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China's asset-backed securities market expands despite worries

But Fitch says mainland needs securitisation to allow for a clean-up of lenders' bad loans

PUBLISHED : Monday, 09 September, 2013, 12:00am
UPDATED : Monday, 09 September, 2013, 3:44am

Beijing is expected to allow mainland banks to sell billions of yuan in asset-backed securities (ABS) soon, adding to concerns about increased leverage in the economy.

Up to 300 billion yuan (HK$380 billion) of ABS will be issued by mainland banks in the near future, bankers say, as the central government encourages lenders to finance new projects with funds from sales of loan-backed securities.

The launch of a large-scale ABS programme could beef up leverage in the financial system, which has been escalating at a rapid pace since 17.5 trillion yuan was pumped into the economy in 2009 and 2010, an amount equivalent to 24 per cent of the GDP of those two years. Lax risk controls could lead to a financial crisis, just as toxic ABS triggered the United States subprime crisis, economists have warned.

Fitch Ratings said that unless ABS quotas were lifted dramatically, the small size of China's securitisation market - less than 0.1 per cent of banks' total assets - meant any attempt to clean up the country's banks by a large-scale transfer of bad loans could be "problematic".

Premier Li Keqiang said at a State Council meeting last month the government would expand the ABS programme, after it approved the sale of 50 billion yuan of ABS last year and 22.85 billion yuan in 2011 in a pilot scheme.

The likely sharp increase in the ABS quota this year underlined the determination of the government to promote securitisation - which helps ease pressure on banks' capital adequacy ratio and transfers credit risk - UBS Securities said in a report.

The authorities would encourage ABS sales to allow new lending for the building of railways, ships and government-subsidised homes, the People's Bank of China has said. The programme will reduce lenders' capital consumption and allow bond market participants to invest in new products, according to the central bank.

Asset-backed securities - backed by loans, leases, receivables or mortgages - are sold by banks to special purpose vehicles (SPV). SPVs bear the default risk after bankers pool and then split the assets into securities. The securities are sold to investors, who receive the cash flows of the assets in exchange for taking on their default risk.

Mainland banks want the expanded ABS programme, especially after the June cash crunch in the interbank market exposed their weaknesses in liquidity management and underscored the extent to which their assets, usually with long maturities, are mismatched with their liabilities, often short-term.

"Asset-backed securitisation, if properly structured, can help banks transfer credit risk to investors and improve banks' asset-liability maturity match," said Liao Qiang, an analyst at Standard & Poor's.

A functioning secondary market for ABS could enable price discovery for illiquid credits and therefore support banks' risk-pricing capabilities, Liao added.

"However, ill-incentivised growth in the ABS market could lead to excessive leverage in the economy and the banking system and liquidity strains in distressed situations, as evidenced in the 2008 crisis in the US."

In the 2008 subprime crisis, when ABS amounted to 60 per cent of bank loans in the US, lenders dropped their guard in monitoring risk when it came to sales of mortgage-backed securities. Moreover, credit ratings agencies turned a blind eye to certain risks. Furthermore, investors thought the mortgage-backed bonds were safe because they were sold by semi-government agencies.

These were the lessons China should learn, said Wang Jian, an economist at the US Federal Reserve Bank of Dallas, on his Sina microblog.

Outstanding loans of mainland banks stood at 68.78 trillion yuan at the end of June. That means 300 billion yuan of ABS would be 0.4 per cent of total loans.

Large-scale sales of ABS were unlikely to take place in the near future because regulations were not in place, said Pang Xiusheng, a vice-president of China Construction Bank, the nation's second-largest lender by assets.

There is no SPV participation in Chinese ABS deals, although the central bank emphasises "bankruptcy remoteness", a major function of SPVs. Trust firms currently play the role of fiduciaries.

The Agricultural Development Bank of China said last week it would sell 1.27 billion yuan of ABS with Citic Trust as fiduciary and Citic Securities and China International Capital Corp as co-underwriters.

The assets - loans made to 36 firms engaged in agricultural product processing, textiles, food processing and other industries - were split into three tranches, according to the bank.

Premier Li said last month that only "good quality assets" should be securitised.

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