As Chinese Developers’ Debt to Equity Soar, Hope Becomes Part of the PBoC Strategy

Interesting ironies developing in the Chinese economy.

First, credit woes has been spreading to reflect on slackening demand for properties.

From Bloomberg’s Chart of the Day: (bold mine)

China’s largest property developers risk missing their full-year sales targets as tighter credit and an economic slowdown cut demand for real estate, fueling concern the industry will struggle to repay debt.

The CHART OF THE DAY shows the 13 biggest developers that provided full-year sales targets achieved 49 percent of those goals by the end of July, the weakest level in at least two years, according to data compiled by Bloomberg. The ratio of debt to equity on a Bloomberg Industry gauge of 84 Chinese property companies has climbed to 128 percent, the highest since at least 2005 and almost double the Bloomberg World Real Estate Index’s 76 percent.

New-home prices fell in July in almost all cities that the government tracks, while sales of residential units slumped 28 percent from the previous month, as China’s broadest measure of new credit sank to the lowest since the global financial crisis. Moody’s Investors Service and Standard & Poor’s said this month some smaller Chinese developers may default in the second half amid falling sales and shrinking access to credit.

So slumping property demand expressed through falling prices has begun to impair on the balance sheets of property developers. This should amplify credit risks as debt servicing burden increases in the face of falling sales compounded by tightening access to credit.

In another Bloomberg article, the Chinese central bank, the People’s Bank of China has reportedly been challenged by the current predicament. (bold mine)

Rising stress in China’s $6 trillion shadow banking industry is testing central bank Governor Zhou Xiaochuan’s resolve to limit monetary easing as risks to the government’s growth target climb.

In the past three months at least 10 trusts backed by assets spanning coal mines in Shanxi to forests in Fujian have struggled to meet payments, sparking protests by investors outside banks that distributed their products. A slump in new credit in July underscored strains on the industry that funded as much as half of China’s recent growth, presenting Zhou with a choice: ease policy to avert a slowdown, or hold the line…

Apparently, the PBoC toes the same line with her contemporaries who has assumed the de facto policy guidepost on bubbles: “We recognize the addiction problem but a withdrawal syndrome would be more catastrophic”. 

So PBoC launched ah ‘targeted easing’ stimulus…

While the People’s Bank of China hasn’t changed its benchmark lending and deposit rates for the past two years, local media reported last month it had extended a 1 trillion yuan ($163 billion), three-year loan to a state development bank to support the funding of government-backed housing projects. It recently granted a 20 billion yuan re-lending quota to some regional bank branches to support agriculture, according to a statement on its website yesterday.

And as an offshoot to their previous undertakings of stimulus and other interventions, the consequences are now the PBoC’s headache:

Local-currency bank loans’ share of aggregate financing -- which includes bank lending, off-balance sheet loans, and bond and stock sales -- fell from 70 percent in 2008 to 51 percent in 2012 as shadow banking surged along with government-led efforts to stimulate the economy.

In the first seven months of 2014, the share of bank loans recovered to 56.7 percent, according to calculations based on PBOC data. In July, bank loans exceeded aggregate financing as other forms of credit shrank.

China’s debt-to-gross-domestic-product ratio was about 250 percent at the end of June, up from about 150 percent before the government rolled out its stimulus campaign in 2008, according to research by economists at Standard Chartered Plc.

And because of too much partying (debt financed asset boom), signs of hangover has emerged:

Shadow-banking assets jumped more than 30 percent in 2013 to 38.8 trillion yuan, according to Barclays estimates.

Trust defaults have escalated in recent months as the economy’s momentum stalled. At least 15 trust products have been reported to have repayment difficulties this year, according to UBS AG, citing media accounts and company disclosures. Local governments are working to avoid defaults, brokering deals between corporates and banks and leaning on lenders to provide bridge loans or take over shadow credit, Wang Tao, chief China economist at UBS, wrote in a July 10 note.

