Cracks widen in the Chinese land and debt ponzi


A look back at recent initiatives by China to get its local government debt market moving from UBS via FTAlphaville:

This is NOT a Chinese “QE”, but a debt restructuring and asset securitization. Contrary to some news report and comments, the RMB 1 trillion local debt swap does not mean the central government “bailing out” local government debt, or the central bank purchasing local debt. In fact, China’s central bank law prohibits the PBoC from directly monetizing government debt. This is about allowing local governments to issue explicit (provincial) government bonds to replace/refinance part of their current stock of debt, which is largely in the form of bank loans and trust loans via various local platforms (LGFVs). In doing so, local debt duration can be lengthened and interest costs can be lowered, as debt restructuring usually achieves. In addition, in this debt swap, loans or loan-type assets will become bond securities that can be sold and are more liquid…

We think the local debt swap is the right step in restructuring local debt and believe this should be done on a much larger scale. We estimate that total local government debt reached RMB 21 trillion by end 2014, of which at least 11 trillion will be deemed direct responsibility of the local governments (the rest could be classified as corporate debt), with average interest rates of 6.5-7%… Current interest rates of LGFV bonds are around 4.7% for 3-year and 5-year durations (Figure 1). Therefore, replacing RMB 10 trillion old debt with new bonds could save annual interest payment by up to 300 billion. In addition, extending the maturity from 3~5 years to 7~15 years could reduce current principal payment by 800~1000 billion per year. Given that local governments are facing increasing pressure to service their debt due to ongoing property downturn and slowdown in tax revenues, lowering debt service costs by replacing old and high cost debt with new bonds at lower interest cost and longer maturity at a large scale would bring much needed relief to local finance, improve debt sustainability, and reduce the pace of NPL formation.

Given the general abundance of domestic saving and controls on bank lending, there should be sufficient domestic liquidity and demand for local government bonds, and there is no need for the central bank to purchase them. More importantly, these provincial bonds are meant to be used strictly for repaying maturing bank loans or other similar debt stock, which means no additional debt will be created in this process, and hence, no extra liquidity will be needed from the central bank.

Versus over the weekend, from PRC Macro’s daily note also via FTAlphaville:


The domestic financial media in China is processing the news that what should have been a routine debt auction by the Jiangsu provincial government failed. This event and subsequent information flows about potential wider delays to the local government bond swap program could trip up China’s market rally. In our view this is raising the stakes for President Xi’s Politburo meeting this weekend, and heading into next week we expect clearer messaging about how Beijing is going to smooth over systemic refinancing needs without roiling markets.

As we have written previously, Q2 is a seasonal peak for refinancing demand, and this failure of a AAA-rated regional government bond issue does not bode well for the now RMB 1.6 trillion local government bond swap program. The PBOC has succeeded in driving down interest rates on government and SOE debt, and this should provide a little bit of breathing room for local governments smarting from a plunge in land-transfer revenues and SOEs that reported dismal profit data for the opening months of 2015. However, this bond failure indicates that even state-owned financial institutions, the primary buyers of local government debt issues, may not look favorably on the risk-return profile of this class of bonds.

Which will mean more pressure on infrastructure and land development as interest rates remain stubbornly high.

Meanwhile, from Investing in Chinese stocks another sector can’t sell enough debt:


Chinese real estate data is improving in first-tier cities such as Beijin. It is possible that March or April will mark the bottom for home prices. It may also be a false dawn similar to the small spikes in sales that followed policy easings throughout 2014.

A couple of things I saw on Friday make me think things may be deteriorating behind the scenes. First is the rapid increase in loans, Loans to Chinese property developers surge again in Q1:

Loans to Chinese property developers surged again in the first quarter despite the country’s housing downturn, official data showed on Friday, a sign that authorities were exhorting banks to do more to support the cooling property market.

Banks’ loans to property developers leapt 24.1 percent to 6.08 trillion yuan ($981.8 billion) by the end of March, central bank data showed, picking up from a rise of nearly 23 percent in the corresponding period last year.

Growth in loans to build public housing was even stronger. They shot up 64.3 percent in the first quarter to 1.28 trillion yuan, faster than last year’s rise of 57 percent.I read this and immediately thought of Kaisa and the steel sector.

Kaisa’s debt load went from 35.2 billion yuan in July 2014 to 65 billion yuan today. About half of that debt is coming due in 2015. As debt was rising from July 2014, Kaisa’s cash balance has gone the other way, collapsing 83%.

In addition to the ¥1.3 trillion in bank loans, much of it short term, the industry’s top 80 firms also owe ¥1.7 trillion in short-term high interest loans. Firms are borrowing to repay old debt, for instance a Xinjian unit of Baosteel saw its short-term debt climb 13.3% last year, even as long-term debt fell 29%.Debt piles up fastest at the end, when the only way to survive is to extend and pretend. Fake it until you make it, stay solvent until business conditions improve and then dig your way out of the hole. A rapid increase in debt can be a sign that the end is close at hand.

Another story out yesterday follows the smae theme, Glorious Property Seen Close to Default After Kaisa Tumble:

Attention has rapidly shifted to Glorious Property Holdings Ltd., whose controlling shareholder is billionaire Zhang Zhirong. Moody’s Investors Service cut its senior unsecured rating to Ca, just one step from the lowest grade typically signaling default, on April 20 citing sliding sales. It settled $19.5 million of interest Friday on its $300 million of 13 percent notes due Oct. 25, which have dropped 6.3 cents this month to trade at 78.4 cents on the dollar.

…Glorious, which according to its website focuses on developing large scale and high quality properties in cities in the Shanghai region, Yangtze River Delta and northeast China, had missed scheduled payments as of Dec. 31 on loans of 149.6 million yuan ($24 million) in principal and 46.4 million of interest, according to its annual results dated April 15.

Since the end of last year, the company also failed to meet repayment deadlines on 500 million yuan of principal and 397.3 million yuan interest on unspecified borrowings this year, it said, without giving further details. While the builder subsequently settled the bulk of the missed payments, it was still delinquent on 130.3 million yuan, it said.

Last year, there were no stop stories of firms at risk of bankruptcy. Even earlier this year, in February, Xinhua coverage coverage indicated that 90% of developers (mainly small and medium firms) are already insolvent, but since the big firms are “too big to fail,” the government will bail them out and the sector will avoid an economic chain reaction. The rapid increase in debt in the first quarter of 2015 fits perfectly with that report.

The cracks are widening in the Chinese land and debt ponzi.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.