Smoke and mirrors. It is the phrase that came to mind when reading Shengjing Bank’s announcement to the Hong Kong Stock Exchange (HKSE) on September 27.
Based in the northeast Chinese city of Shenyang but listed in Hong Kong, the state lender said it had agreed to sell a portfolio of assets, valued at Rmb176 billion ($24.1 billion), to Liaoning Asset Management Company, an organization ultimately owned by the provincial government.
The kicker here is the strange nature of the deal. Shengjing Bank said Liaoning Asset would buy the portfolio by issuing it with 15-year special-purpose notes with an annual interest rate of 2.25%, in a single lump sum.
Yes, you read that right. The buyer is paying for the assets it is acquiring by borrowing heavily from the bank it is purporting to be trying to save. Even in China’s super-opaque financial sector – where policymakers go to extreme lengths to prevent financial institutions, particularly retail-facing lenders, from succumbing to bankruptcy – it is a weird deal.
And when you start to peel the onion, it gets stranger still.
The announcement to the HKSE contained no details about how Liaoning Asset would repay the principal. It did trumpet a few anticipated benefits, including a lower non-performing loan (NPL) ratio and a higher capital-adequacy ratio. Though in a report published on October 13, Fitch Ratings warned the deal would have “limited impact” on bank cashflow.
China has history here. In 2000 and 2001, the central government set up four asset management companies (AMCs), using them to store $169 billion-worth of bad loans built up by the big-four state lenders, such as Bank of China. In 2003, Beijing kick-started the listing process for the quartet by bailing them out using the country’s ample foreign-exchange reserves.
The AMCs were set up to absorb, digest and ultimately expel those NPLs, before shutting up shop. Yet most laboured on, transforming themselves into financial holding companies. Today, they are part of a network of five national and 59 local AMCs.
Portent
Shengjing Bank feels different. The structure of its bailout by Liaoning Asset, which is pending approval, feels more like a portent of what is to come rather than an echo of the past.
China’s banking sector is a confusing mishmash of institutions. The biggest state lenders are, if company filings are to be believed, well-run outfits with low NPLs. But as banks decrease in size, so do quality levels – of assets, management and oversight.
Shengjing Bank is just one of the country’s 125 city commercial banks, a group that accounted for 16% of all industry assets at the end of 2022. Many are unlisted. And while most are local outfits, a few – Shengjing included – operate across multiple provinces.
Analysts have long fretted about the general quality of this sprawling group’s asset base, not to mention thousands of even smaller urban and rural credit cooperatives.
The plight of parts of the banking sector, exacerbated by a deteriorating economic picture, may make Shengjing’s bailout the first of many, analysts warn
Occasionally, a firm’s problems are so endemic that Beijing is forced to act. In August 2020, Baoshang Bank, an Inner Mongolia lender once controlled by the private conglomerate Tomorrow Group, filed for bankruptcy. For years, Tomorrow’s owner, the now jailed tycoon Xiao Jianhua, in effect treated Baoshang as his in-house bank.
The plight of parts of the banking sector, exacerbated by a deteriorating economic picture, may make Shengjing’s bailout the first of many, analysts warn.
“[L]ocal AMCs are taking on a larger role in resolving China’s non-performing assets as the country’s slowing economy and persisting property-sector downturn push small regional banks to step up their [NPL] disposal efforts,” Fitch warns.
Ironically, Shengjing has historic links to Evergrande, the firm whose travails encapsulate the dire state of the onshore property space. On Monday, a Hong Kong judge gave the world’s most-indebted developer until December 4 to resolve its towering debt crisis or face liquidation.
In 2016, Evergrande took a 17.28% stake in Shengjing – rising to 36.4% three years later – in return for taking on Rmb50 billion of the lender’s troubled assets. It sold its remaining stake in the bank in September 2022.
Pilot
So where do we go from here? More bailouts are surely the direction of travel. Beijing loves to test-run a pilot project before unveiling it on the national stage, and if it works, the Liaoning-Shengjing Bank model may be used more widely.
The purchase price of the portfolio of assets is, Fitch notes, only 4% lower than its book value of Rmb183.7 million – a number that includes Rmb154.4 billion in principal and Rmb29.3 billion in accrued interest, according to bank disclosures.
This is suggestive of three things.
First, that Liaoning Asset almost certainly overpaid. Shengjing Bank’s official NPL ratio of 3.17%, as of the end of June 2023, is likely a substantial under-sell. Mainland analysts put the real level as high as 20%.
Second, that in value terms, future bailouts of this kind will tilt greatly in the seller’s favour. Local AMCs, notes Fitch, “could face pressure to acquire bad debt at prices that make it challenging to earn a commercial return, as may be seen in this case”.
Finally, it offers a partial insight into the true state of China’s smaller regional lenders. The relative size of the disposed assets – Liaoning Asset bought about 17% of Shengjing’s assets – may be a sign of “mounting pressure at some weaker banks”, the ratings agency adds.
In China’s mysterious and impenetrable banking sector, where so little makes sense, it is smoke and mirrors all the way.
