Which banks have been
de-rated the most since the latest Euro-explosion at the beginning of
August? Easy question, that – European banks, of course. But
China's banks are running them an uncomfortably close second.
The latest bout of
Eurocrisis broke raging from its cages at the beginning of August –
I know because I was worried I was flying into a banking collapse in
Cyprus for my holidays - and since then the average CDS price fo 5yr
European bank bonds has risen by 150bps to 517. Despite rating
agencies' downgrades, we're seen only a pale echo of that rise for US
banks: during the same period CDS rates rose only 90bps to 225.
There has been roughly the same rise for Asian banks (including
China) – they've added 93bps to 250.
But CDSs for China
Development Bank have risen 149 to 305, and for Bank of China
they've risen 142bps to 288. This re-pricing isn't generic, and isn't
typical of the market – it seems it is specifically pointing to a
previously unacknowledged leveraged vulnerability in China's banks to
the risks posed by the Eurozone. Since neither of these banks is
known or expected to have anything significant in the way of direct
exposure to the Euro-threat, it needs some explanation.
And yesterday, we got
the clearest possible explanation from the IMF in its latest Global
Financial Stability Report. A good deal of that report wraps itself
around Europe's problems, of course, but China's situation gets a
full page box all of its own (here – Chapter One, Page 40). It's a must-read.
It points out that
during 2009-10, China experienced one of the highest rates of credit
expansion in the world, as authorities boosted investment spending –
in fact, an accompanying chart shows it surpassed only by Vietnam and
Belarus. (Interesting factoid: since then, the Vietnamese Dong has
fallen by 15% vs the dollar, the Belarus Ruble has lost 60%, and the
yuan has risen 8%.) 'Many of those investment projects are thought
to lack longer-term commercial viability, putting the repayment of the
underlying debt in doubt.' Recent policy tightening has slowed
headline loan growth, but other forms of credit have surged. . . .
These include;
- bank acceptance bills and trust loans, now also regulated more tightly;
- inter-corporate lending and credit from small loan companies; and
- funding from banks based in HK and offshore bond markets.
'Based on the
authorites total social financing data, the stock of domestic loans
reached 173% of GDP at end-June. This places China well above the
levels of credit typically observed among countries at the same
income level. . . . '
'A long-running real
estate boom . . . adds another layer of risk. . . . In this
environment, the authorities' current efforts to cool the market might
induce a sharper-than-expected correction in prices, depressing
collateral values. A weaker property market could also put further
pressure on local governments, which rely heavily on revenue from
land sales.'
What to do? I think the
IMF's conclusions are absolutely on the money. 'While they believe it
will be costly, most analysts consider that the likely fallout from
China's credit boom will be manageable. One key source of confidence
is China's strong fiscal position, including a large stock of
public-sector assets and low central government debt. Nevertheless,
even those buffers do not preclude significant bouts of uncertainty
as to how losses will ultimately be allocated among the banks'
private investors and local and central government. To the extent
that the government needs to step in, the consequence could be a
substantial worsening of China's public debt metrics and a narrower
scope for future fiscal stimulus.'
Those two last points –
about the scrap to avoid holding the losses, and the extent to which
the hangover from 2008-2010 will constrain Chinese government policy
choices over the next 18 months – should be carved in stone above
every asset-allocators desk.
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