China is set to revive Credit Asset Securitization(CAS) indicating a market-based approach to restructuring program.
Wei Yao, an analyst at Societe Generale highlights why policy makers favor a securitization tool and its limitations to pursue ensuing restructuring of non-performing debt.
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China’s experiment with CAS
Chronicling the journey of CAS in China, Wei Yao notes CAS got off to a reasonable start in 2005 when the government accelerated policy initiatives to set up the regulatory framework. By 2008, domestic issuance of asset-backed securities rose to CNY70 billion from almost zero.
However, in the aftermath of Lehman collapse, Chinese policymakers suspended the trial program, with their subsequent gingerly approach towards CAS seeing deals worth CNY 22 billion and CNY50 billion during 2011 and 2012.
During August, the State Council expressed its intention to go ahead with a pilot scheme for securitization with a new round of CNY 300 billion is anticipated to hit soon.
Benefits of securitization
Dwelling on the two main benefits of securitization, Wei Yao points out liquidity transformation and risk transformation are the key merits.
Liquidity transformation can be achieved by securitizing illiquid assets into liquid market instruments, besides creating instruments of high credit quality out of lower credit quality debts. Sensing this potential, government’s new policy guideline echoes ‘better utilization of stock’ enabling debt roll-over burden on banks. The liquidity transformation would help banks to free up their capital for new lending, particularly infrastructure loans as the favored underlying assets.
Interestingly, the biggest infrastructure lender, China’s Development Bank is reportedly taking up two-thirds of the quota in the upcoming program.
Wei Yao points out that though the Chinese government has highlighted that only good quality assets will be targeted for securitization, their timing and indication of infrastructure loans as a priority leads to speculation that the policy makers might consider securitization as a financial market tool to restructure non-performing loans as well.
The analyst notes in the past China did try this approach, as in 2004, Industrial and Commercial Bank of China (HKG:1398) (SHA:601398) securitized a batch of non-performing loans having a face value of CNY 2.6 billion into CNY 820 million notes, coughing up a heavy hair-cut.
Wei Yao reports that before the securitization process, the non-performing loans were in the past always written down and transferred to bad banks at big discounts. Besides, unlike developed markets, the available pools of debt collaterals were less diversified.
The Societe Generale analyst also points out fast-growing informal securitization, wherein he observed there is a sudden and sharp increase in banks’ net claims on non-bank financial institutions (NBFIs). Wei Yao cautions some of the claims of banks on NBFI’s could be disguised lending from formal banks. The following graph illustrates such increase in claims on NBFIs:
With off-balance-sheet lending through inter-bank market shooting up to CNY 4 trillion, the analyst emphasizes the urgency involved in pushing ahead with CAS.
Wei Yao also points out with over CNY 7 trillion assets under management, insurers are also tagged under eligible investors under the proposed securitization trial.