In the weeks since Covid-19 halted the economy, China has taken several steps to avoid outright bankruptcies and defaults. The stress on corporate balance sheets is real. Non-performing loans as a portion of the total on lenders’ books, estimated at over 10% before the epidemic, are expected to rise. China’s banks and bad-debt managers held $1.5 trillion of non-performing and stressed assets at the end of 2019, according to a recent PricewaterhouseCoopers LLP study.If banks start recognizing too much of China Inc.’s bad debt, their credit costs will rise sharply and eat into profitability and capital. On the other hand, the additional hit because of forborne loans could run to as much as 1.6 trillion yuan ($224 billion), according to S&P Global Ratings. That will crimp their ability to lend.
So far, commercial banks aren’t foreclosing on China Inc. and the pressure to roll over is rising. Since late January, almost a fifth of principal and interest payments on loans to small and medium companies have been deferred. Chinese courts are pushing creditors and debtors to settle outside the judicial system. Convinced that recoveries will be poor anyway, investors are walking into so-called exchange offers, effectively extending debt on new terms.All of this, however, doesn’t amount to the cleanup that China needs at the risk of deep systemic pain. It simply puts off difficult decisions on debt resolution. Clearing out the stock of almost worthless borrowings will create room for more, hopefully productive credit growth. Meanwhile, there would be some credibility in declaring losses: Everyone knows the non-performing loans exist and the virus-induced pain will eventually show up somewhere.
For creditors, maintaining the status quo has meant taking bad deals. Consider the recent cases of debt exchanges. Water and sewage treatment company Beijing Sound Environmental Engineering Co. said in February that it wasn’t sure it could repay its bonds. In March, the company said it had completed a debt swap for its 500 million yuan three-year medium-term notes at a slightly higher coupon. Most bondholders took the deal and 100 million yuan wasn’t repaid. That barely compensates investors for staying. Similarly, in state-owned commodity trader Tewoo Group Co.’s exchange offer, investors will take a significant haircut and the new bonds will be longer tenor for a far lower coupon. No one is offering — or getting — great outcomes.
At China’s banks, the loan-to-deposit ratio is close to 80% and rising. As of March, banks had already pushed out 1.8 trillion yuan to deal with the Covid-19 impact. Their capital buffers aren’t placed to protect against a big jump in non-performing loans. The cushions look adequate for now, but that’s only until they don’t. Beijing is a big shareholder and dividend income matters. Yet the government needs them to lend more to ever-weaker borrowers, and has released funds and set up facilities to allow it.
That everyone, including the government, is turning is out to be a loser raises the question of whether Beijing has many options left, or even room for forbearance. Recent moves signal it doesn’t. Authorities are reforming and expanding the “bad banks,” or national-level asset management companies, that were established after the Asian financial crisis to help clean up lenders’ balance sheets. Special sovereign bonds have also been issued that could be used to recapitalize banks, or to create liquidity with the AMCs to buy up bad assets at market value. That, though, risks creating a capital hole for banks, and the managers don’t have gobs of capital to put to use without hitting leverage limits.
Such a process needs to be done before the billions of dollars of NPLs have to be recognized, rather than after. The case of Bank of Jinzhou Co. is an indication of what could go wrong. The central bank has effectively become a shareholder, while China Cinda Asset Management Co. will provide equity and buy 150 billion yuan of assets. It’s had to issue share capital well below book value, breaking with a long-held line. The bank had gone bad some time before it went under, and the last-resort restructuring has opened up questions around transparency.
China can’t afford that for the whole system, but it needs to start somewhere. There isn’t much trust in Chinese banks, with their price-to-book ratios trading at historic lows. A delayed diagnosis will be a missed opportunity.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Anjani Trivedi is a Bloomberg Opinion columnist covering industrial companies in Asia. She previously worked for the Wall Street Journal.
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