Money Matters

Chinese banks swap transparency for debt

All provincial and city banks have seen a jump in their government bond portfolio

PUBLISHED : Friday, 22 April, 2016, 12:18pm
UPDATED : Friday, 22 April, 2016, 12:18pm

Abracadabra. Beijing is trying to do to its mammoth debt what David Copperfield has done to the Statue of Liberty – make it disappear, at least for the moment.

And the magic seems to be working, at least as far as the public records of its listed banks are concerned. Under a programme with the misleading title of “asset replacement”, Chinese banks last year swapped 1 trillion yuan of their loans to debt-ridden quasi-government financial arms into bonds of the parent local government. Yet, you will find no trace of that in the company announcements or financial statements of any Chinese bank listed in Hong Kong – except one.

The big question is, how our regulators see their job – ticking a checklist, or genuinely upholding a transparent and fair market

The Bank of Qingdao is the only bank that has left any clue on the swap. Its 2015 annual report said: “Affected by the asset replacement of local governments, and to enhance the financial cooperation with and support to local governments, the company increased investments in local government bonds, resulting in an increase in held-to-maturity investments.”

The change in government bond investment can therefore be taken as a measure of the size of the swap. Going by that yardstick, your diligent columnist pored over the financial statements of 10 provincial and city banks listed in Hong Kong and calculated that they have forked out more than 57 billion yuan for government bonds under the swap deal.

This is what Money Matters found: all provincial and city banks have seen a jump in their government bond portfolio. The bond holdings more than doubled at six of them. Newly listed China Zheshang Bank tops the list with a 210 per cent jump of over 14.5 billion yuan.

This sudden spurt of interest in government bonds is clearly a new phenomenon, and most of these bonds are unrated. Hence one can safely assume that they are largely related to the debt-bond swaps.

Money Matters ran similar forensics on national banks but their bond portfolio proved too complicated to decipher and could not arrive at a conclusive figure – your columnist’s diligence notwithstanding.

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These government-orchestrated swaps do several things. First, replacing questionable loans with government bonds creates the impression that the non-performing loan ratio is easing. Second, with a supposedly cleaner loan book, banks can claim a healthier loan-deposit ratio and extend new loans. Third, it allows banks to press auditors for a smaller provision citing the implicit guarantee of government bonds.

All of these are based on one big assumption – the local governments have greater financial clout than their financial arms. But if a financial arm that relies on 70 per cent of a province’s land sale proceeds cannot meet loan obligations, how can its government – which lives off the other 30 per cent – be more credible?

To understand how far the balance sheet has been distorted, you would need to know the following: How much debt has been swapped? How are the swaps done? Is it one yuan debt for one yuan bond? Which loans were swapped? What are the terms of the bonds, such as the guarantee, maturity and coupon? There is zero information on any of these.

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But how can the bank not tell? Isn’t the scheme a bailout of sorts for the local governments, which directly hold stakes in many of these banks? You would wonder.

The answer is, they don’t have to tell. Our regulators do not classify swaps with the government as connected transactions. Besides, given the size of most Chinese banks, none of these deals would hit the asset disclosure threshold of 5 per cent. Investing in bonds is also no extraordinary business for a bank that would trigger a disclosure.

The big question is, how our regulators see their job – ticking a checklist, or genuinely upholding a transparent and fair market.

More than a decade ago, our regulators would go beyond the books to ask every state-owned enterprise for additional disclosure. Is your company suffering from triangular debt? Has the company sold any equity to your staff at a discount?

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There is no reason why that cannot and should not be done now.

Don’t imagine the issue will go away. Beijing has already announced more debt-to-bond swaps this year, plus a scheme to change loans into debtors’ shares. Chinese banks will give up the protected entitlement of a lender for equities in sleepy, if not collapsing, state-owned enterprises, under the scheme. But the shareholders will be kept in the dark. All they will be able to see is an increase in investment in unlisted shares. As long as the swap in holding doesn’t cross 20 per cent, no one will know.

Abracadabra. Gone will be the bad debt, so will the reputation of our market.