Securitisation is taking off in China, creating some much needed breathing room for banks and heavily indebted borrowers, but a lack of reliable data is keeping foreign investors away.
Three securitisations of bank non-performing loans within a single month have given a clear signal that structured finance is set to play a major role in China’s efforts to prop up its faltering economy.
Bank of China and China Merchants Bank (twice) sold securities backed by NPLs in the mainland’s interbank bond market in May and June, the first such transactions since 2008 as Chinese banks take steps to deal with mounting bad loans.
At the same time, companies have raised funds in the stock exchange market from securitisations of more exotic assets, such as tuition fees and cinema tickets.
Chinese governments – at the central and local level – are supporting such innovations as they free up bank balance sheets for new loans and generate cashflow in the corporate sector without adding pressure to the banking system.
In particular, local governments have gone to great lengths to encourage asset securitisation in the hope of reinvigorating their economies.
Recently Hebei province in Northern China introduced an incentive programme in which local financial institutions and companies incorporated in the province will receive up to 0.1% of the issue size of each offering of asset-backed securities as a reward.
Despite China’s growing enthusiasm for ABS, foreign investors are watching with scepticism as the market still lacks infrastructure such as a national database for diversified assets, a clear legal framework and a broad base of investors.
“The data is the biggest barrier to the development of NPL ABS,” said Ben McCarthy, head of Asia-Pacific structured finance at Fitch Ratings.
“There is very limited history available on how NPLs in China have performed and how loans in different asset classes performed. Information of defaults on either residential or commercial loans is difficult to obtain. Getting an understanding of how long it takes to recover through the court system is also a barrier.”
In late May, BoC and CMB raised a combined Rmb533m (US$80m) from NPL-backed securities under a Rmb50bn pilot scheme in the interbank bond market. One month later, CMB launched its second NPL-backed transaction.
The three deals were backed by corporate loans, credit card consumer loans and micro loans to individuals, respectively.
The senior tranche in those deals was between 1.9 times and three times subscribed.
Investor interest was supported by deep discount rates on the underlying assets, which were seen as of relatively high quality, bankers said.
The senior tranches of those transactions were taken mostly by banks, while the subordinated notes went to state-owned asset managers and private funds with experience in dealing with bad loans, they said.
Notably, in CMB’s last deal, the subordinated tranche was issued at 102, indicating strong demand for the notes.
The Rmb50bn pilot scheme is equivalent to only a tiny fraction of the Rmb1.27trn of NPLs reported at the country’s commercial banks at the end of March, but will nevertheless have a big impact on the ABS market, which stood at Rmb770.4bn in terms of outstanding securities at the end of last year.
However, it is securitisations in the stock exchange market that have attracted the most attention over the past year.
Procedures regarding ABS are easier and thresholds are lower in the stock exchange market, where the majority of securities are backed by leases, company receivables and fees from utility services.
The underlying assets have also included small loans to e-commerce vendors and college students, as well as cinema box office sales, amusement park ticket revenues and tuition fees.
“We often receive inquiries from investors over ABS in the stock exchange market. Compared to unsecured cash bonds, many investors favour ABS, seeing them as supported by cash-generating assets,” said a Shanghai-based underwriter.
The diversification of underlying assets has come with rapid growth in volume. Across both markets, the total volume of new ABS offerings rose 84% last year to Rmb603.1bn, mainly driven by a 384% surge of new issuance in the stock exchange market to Rmb194bn, according to China Central Depository & Clearing Co.
Although securitisation in China is gaining momentum just as regulators are opening the borders to international investors, foreign funds remain almost entirely absent.
Official data showed that Chinese banks held 58.5% of ABS at the end of 2015 in the interbank bond market, while non-banking financial institutions held 41.4%. Non-financial investors and foreign investors accounted for only 0.07%.
As a comparison, foreign investors hold about 2% of all bonds in China’s Rmb5trn onshore market.
Market participants say the lack of investor diversification is also worrisome, especially since the lion’s share of ABS is held by banks.
“ABS in China hardly helps spread risks beyond the banking system. Banks simply help each other clean up their balance sheets,” said a Chinese banker with a mid-sized bank.
“Furthermore, many non-banking financial institutions, such as fund managers, act as conduits for banks’ money to invest in ABS,” he said.
Foreign analysts say that the market still lacks qualified investors capable of assessing risks and that the poor availability of data on default rates and foreclosure procedures has made the pricing of underlying assets challenging.
“When we look at investor distribution in the US ABS market, the role of insurance companies is very strong. They are long-term holders of ABS and they are capable of analysing risks. They not only buy the senior tranche but also the mezzanine tranche,” said Alexander Batchvarov, head of international structured finance research with Bank of America Merrill Lynch.
“But they (capable investors) don’t exist yet in China for mezzanine tranches. Whether they are specialised funds, insurance firms, pension funds, or providence funds remains to be seen.” he said.
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