Those attending the June event – Opportunities and challenges: What’s next for China’s NBFIs – were optimistic that China’s dynamic new economy would provide real opportunities for non-bank financial institutions (NBFIs), including leasing and securities companies, together with a renewed focus on distressed asset management, both onshore and offshore.
But it’s not all smooth sailing ahead for NBFIs that provide credit to sectors under-serviced by traditional banks. Sometimes described as shadow banking, NBFIs encompass a diverse financial group, offering higher returns with higher risk. They also have a vital role in providing finance to sectors where traditional lenders are restricted in lending, such as infrastructure and property developers.
June 12th 2019
The American Club, Hong Kong
Priscilla Cao, chief investment officer, capital market, China Cinda (HK) Holdings Company
Sean Chang, head of fixed income, Ping An Insurance Group
William Fung, managing director, chief investment officer, AMTD Group
Hanzhi Ding, head of research, Huatai Financial Holdings (Hong Kong)
Wesley W.P. Kong, joint group head of global markets, head of fixed income, currency and commodities, Haitong International Securities Company
George Wong, managing director, head of treasury, Guotai Junan International Holdings
Sally Yim, associate managing director, Moody’s Investors Service
David Yin, vice president – senior analyst, Moody’s Investors Service
Ingrid Piper, commercial editor, FinanceAsia
SIZE AND SCALE
China’s NBFI universe is vast, connecting banks, local governments, companies, financial institutions and even consumers with a host of services including asset management products (AMP), entrusted loans, trust loans, and online lending.
The sector includes distressed asset managers (AMCs) – China’s big four include: China Huarong AMC, China Cinda AMC, China Great Wall AMC, and China Orient AMC, plus smaller local AMCs, leasing companies, insurers, hedge funds, brokerages, investment banks, private equity and money market funds – all indelibly linked to China’s traditional banks.
According to Moody’s Investors Service vice president and senior analyst, David Yin, NBFIs are still a fairly small portion of the economy given China’s banks hold more than Rmb260 trillion ($38 trillion) in total assets.
Securities companies hold assets of around Rmb6 trillion, for example.
Shadow banking assets grew to around $10 trillion according to Moody’s Investors Service, then lost ground to around $9 trillion by 2018, after regulators targeted WMPs and trust products. But when viewed on a global perspective, China’s riskiest assets (16%) are only around half of those of the US (31%). Still, the nation continues to face ongoing issues with non-performing loans. Bloomberg statistics show onshore defaults of close to Rmb42 billion in this year alone with offshore defaults at $1.77 billion.
REGULATORS IN ACTION
Since 2017, regulators have targeted financial institutions, aiming to curtail the upward trajectory of China’s bad debt. And they are showing no signs of easing up. In May 2019, regulators warned banks about the need for greater transparency in relation to non-performing loans. In the same month, the China Banking and Insurance Regulatory Commission (CBIRC) took control of Baoshang Bank, the first such government action of this kind in 17 years.
Not surprisingly, the shockwaves reverberated. AMTD Group works with mainland regional banks as IPO underwriters, additional tier 1 (AT1) capital issuers and manages assets overseas. “Right after the Baoshang situation emerged, the price of AT1’s of regional banks fell quite a bit,” William Fung, the group’s managing director and chief investment officer said.
“Regulations for these banks have been tightened up quite aggressively by the Chinese government. The question is whether Baoshang is an isolated idiosyncratic situation or are we seeing the tip of the iceberg? I wouldn’t be surprised to see similar situations,” Fung said.
With the Baoshang situation and the risk of contagion spreading in mind, Wesley Kong, Haitong International Securities’ joint group head of global markets, head of fixed income, currency and commodities, admits investors are becoming increasingly cautious about smaller regional banks and lower-tier NBFIs, and funding costs had already risen.
“The chance that Baoshang will cause a system-wide crisis is quite low. Baoshang was a very special case with an 89% shareholding held by a single group, and the local government did not have the ability to carry this heavy burden,” adding that the central bank had taken well-timed action to mitigate the effect on the market.
