Yields on NCDs have risen sharply for lowly rated issuers
“There aren’t 300 pieces of silver here,” the Chinese say, referencing the apocryphal tale of a man who buried 300 pieces of silver under a sign bearing these words. The silver was stolen by his neighbor, who left a different note: “Neighbor Wang didn’t steal.”
Chinese officials have been adamant that last month’s regulatory takeover of Baoshang Bank, a small lender in northern China, was an isolated case and not indicative of broader problems at small banks. Markets, eyeing some obvious signs of trouble, don’t agree.
Yields on negotiable certificates of deposit, a crucial funding tool for some small lenders, have risen sharply for lowly rated issuers. Issuance has plummeted. The market appeared to calm down on Tuesday, but only after the central bank agreed to indirectly back another troubled small lender, Bank of Jinzhou, by greenlighting the issuance of a “credit risk mitigation warrant”—an instrument akin to a credit-default swap—for its latest NCD. Should Bank of Jinzhou default, a state-owned credit insurer backed by the central bank will pay up. Bank of Jinzhou became a focus of market attention after the auditors for its 2018 accounts resigned in late May.
Baoshang Bank isn’t the only small lender sending out worrying signals.PHOTO: CHINA STRINGER NETWORK/REUTERS
A central bank backstop for troubled lenders may help paper over cracks in the Chinese financial system. But as investors learned in 2008, “spreading risk” is a double-edged sword. If the practice becomes widespread, it might cause larger problems down the road.
The NCD market was spooked for two clear reasons. First, unlike most short-term lending arrangements in China, NCDs have no collateral. That means if a borrower defaults, losses are larger. Second, Baoshang isn’t the only small lender sending out worrying signals. As many as 19 small Chinese banks, including Baoshang and Jinzhou, delayed releasing 2018 annual reports, according to a May analysis by Barclays.
The largest bank on the list—Hengfeng Bank, or Evergrowing Bank in English—had 1.4 trillion yuan ($202.58 billion) in assets. That compares with total Chinese banking assets of 276 trillion yuan in March. Hengfeng’s NCDs have received a lukewarm reception since Baoshang’s takeover. The lender issued only 11% of a planned 2 billion yuan ($289.4 million) in three-month NCDs on Monday, according to Wind.
The central bank’s latest move has pacified investors for now, even if yields remain elevated. Following Jinzhou’s successful NCD sale, total issuance hit 195 billion yuan on Tuesday, up from a paltry 55 billion yuan on Monday.
Chinese regulators are nothing if not experts in plugging holes in dams. This doesn’t seem like a long-term solution, but so many plugs make it hard to know where and when the dam will eventually burst.