China Traders Hold Noses at Plan to Repackage Bad Loans as Bonds

  • `There will likely be no buyers' of the debt: China Securities
  • China said to allow 50 billion yuan of such asset-backed notes

Bond traders at Chinese banks say they’ll avoid notes backed by the nation’s highest non-performing loans in a decade.

Regulators will allow domestic banks to issue up to 50 billion yuan ($7.7 billion) of such asset-backed securities and Bank of China Ltd. plans its first sale since 2008, people familiar with the matter said last month. Guangzhou Rural Commercial Bank Co. said it wouldn’t be interested in buying debt underpinned by NPLs due to lack of transparency. Guangdong Shunde Rural Commercial Bank Co. said probably only wealth-management departments of lenders would want to add exposure to soured loans.

QuickTake China's Debt Bomb

“It would be too risky for us to invest,” said Lin Yijian, a bond trader at Guangzhou Rural Commercial Bank in the southern city of Guangzhou. "We wouldn’t know what exactly would be in the bundled assets and it would take a long time for us to do due diligence on them."

Only three Chinese firms had sold bonds backed by NPLs before the global financial crisis forced a halt to securitization. The ban ended in 2012 with products tied to performing assets such as car financing that were so popular that China is now second only to the U.S. as a market for such debt. But securities backed by bad lending present a bigger test of bank demand after new soured loans almost doubled last year to 431.8 billion yuan.

Three calls to China Banking Regulatory Commission, which approves banks’ securitization transactions, went unanswered. A media officer at Bank of China declined to comment.

“Chinese banks may be cautious about investing in NPL asset-backed securities because their default risks are higher,” said Song Qiuhong, a bond trader at Guangdong Shunde Rural Commercial Bank in the southern city of Foshan. “But if the yields are high enough, they may attract money from wealth-management departments which manage money for banks’ clients.”

Asset-backed sales surged 41 percent last year to 397 billion yuan, according to Bloomberg-compiled data. Yet the volume was only a fraction of the U.S. market, where companies excluding state-owned mortgage firms Fannie Mae and Freddie Mac issued $436 billion alone, according to Standard & Poor’s.

The bad loan ratio among Chinese commercial banks climbed to 1.67 percent at the end of 2015, the highest since 2009, amid the slowest economic growth in a quarter century. DBS Vickers Hong Kong Ltd. sees it reaching 2 percent by year-end. Total bad loans reached a decade high of 1.27 trillion yuan in December. 

Bond Risk

“It would be hard for banks to issue asset-backed securities tied to bad debt because there will likely be no buyers,” said Ji Weijie, a credit analyst at China Securities Co. “When economic growth is in a downward trend, the return on distressed assets will be unstable because it is harder to dispose assets.”

The cost of protecting debt in Industrial & Commercial Bank of China Ltd.’s from default reached a record 199.5 basis points in January. It has since dropped to 152 basis points. At least 10 Chinese firms have reneged on domestic bond obligations in the past two years. The mounting failures have come despite falling borrowing costs after monetary easing, with yields on five-year top-rated yuan corporate bonds plunging to 3.25 percent on Tuesday, close to the lowest in a decade. 

China Orient Asset Management Co., one of the nation’s four bad-loan managers, sold China’s first notes backed by NPLs in 2006. Mei Xingbao, former head of the bad bank, said in an interview that securitization of NPLs is a good way for banks to dispose of bad assets.

“China is likely to do NPL securitization in a more prudent way and see how the market will take it,” said Aaron Lei, director for structure finance ratings at S&P. “China has no precedent of large number of bankruptcy events so it may become challenging to assess the valuation of some distressed assets.”

It’s not just that banks aren’t interested in buying such notes, they may also be reluctant to sell, said Shujin Chen, an analyst at DBS Vickers.

“They can get more money back if they dispose of the assets themselves,” Chen said. “For other investors, lack of information would be the key risk because the issuers will be the ones who have the most complete information about the underlying assets."

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