Portfolio | China’s debt for bond swap a plus for banking stocks

Banking stocks may actually turn out to be major beneficiaries of China’s newly rolled out local government debt-for-bonds exchange programme, argues a recent report that challenges an earlier theory bankers had to be strong-armed into the scheme.

Banks will benefit because the return on equity on newly issued government bonds, at 81.7 per cent, will be four times higher than returns currently earned from local government debt, BNP Paribas analyst Judy Zhang estimates.

Zhang assumes a risk weighting of 20 per cent for a 10-year bond and a yield of 3.58 per cent, with financing provided by further cuts in bank reserve requirement ratios.

"We think the market under-estimates the potential profitability of local government bonds. They don’t seem a bad deal for the banks," she wrote.

So far local governments from 21 provinces have issued around 654 billion yuan in bonds, 25 per cent of the 2.6 trillion yuan year-end local government bond issuance quota, in a programme aimed at clearing up the morass of local government debt vehicles.

It’s one of the biggest financial reforms to date under president Xi Jinping though its launch earlier this year was somewhat marred after pilot bond auctions in Jiangsu and Anhui failed to attract interest, forcing Beijing to offer sweeteners.