Markets

Christopher Langner is a markets columnist for Bloomberg Gadfly. He previously covered corporate finance for Bloomberg News, and has written for Reuters/IFR, Forbes, the Wall Street Journal and Mergermarket.

Chinese bankers often pride themselves on having studied in the U.S. or the U.K and true to form, they're bringing home a lot of the intricate financing that helped people overseas get loans for homes, cars and education. But these financiers are taking creative structures one step further.

On Monday, Bloomberg News reported that China will allow domestic banks to issue as much as 50 billion yuan ($7.6 billion) of asset-backed securities that would be paid back using the proceeds from nonperforming loans. (Yes, you read that correctly.) The structure they're employing is similar to the method that was used to repackage subprime mortgages in the U.S. ahead of the global financial crisis.

Plastic Surgery Not Enough
The ratio of bad loans on Chinese banks' balance sheets is at the highest since the global financial crisis
Source: China Banking Regulatory Commission

But when bankers in America were bundling those low-doc mortgages into AAA-rated bonds, they still expected most of the loans would be repaid. In this case, the debt has already gone bad. Considering hardly any Chinese asset-backed securities have ever received a less than AA score from a local rating company to date, chances are these ones will be awarded the same grade.

Of course, investors buying these bonds should be aware they're backed with debt that's already soured, regardless of its credit score. Yet, the move is worrying because it's the latest in a string of revivals in China of dangerous structures that were common in the West before being all but abandoned after 2008.

Many of the instruments are helping banks disguise or unload their exposure to troubled companies in the same way issuance of asset-backed securities helped U.S. and British lenders mask their exposure to souring home payments as loans became delinquent.

Ironically, China had pretty much banned asset-backed securities until 2013 because of what happened during the credit crisis. Since authorities began allowing them again, they've spread like wildfire. Official data indicate that 593 billion yuan of ABS were sold last year, 79 percent more than in 2014. Less comprehensive Chinabond data show some 678 billion yuan being issued over the past two years:

Old Mistakes Revisited
After four years with no asset-backed securities sales, companies in China have issued about 678 billion yuan since 2013
Sources: Bloomberg; Chinabond

The first quota of 50 billion yuan is just a test. If there's enough demand you can bet there will be plenty more of these repackaged bad-loan bonds floating around China in coming years. The amount of debt classed as nonperforming at Chinese commercial banks jumped 51 percent from a year earlier to 1.27 trillion yuan as of Dec. 31, the highest since June 2006, data from the China Banking Regulatory Commission showed last month.

Big Bad Debt Problem
Soured loans in China reached 1.27 trillion yuan in December, so there may be a lot more ABS backed by such debt
Source: China Banking Regulatory Commission

Asset-backed securities in themselves aren't necessarily bad. They allow banks to recover monies they advanced faster, and spread the wealth. In the U.S., there have been calls for a revival of mortgage securities without government support, so long as various checks and balances are in place.

The problem is when they start to be used as steroids to bolster bank balance sheets that in reality are anemic. Beijing hopes this first quota will help clear some of the bad assets, allowing banks to accelerate new lending and give the economy a nudge. (In a similar vein, the People's Bank said Monday it's cutting the amount of cash lenders must lock away, a further signal that shoring up growth is a top priority.)

Except that with these ABS, any momentary fillip would be fleeting.

In the U.S, when the time of reckoning came for subprime mortgages, it became clear those financial institutions were in fact still liable for the poor-quality debt. It's some recent history that Chinese bankers would do well to remember.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Christopher Langner in Singapore at clangner@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net