More Signs of Cracks in China’s Massive Bubble: Bond Auction Failure, Rising NPLs, More Defaults

Aside from this week’s slump in external trade where both China’s export and imports fell in March y-o-y by 6.6% and 11.3% indicative of an intensifying economic slowdown, reports also say that property developers have substantially scaled back in raising money through the shadow banking system via trust sales

From Businessweek/Bloomberg:

Chinese developers raised 49 percent less through trusts in the first quarter as the collapse of Zhejiang Xingrun Real Estate Co. highlighted default risks.

Issuance of property-related trusts, which target wealthy investors, slid to 50.7 billion yuan ($8.16 billion) from 99.7 billion yuan in the fourth quarter, data compiled by Use Trust show. The yield on AA rated five-year bonds has climbed 175 basis points in the past year to 7.23 percent, according to Chinabond. That compares with a2.74 percent on corporate securities globally, Bank of America Merrill Lynch indexes show…

New property trust offerings accounted for 30 percent of total trust sales in the first quarter, down from 33 percent in the last three months last year, according to data compiled by Use Trust. Figures from the research firm are for collective products only, which are sold to more than one investor.

And even more signs of debt delinquency or risks of debt default…

Companies with other kinds of building projects are also facing repayment concerns. A unit of China Sports Industry Group Co. (600158) failed to repay 144 million yuan of principal on a 600 million yuan trust loan for a sports center development, according to a statement from the company to Shanghai’s stock exchange dated April 4.

And the exposure on trust products, which are part of the shadow banking system, have been sizeable.

Outstanding property trust products, including collective and single, totaled 1.03 trillion yuan as of the end of last year, accounting for 10 percent of all types of trusts, according to data posted on the website of China Trustee Association.

And as more delinquent companies surface, these have been reflected on Non-Performing Loans (NPL) of banks.

Here is an update from Marketwatch/Caixin:

Bad loans have sharply increased for many Chinese banks as more companies struggle to make repayments, data from recent bank annual reports show.

The total value of non-performing loans at 12 major banks was 467 billion yuan on Dec. 31, an increase of 76.3 billion yuan ($12.3 billion), or 19.5%, from the beginning of 2013.

And in jeopardy are big state owned companies and their subsidiaries involving steel producers and traders and the coal mining industry.

Among the defaulters were subsidiaries of big state-owned enterprises (SOEs), which banks normally view as safe clients, a loan officer at a joint-stock bank said. In many cases, he added, the parent SOEs did not save their subsidiaries, mostly because they were in deep trouble themselves.

In addition, importers have been defaulting too. From Reuters/Chicago Tribune

Chinese importers have defaulted on at least 500,000 tons of U.S. and Brazilian soybean cargoes worth around $300 million, the biggest in a decade, as buyers struggle to get credit amid losses in processing beans.

Three companies in the eastern province of Shandong had defaulted on payments for shipments as they were unable to open letters of credit with banks, trade sources said on Thursday.

The same report cites that along with commodity firms, semiconductor and software companies are among the most at risk of credit defaults

Many defaults seem to be surfacing in many corners of the Chinese economy almost simultaneously.

But as rising incidences of defaults emerge, in desperation Chinese investors have shunned private sector debt and have gravitated into the riskier local government debt in hopes that the latter will be supported by the national government. This despite warnings from authorities.

From another Bloomberg report:

China’s first default is prompting investors to discriminate against privately-owned companies, boosting demand for local government bonds even as the central bank warns of the dangers of a $2.9 trillion pile of debt…

Premier Li Keqiang said last month that failures of financial products are “unavoidable,” a week after a solar company whose controlling shareholder is the chairman became the first Chinese issuer to default on its onshore notes. Risks of nonpayment have climbed as economic growth slows after a five-year credit binge. Li said there would be no “regional financial risks,” prompting investors to bet the state would stand behind local-government financing vehicles.

So despite the Premier Li’s  pronouncement last week that there will be "no major stimulus—"We will not take, in response to momentary fluctuations in economic growth, short-term and forceful stimulus measures…We will instead focus more on medium- to long-term healthy development"—assurances of containment from debt woes has provided investors the incentive to shift towards LGY debt. 

The Chinese government has announced at the start of April of a 'minor' stimulus program consisting of “additional spending on railways, upgraded housing for low-income households and tax relief for struggling small businesses”, as discussed here.  Importantly the formal declaration had been “short on specifics”.

This shows that in the world of politics, communications are meant to be opaque, and promises are meant to be broken. While the conflicting position by the government gives her leeway or the flexibility adjust, unfortunately this has also been aggravating the risk environment.

And as the same report indicates, many of the private sector debt exposure signify as offspring of the local government. 

Regional authorities, which aren’t allowed to sell debt directly, have set up thousands of financing vehicles to raise funds to build subways, highways and sewage works. Local governments are responsible for 80 percent of spending while they get only about 40 percent of tax revenue, the legacy of a 1994 tax-sharing system, according to the World Bank.

A 2008 stimulus package deployed amid the financial crisis and funded with off-balance sheet lending added to the debt burden for local governments. Their liabilities rose to 17.9 trillion yuan as of June 2013 from 10.7 trillion yuan at the end of 2010, according to National Audit Office data.

LGFVs were among the three riskiest types of debt highlighted by the People’s Bank of China in its fourth-quarter policy report. Their debt is headed for a “mini crisis” because defaults will be needed for restructuring, Li Daokui, a former adviser to the central bank, said March 25.

In other words, many Chinese local governments have been circumventing rules set by the national government as previously noted here which has been a potential source of China’s Black Swan. The above also serves as a showcase of deep conflicts within governments. 

And speaking of internal conflicts, in the face of intensifying debt concerns, the friction between Chinese financial regulators particularly the central bank, the People’s Bank of China (PBoC) and China Banking Regulatory Commission (CBRC) has likewise been deepening. According to the Financial Times, the PBoC accuses the CBRC of being “too close to the state banks” or regulatory capture while the latter blames the former for creating the current conditions and “promoting financial innovation” or “regulatory arbitrage”. The report also says that the CBRC warned of such risks from the stimulus launched in 2008.

All these seeming state of confusion has brought about even more risks and uncertainties. Yet these are indications that current adjustments to the China's debt burden would most likely be disorderly.

Finally, last week the Chinese government also suffered her first bond auction failure since June of last year.

From another Bloomberg article:

China’s Ministry of Finance failed to sell all of the bonds offered at an auction today for the first time in 10 months amid speculation short-term interest rates will climb as corporate tax payments tie up funds.

The ministry sold 20.7 billion yuan ($3.3 billion) of one-year debt today, less than the planned issuance of 28 billion yuan, according to a statement on its website. The average yield of 3.63 percent compared with the median estimate of 3.4 percent in a Bloomberg News survey yesterday, when the yield on similar-maturity existing notes was 3.32 percent.

The credit crunch has now been spreading from the private sector, to the local government and now to the national government: such is the periphery-to-core dynamics in motion.

And my impression is that 'tax payments' serve as smoke screen to the real dynamic—which as shown from the compilation of reports above, are signs of the widening fracture of China’s bubble.

The USD-Yuan and yields of 10 year lcy sovereign debt closed the week almost unchanged. 

Nonetheless despite all the above, China’s stock market bulls pushed the Shanghai index nearly to February highs after this week’s 3.48% run. 

Maybe the stock market sees a world differently from that of the real economy.