problem, the CBIRC set out three objectives for the next three years:
- Rectifying related-party transactions in 2020
- Establishing mechanisms for protection of small shareholders in 2021
- Exploring new mechanisms for curbing bad corporate governance in 2022
In a QA session for the plan, the CBIRC said it will:
- Conduct a comprehensive evaluation of corporate governance on banks and insurers by the end of this year,and then start to rectifymisconductbased on evaluation results.
Get smart: China’s regulators are learning from the spate of recent failures at financial institutions. The key lesson:
- Bad corporate governance is a major risk to the financial system.
Get smarter:Three-year actions plans have proliferated over the past few years– to greateffect. Now that this plan has dropped, expect the regulatory action on this front to ramp up significantly.
6. More details on the big new property policy proposal
Over the past two weeks, we’ve been highlighting new rules thatthe central bank (PBoc) and housing authorities (MoHURD) are rolling out to curb borrowing among overly indebted property developers.
Recall: On August 20, the regulators held a meeting with developers in Beijing to discuss thenew measures(seeAugust 20 China Markets Dispatch).
On Friday, we got theinside look at what took place and how things are shaping up.
According to reports from several media outlets,the meeting was held to discuss how various borrowers will be constrained by the so-called “three red-lines” (see August 18 China Markets Dispatch).
To recap, the “three red-lines”are:
- A liability/asset ratio (after excluding advance receipts) of over70%
- A net debt-to-equity ratiogreater than 100%
- A cash-to-short-term-debt ratioless than 100%
And the related restrictions are as follows:
- Developers that hitall three criteria can’t increase their debt levels above those seen inJune 2019.
- Developers that hittwo of the criteria can only increase their debt levels by 5% a year.
- Those that hitone criteria can increase their debt levelsby 10% a year.
Twelve developers were called to the meeting with regulators, and based on industry estimates, most of them will see their ability to get new financing severely impacted by the proposed policy.
Invited developers that cross all three red-lines include:
Invited developers that cross two of the red-lines include:
- Sunshine City
Invited developers that cross one of the red-lines include:
- Country Garden
Invited developers that cross no red-line but would still see their debt growth capped at 15% per year include:
- Poly Group
- China Overseas
- China Resources
- Overseas Chinese Town
Get smart:Theproposed “three red-line” policy will shake up the industryin a big way (see next entry).
7. More details on the big new property policy proposal, cont’d.
Beyond the attendees at the big recent property meeting (see previous entry), we’ve also go more details on the expected policy changes.
- The proposed “three red-line” policy will reportedly take effect on January 1, 2021.
- Thepolicy is not only aimed at bringing down debt levels, but also at adjusting asset structure in the industry.
The timeline: To get the new policy up and running, property developers will reportedly be asked to:
- Submitplans on how they will lowerdebt levels to authoritiesby the end of September.
- Reducedebt in such a way that they are notin violation of any of the three red-lines in the next three years, or see newfinancing channels cut off entirely.
Hold up: We’ve seen come conflicting reporting on this. Some of which paints a less dire scenario for developers. These reports indicate that:
- The deadline to submit plans for lowering debt levels by the end of September is unconfirmed.
- The meeting was a symposium, during which regulators mainly sought to learn about the situation on the ground, but did not put forward concrete demands.
- Financial institutions are still waiting for directives on how to treat real estate financing.
- The proposed policy willlikely be piloted among a handful ofproperty developers first, before being extendedto the broader industry.
Get smart:There’s obviously still a lot to nail down here in terms of details.
Our read: If the new policy really is intended to “adjust asset structures” in the industry, then it means policymakers are intent on forcing developers to sell off assets in order to maintain healthy cash flows.
The information contained in this newsletter does not constitute investment advice.