While the People’s Bank of China (PBOC) moved swiftly to ease concerns about short-term liquidity, by injecting Rmb150 billion ($21.7 billion) into the financial system, it’s not just China’s ballooning debt-to-GDP ratio that’s concerned the roundtable guests.
Commenting on actions by China’s regulators to contain risks in the financial system, as David Yin, vice president – senior analyst, Moody’s Investors Service, puts it, in general, the pain of the past two years’ more stringent regulation has been worthwhile: “We believe this is a positive development even though in the short term they [regulators] may slow down the growth of NBFIs.”
Adding to NBFI disquiet are the chronic issues that don’t look like going away soon.
From a securities company perspective, Huatai Financial Holdings (Hong Kong)’s head of research, Hanzhi Ding named political and trade disruption as a top risk in the year ahead, created by volatility and US-China trade tensions. “A liquidity crunch risk for a securities house is very low because we conduct our business as a fee-based and balance sheet business. The key risk in my view is external risk – geopolitical risk. The US-China tension will be of concern for our business as well as asset management and FX trading businesses.”
Sean Chang, head of fixed income of Ping An Insurance Group, admits the trade situation has created uncertainty among investors. “When they start getting a list of companies affected by this political situation like Huawei, that creates an even more uncertain environment, with investors asking whether or not the Chinese government should continue to support these private companies.
But, at the same time, there is a political situation involved, and banks supposedly should keep them alive, and provide credit lines.”
However, Chang believes investor uncertainty will be reduced with good financial results. “The next earnings results season is going to be quite important and this will reflect the kinds of risks [within] bank balance sheets and the NBFIs.”
Regulatory reform can also be viewed positively. China’s big four AMCs were targeted early and are now less sensitive to tightening because they have counter-cyclical distressed asset management businesses and diversified funding sources. It has also left companies like China Cinda AMC in a healthier position according to Priscilla Cao, chief investment officer, capital market, China Cinda (HK) Holdings Company who spoke at the roundtable in a personal capacity.
“An AMC not only depends on expanding financing, it depends on distressed asset supply to expand the business. By creating operating efficiencies, we may try to make the cycle shorter instead of relying on funding to expand the business. Even if there is tightening, it might impact some funding costs but it’s not that big an impact,” she said.
Regulatory oversight has impacted AMCs. A recent Moody’s Investors Service report about the troubled AMC – China Huarong Asset Management – indicates capital constraints will keep it focused on core business (distressed asset management), for the next two years. Its weakened fundamentals combined with volatile markets will constrain capital and Moody’s warns its plan to issue offshore preference shares could be costly.
On a domestic scale, a new player is rising fast. China’s provincial distressed asset management companies – local AMCs – are flourishing at a time when bad debt hit a 20-year high (2018). Both city and rural commercial banks accounted for 41% of the system’s non-performing loans (NPL), by the end of March 2019.
Over the past three years, this sector has grown to more than 50 licensees servicing regional and small banks. Moody’s Investors Service recently reported that provincial level AMCs are adding to capacity and helping to resolve China’s NPLs problem. Delinquent assets originating from regional banks are now a key source of escalating debt which, according to CBIRC, reached Rmb 2.2 trillion, as of March 2019. But Moody’s also suggests uneven oversight may lead to NPL manipulation.
As NPLs shift from large state-owned banks to smaller banks a (9% rise since 2017), both CBIRC and the National Audit Office have issued warnings, stepping up penalties on banks and asset managers hiding bad debt. But, there also seems plenty of opportunities ahead.
China’s bond market – the world’s second largest, is one such opportunity. According to the PBOC, the mainland’s onshore debt market is worth around $13 trillion with foreign ownership at around 2%. The offshore market is one-tenth of this size.
The recent inclusion of the Bloomberg Barclays Global Aggregate Index is the latest step in the opening up of China’s bond market. According to Citigroup, foreign bond buyers could invest between $100-130 billion in mainland bonds this year with Standard Chartered predicting this may reach $286 billion by 2021.
Haitong International Securities has participated in Bond Connect since Day One. “Bond Connect gives all players a good window to take a look at the market and to see where the interest is and how investors can prepare for the next five to 10 years,” Kong said.
