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Ft - Sliced And Diced Loans Take Off In China

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CDO^2 anyone?? Uuuhh, I smell a bit: Monolines! This is 2008 all over again just slightly bigger...

February 19, 2015 7:36 am

Sliced and diced loans take off in China

Gabriel Wildau in Shanghai

Call it déjà vu with Chinese characteristics: collateralised loan obligations, the sliced and diced loan bundles that helped tip the world into financial crisis in 2008, are surging in China.

While CLOs fell into disrepute in the US and Europe after the crisis, China is promoting issuance of asset-backed securities as a means of weaning investors away from riskier shadow bank products while also ensuring enough credit flows to the slowing economy.

Issuers appear to be heeding the message. Following years of delays and false starts, CLOs are now the fastest growing asset class in China’s financial system, with issuance of asset-backed securities up more than tenfold to Rmb326bn last year.

A senior China Banking Regulatory Commission official predicted last month that China’s CLO market would “grow by leaps and bounds” this year, adding that Rmb90tn in outstanding bank loans could theoretically be eligible for securitisation.

While the resurgence of sliced and diced leveraged loan CLOs in the US has triggered regulatory concerns, analysts are unperturbed by the Chinese versions, where the bulk of such securities are backed by corporate loans originated by commercial banks.

So far, say analysts, Chinese banks are largely selling plain vanilla products.

“US CLOs’ assets are non-investment grade while their Chinese counterparts are backed by the relatively higher quality loans on banks’ balance sheets,” says Jerome Cheng, senior vice-president for Moody’s in Hong Kong.

For banks, securitisation offers new options for managing their balance sheets and preserving capital, while for securities companies, the products are a profit driver to reduce their reliance on trading commissions and initial public offerings.

“Policy support is the dominant factor [in recent growth]. The central government carried out the securitisation pilot in order to tackle the high cost of financing for companies,” analysts at China International Capital Corp, a Chinese investment bank, wrote in a note last week.

China launched its initial securitisation pilot programme in 2005 but suspended it during the financial crisis in 2008. The programme was relaunched in 2012, but deal flow remained light as rules required the banking regulator to approve each deal.

But last month the CBRC eliminated the approval requirement for 27 commercial banks, allowing them to conduct new securitisation deals under a streamlined registration procedure.

Chinese banks are under pressure to curb balance sheet growth as regulators phase in tough new capital adequacy requirements in line with global rules known as Basel III. Securitisation lets lenders offload assets while maintaining relationships with clients.

Until now China Development Bank, the state-owned, non-commercial lender whose loans mainly support infrastructure projects, has been the most active issuer of CLOs, primarily packaging railway construction loans.

But in January HSBC became the first foreign bank to complete a Chinese securitisation deal, selling Rmb995bn in bonds backed by corporate loans in China’s interbank market, while retaining an equity tranche worth an additional Rmb335bn on its own balance sheet.

Corporate loans were the underlying assets for 86 per cent of CLOs outstanding at the end of January, according to CICC. Auto loans and residential mortgages together account for another 7 per cent.

In spite of the recent growth, China’s securitisation market remains tiny compared with those of developed economies. CICC says outstanding securitised products total 0.5 per cent of GDP in China, compared with 60 per cent in the US, 3.6 per cent in Japan and 2.8 per cent in Germany.

On the investment side, foreign investors accredited through China’s Qualified Foreign Institutional Investor programme can buy CLOs in the interbank bond market, where most such products trade, or on the stock exchange. Foreign central banks, as well as commercial lenders involved in renminbi trade settlement, can also apply for access to China’s interbank market through a separate programme.

The rise of securitisation is coinciding with marked slowdown in the growth of other, riskier forms of off-balance sheet finance.

In 2012-13, demand for securitised products remained tepid because fixed income investors could earn higher interest rates from so-called wealth management products issued by banks and trust companies.

Backed by loans to local governments, property developers and other borrowers that struggle to obtain normal bank finance, such products are essentially informal securitisations that promise a fixed rate of return.

But unlike the full-fledged securitisations now on the rise, there is no secondary market for wealth management products, which means investors must hold them to maturity.

For issuers, dangerous liquidity risk arose from the maturity mismatch between the relatively short-dated products they sold, typically a year or less, and the longer-dated underlying assets they used to generate attractive yields.

When products matured, banks were forced to make cash payouts even when the underlying loans had not matured and could not be easily sold off. Elevated cash demand amid a flurry of wealth management products coming due was a key cause of a nasty cash crunch in China’s interbank money market in mid-2013 that briefly sent shockwaves through global markets.

Since then, however, a string of regulations has effectively curbed many of the risky practices that allowed banks and trusts to offer wealth management products at yields as high as 10 per cent. That in turn has reduced their competitive advantage over securitised products.

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