China's S$5.5 trillion wealth products reel as bond binge unwinds

Chinese Renminbi bank notes are displayed for a photograph in Beijing, China.
Chinese Renminbi bank notes are displayed for a photograph in Beijing, China.PHOTO: BLOOMBERG

BEIJING (BLOOMBERG) - China's bond market is facing more turbulence as banks scramble to avoid losses on wealth management products that raised US$3.8 trillion (S$5.46 trillion) from the nation's savers.

The investment plans typically use leverage to boost returns on the 56 per cent of their holdings parked in fixed-income securities. That model is under threat after Chinese corporate notes plunged the most in nine years in the fourth quarter. Banks may have to use their own money to repay holders of maturing WMPs because it will be hard to sell bond holdings during an extended rout or to raise cash by issuing new products, Citigroup wrote in a Dec 21 note.

The risk of a vicious cycle of bond losses, cash shortages, payment failures and further debt-market declines has prompted China's policy makers to step in. President Xi Jinping pledged last month to make controlling financial risk a top priority for 2017 and the central bank said it will count WMPs when assessing bank risks.

"The government's recent comments on preventing financial risks sent a signal that liquidity is set to be tightened and there's no chance of a bull market," said Oliver Rui, professor of finance at the China Europe International Business School in Shanghai. "So a natural reaction is to dump bond holdings as soon as you can, especially for those with high leverage."

What makes such products particularly risky are their short time frames. Chinese company bonds have an average maturity of 7.7 years, while the most-recent government data show a typical WMP matures in 127 days. China International Capital Corp estimates such plans hold more than 50 per cent of all outstanding Chinese corporate bonds. The ability of lenders to step in with bailouts depends on their capital buffers.

"Small banks will be tested in the next six months by liquidity problems," said He Xuanlai, a Singapore-based analyst at Commerzbank. "In next six months there might be industrial consolidation."

Rural and city commercial banks, with less access to deposits to fund their businesses, are the most aggressive WMP issuers, according to PY Standard, a Chengdu-based research firm. They also have the weakest finances and are the most exposed to surging money market rates.

Signs of financial stress, including a payment failure involving alleged fraud, caused the three-month Shibor borrowing rate to surge 55 basis points in the past six weeks to 3.55 per cent. That fed through to the bond market with the Bank of America Merrill Lynch benchmark for corporate notes losing 3.1 per cent in the fourth quarter, while government debt dropped 2 per cent, amid signs of global reflation.

The central bank said last month it plans to include off-balance sheet WMPs in measuring banks' credit growth this quarter under its so-called Macro Prudential Assessment, because such products are often similar to loans and offer guaranteed payments.

"The risks of deleveraging in the financial system will eventually spread to WMPs," said Larry Hu, a Hong Kong-based head of China economics at Macquarie Securities. "The government would rather deal with it while it still can instead of waiting for it to get out of control."

Fitch Ratings estimates an additional 1.7 trillion yuan (S$352.58 billion) of capital would need to be set aside if banks had to account for WMPs in their balance sheets. Natixis estimates that banks' assets to equity ratio would increase to 16 times if WMPs were included as of June 30, up from 14 times without.

Shengjing Bank, in China's northeastern province of Liaoning, boosted its WMP balance sheet 370 per cent in the 12 months through June. Growth at Shenzhen-based Ping An Bank and Beijing-based China Minsheng Banking. exceeded 100 per cent, earnings reports show.

Jason Bedford, a Hong Kong-based analyst at UBS Group AG, said the rules are "a shot over the bow more than anything else, to stop the double- and triple-digit growth rates."

Bank of Communications predicts WMP assets will grow by less than 20 per cent this year, down from 59 per cent last year and the slowest pace since at least 2009. Commerzbank sees a drop this quarter.

Banks are desperate to keep the party going, pledging an average 4.2 percent return on WMPs sold in the final week of 2016, up from 3.9 per cent two weeks earlier, according to PY Standard.

"It's a very competitive market," said Jack Yuan, a Shanghai-based analyst at Fitch. "The biggest challenge for banks is how to find high-yielding assets and retain customers while managing risks. The risks can be quite murky."