While Bond Connect is providing good returns plus more direct access for foreign investors, they still seem reluctant although the investment house Natixis, recently attributed an increase in foreign ownership of Chinese bonds (May 2019) to bond inclusion, despite renminbi depreciation and the re-escalation of US-China trade issue, noting foreign ownership of government bonds rose to 8.2% up a marginal 0.1% and policy bank bonds increased to 2.8% up 0.3%.
George Wong, Guotai Junan International Holdings’ Hong Kong-based managing director and head of treasury, agrees demand is there but so too is caution. From an investor’s perspective, he thinks the question is: “Will I get my money back in two, three, or five years’ time?” adding that “This will require a bit of confidence and this will come from credibility – it could be coming from a big rating agency, a track record or because the issuers are big and reputable.”
Wong stressed Tier 1 NBFIs will continue to be supported by investors, although those issuers don’t need as much money as Tier 2 and Tier 3. “There will be NBFIs who find it tough or more expensive to borrow money, and there will be others that find the market supportive and favourable for their issuance, be it onshore or offshore.”
Currency risk remains a challenge according to Chang. “Investors will have an issue with currency risk. It’s not easy to take currency out of the system or through Bond Connect. Currency wise, it’s evolving every day and there is volatility in the current market, so investors will be exposed to that.”
Despite having several major domestic rating agencies, Chang is of the opinion they are yet to create credibility with international investors. Having an international rating, he believes, would also encourage investors. “It validates your financial standing, it’s really up to the NBFI, whether they only care about onshore investors or do they wish to go offshore,” says Wong.
One area with a good supply of NBFIs coming to offshore markets is via China’s leasing companies wanting to expand shipping or aircraft leasing. Sally Yim, associate managing director, Moody’s Investors Service, says companies have moved out to greener pastures as a result of government directives for banks to support the real economy, a move that’s limited onshore opportunities for these companies.
“Chinese airlines are expanding with increasing numbers of passengers, freight and goods so leasing is very active in this space,” she says. The move offshore is also leading to these NBFIs issuing US dollar bonds to support their businesses overseas.”
Going global may also present opportunities to ambitious NBFIs who see it as a strategic move. “We at Huatai want to do it in order to meet the demand for China capital and global capital. For a lot of China’s brokerages in Hong Kong, cross-border transactions, asset management, wealth management, equities and derivatives will be a booming market for NBFIs. Going global is a risky move but it won’t stop or delay the pace of China’s NBFIs doing so,” Ding said.
But it is in China’s controversial online lending space, which includes peer-to-peer (P2P) and business-to-peer models, that roundtable participants expressed optimistic views about opportunities in this new economy. For example, P2P lending peaked at $150 billion loans outstanding, 50 million investors and 6,600 platforms, it has finally come down to approximately 50 P2P survivors, according to Bloomberg data.
AMTD Group’s Fung says a lack of regulation caused the P2P problem, but those survivors stand to benefit as there is fundamental demand for this service. “Right now, it’s let’s see who’s the last man standing. Those that remain are going to make a lot of money,” he said, adding that they will also be regulated and trusted.
AMTD Group invests in P2P platforms in China and an incubator in Hong Kong. It recently partnered with Xiaomi to obtain one of Hong Kong’s prized virtual banking licences. “P2Ps grew too fast and out of control, everybody thought this was the best thing since sliced bread. People didn’t think too much about the risk from an investor’s perspective. They thought when things don’t go well the Chinese government will step in,” he said.
In Cao’s view, P2Ps should be intermediaries or brokers, and not mixed with investment management, a grey area that Yin says should provide protections for both borrowers and investors. “From my perspective, this sector has huge potential, but these new platforms are still engaged in financing activities and should be regulated.”
As China’s new economy evolves, matures and expands, such is the pace of change in China that Wong sees a different universe evolving for NBFIs.
“I feel that in five years’ time, if we are sitting here again, my compatriots will not be these guys. We may not be borrowing money [from banks] because we may be borrowing from companies like Alibaba or Tencent with links into P2P and B2P, and that’s scary and exciting at the same time,” Wong said.
China Huarong Asset Management Co., Ltd.
Moody’s Client Services