- Manager says 10% asset loss would cut equity by $3.5 trillion
- China would have to print $10 trillion to recapitalize banks
Kyle Bass, the hedge fund manager who successfully bet against mortgages during the subprime crisis, said China’s banking system may see losses of more than four times those suffered by U.S. banks during the last crisis.
Should the Chinese banking system lose 10 percent of its assets because of nonperforming loans, the nation’s banks will see about $3.5 trillion in equity vanish, Bass, the founder of Dallas-based Hayman Capital Management, wrote in a letter to investors obtained by Bloomberg. The world’s second-biggest economy may end up having to print more than $10 trillion of yuan to recapitalize banks, pressuring the currency to devalue in excess of 30 percent against the dollar, according to Bass.
Bass, 46, scored big after betting against mortgages in 2007, racking up gains as the world’s largest banks wrote off more than $80 billion in subprime losses. All his calls haven’t been as prescient. He revealed wagering on a collapse in Japan’s government-bond market in 2010, a short position that Bass later acknowledged that other bond investors had nicknamed “the widow maker.”
“What we are witnessing is the resetting of the largest macro imbalance the world has ever seen,” he wrote in the letter. “Credit in China has reached its near-term limit, and the Chinese banking system will experience a loss cycle that will have profound implications for the rest of the world.”
Bass said his hedge fund has sold most of its riskier assets since the middle of last year to position itself for 18 months of “various events that are likely to transpire along this long road to a Chinese credit and currency reset.” In an e-mailed response to questions, he said about 85 percent of his portfolio is invested in China-related trades.
“The problems China faces have no precedent,” Bass wrote in the letter. “They are so large that it will take every ounce of commitment by the Chinese government to rectify the imbalances. Risk assets will not be the place to be while all of this is happening.”
Chinese growth, which averaged 10 percent for three decades through 2010, has decelerated for five straight years and in 2015 slowed to 6.9 percent, the lowest rate in a quarter of a century. It will ease to 6.5 percent this year, according to a Bloomberg survey of economists. The economy continues to transition toward growth driven by services and consumption instead of manufacturing and investment, but the new drivers haven’t yet proven sufficient to offset the lagging older ones.
Bass estimates the Chinese economy actually expanded last year at a slower pace than reported, about 3.6 percent, according to the letter. He estimates that of China’s $3.2 trillion in foreign-exchange reserves, about $2.2 trillion are liquid.
The banking system, which he estimates swelled 10-fold in assets over the last decade to more than $34.5 trillion, is fraught with risky products used by financial companies to skirt regulations, wrote Bass. The nation’s expanding shadow banking system -- which he says has grown almost 600 percent in the last three years, citing UBS Group AG data -- “is where the first credit problems are emerging.”
Wealth-management products, which have been used by Chinese banks for off-balance sheet lending and to lure buyers with perceived guarantees and yields that trump the deposit rate, are being brought back onto the balance sheets as they begin to fail, according to Bass. He also said the use of trust-beneficiary rights -- the legal rights to trust products -- are “ticking time bombs” because they’re used by banks to hide loan losses.
“We believe the epicenter of the problem is the Chinese banking system and its coming losses,” he wrote. “Until China experiences a significant devaluation, it will not be able to cope with the build-up of credit that has helped fuel its rise, but may, in the short-term, be its undoing.”
Since his successful call betting on subprime mortgages, Bass’s performance has been more mixed, with his main fund returning about 1.6 percent annualized as of last August, the New York Post reported at the time.
In 2010, Bass began publicly forecasting a collapse in Japan’s government-bond market. At the time, he said that it would take three years or so for the stress to show in Japanese bond markets. In a 2013 interview with Bloomberg Television, Bass said he expected that the trade would eventually make “300 to 400 times our money.”
The manager, who has challenged dozens of U.S. drug patents since early 2015, recommended shares of the pharmaceutical company Perrigo Co. at an investment conference last May. The stock fell about 18 percent in U.S. trading from May 7, when Bass made his presentation, to Sept. 30, when Hayman no longer reported owning the stock in quarterly filings.
In October, Bass said China was facing a cycle of credit contraction, and he predicted an emerging Asia banking crisis.