China Credit Trust Co. last month delayed payments on a 1.3 billion-yuan high-yield trust product backed by coal-mining assets in Shanxi after the borrower failed to raise funds to repay investors, according to a company statement. That triggered protests outside the Shanghai branch of the Industrial & Commercial Bank of China Ltd., which sold the product, according to local media reports.

Chinese debt woes hasn’t just been from the context of statistics, these are symptoms of a much larger disease, misallocation of capital. Therefore, working to avoid defaults by shifting productive capital to survive zombie companies simply will add to the present dilemma which means it won’t last.

And clearly hope has become part of the PBoC strategy. 

The hangover effects appears to have even spread to the mutual fund sector

From the South China Morning Post (bold mine)

The mainland's shadow banking woes have spread to the mutual fund sector, fuelling fears that defaults and frauds could spread in waves despite Beijing's efforts to deleverage an economy facing the risk of a hard landing.

Two recent scandals were fresh signs that nearly 1.5 trillion yuan (HK$1.89 trillion) of capital raised by the subsidiaries of mutual fund houses is exposed to risks due to the absence of an efficient monitoring system.

Earlier this month, Shanghai Goldstate Brilliance Asset Management, an alternative investment arm of Value Partners Goldstate, announced a 600 million yuan real estate fund would not be able to pay interest to investors, indicating the product would fail amid a weakened property market.

At the same time, Wanjia Win-Win, a subsidiary of Wanjia Asset Management, said it had uncovered fraudulent actions by a partner, Shenzhen Jingtai Fund Management, in the operations of a real estate fund started in June…

About 70 alternative investment companies have been set up by mainland mutual fund houses, with total assets under management of about 1.5 trillion yuan.

And because of the constrained access to credit, credit starved entities has been loading up from foreign sources

From the Wall Street Journal Real Time Economic Blog (bold mine)

Both disclosures offer insight into a recent surge in foreign lending to China as tighter lending conditions there and low global interest rates push more Chinese companies to borrow offshore. According to the latest data from the Bank for International Settlements, outstanding foreign loans to China rose 38% on year in the first quarter of 2014 to a record $795.7 billion, a fourfold increase since 2010.

Of the 25 countries whose banks report lending data to BIS, the biggest surge in new loans in the year ended March 31 — $50 billion — came from banks based in the United Kingdom, a group that includes HSBC and Standard Chartered, both British-domiciled banks with most of their assets in Asia. French banks were the second-largest source of new credit, extending $20.6 billion in new loans to China. Japanese banks were third, raising their exposure by $15.8 billion over the same period.

The rapid growth in credit to China left British banks as China’s largest foreign lenders, with a record $221.2 billion in outstanding loans to China. U.S. banks were second with a record $86.5 billion and Japanese banks third, with a record $77.4 billion.

So ‘misery loves company’ has been transmitted through foreign financial institutions. Aside from PBoC stimulus, Chinese (private and hybrid) firms continue to survive because of access through the global chase for yields. Yet this underscores the elevated risks of contagion

And of course, junctures in the credit markets will filter down into the real economy which will have a feedback mechanism: credit problems will hurt the real economy and the real economy will aggravate on credit woes.

And the stimulus have yet to weave its magic as shown in the above chart. According to the WSJ Real Economic Blog

The latest figures out of China indicate recent stimulus attempts have yet to relieve distress in lending and real estate markets.

So how should stocks respond to a slowing economy, to a decline in earnings and rising credit risks?

In the case of the Chinese stocks, since the targeted easing last June PLUS the recent massaging of IPOs the Chinese equity benchmark has been significantly been UP!

So are stocks about fundamentals as textbook says? The answer is it depends on the type of fundamentals. Post Lehman crisis, "fundamentals' have been determined largely by central bank subsidies to financial markets and secondarily government policies.

The Pre-Lehman crisis world illustrates the disconnect between stocks and the real economy or what has been a parallel universe!

Don't worry, risks have all vanished, central banks has assured that stocks have been bound to rise forever!