Just last week we noted that in the latest shocker to emerge out of corporate China, at least a quarter of Chinese companies were unable to generate enough cash to cover their interest expense: as we noted previously this is the Ponzi Finance stage of China’s debt curve, the one that comes just before the inevitable “Minsky Moment” at which point all bets are off.
The implications of this, for the nation with nearly $20 trillion in corporate debt as well as a grand total of 300% in debt to GDP are staggering: it means that sooner or later, up to a quarter of bank loan exposure will have to be discharged, restructured, equitized or otherwise eliminated due to its non-performing nature, dramatically impacting not just the asset side of the bank ledger, but the liabilities as well, namely deposits, which could see a drop in the trillion.
Overnight, in a report published by S&P Global, the rating agency’s analysts noticed not only the latest deterioration in corporate China, but also the relentlessly growing leverage, noting that rising debt levels will worsen the credit profiles of China’s top 200 companies, requiring the country’s banks to raise $1.7 trillion in capital to cover a likely surge in bad loans.
How does S&P get to that number? The rating agency estimated the problem credit ratio at Chinese banks was 5.6% at the end of 2015. In a downside scenario of unabated credit growth, that ratio could worsen to 11-17 percent. In such a situation, banks would need as much as $1.7 trillion in recapitalisation funds by 2020. Even under a base case scenario, they would require $500 billion.
Of course, this should also not be news to regular readers: recall that in our post from February 1 of this year titled “Meet China’s Latest $1.8 Trillion “Problem“, we came to the exact same conclusion regarding China debt debt.
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Just like the recent China Beige Book release, the S&P study sees little scope for improvement in 2017 amid worsening leverage and substantial excess capacity in almost all sectors. Seventy percent of the companies surveyed were state owned, comprising 90 percent of the sample companies’ debt.
Furthermore, anyone anticipating a slowdown in the torrid pace of Chinese debt issuance may be disappointed: S&P expects China’s government to continue to allow rapid credit growth over the next 12-18 months before attempting to rein it in, implying that risks would heighten in one to two years’ time according to Reuters.
S&P notes, as one can expect, that debt has emerged as one of China’s biggest challenges, with the country’s total debt load rising to 250 percent of GDP, according to the agency. However, if one uses IIF calculations, the number is far greater, and is now over 300%.
S&P is not alone in its warning: As the Bank of International Settlements (BIS) warned recently, excessive credit growth in China is signalling an increasing risk of a banking crisis in the next three years. Furthermore, just last week, the IMF has warned China its credit growth is unsustainable, with corporate borrowers sitting on $18 trillion in debt, equivalent to about 169 percent of gross domestic product (GDP).
For now Beijing’s response has been mostly optical. On Monday, the Politburo announced a series of guidelines aimed at cutting company debt levels which some fear could destabilise the world’s second largest economy. Encouraging mergers and acquisitions, bankruptcies, debt-to-equity swaps and debt securitisation are some of the measures intended to improve credit allocation and stop wasteful spending in the economy. The problem is that all those “other” market participants, mostly SOE banks, for whom the soon to be impaired debt is an asset, will need lots of cash, as much as $2 trillion according to S&P, to offset the hole on the balance sheet.
How China’s banks will raise this amount is unclear.
“We expect further deterioration in the credit strength of state owned enterprises as they continue with their debt-funded expansion,” S&P Global’s report said. “High leverage in corporates will likely constrain investments and aggregate demand.”
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