China debt: Baoshang bailout rattles lenders

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The move prompts questions about which other banks could be at risk, and forces the central bank to guarantee Bank of Jinzhou’s issuance of short-term debt.

By Rebecca Feng

The People’s Bank of China (PBoC) and the China Banking and Insurance Regulatory Commission (CBIRC) placed Baoshang Bank, a medium-sized regional bank in Inner Mongolia, under the control of China Construction Bank, one of the country’s four megabanks, on May 24.

The PBoC says the bank has “serious credit risk” and pledged to guarantee all retail deposits, no matter how large. Repayments of institutional deposits and interbank liabilities larger than Rmb50 million ($7.2 million) are up for negotiation.

Ting Lu_160x186

Ting Lu, Nomura

The move appears to be the natural consequence of leverage building up in China’s financial system, despite efforts by the government to reduce borrowing by banks and corporations. Many offshore bankers told Asiamoney they thought the bailout was a one-off, but the impact on the debt markets was noticeable immediately.

China’s big banks have become extremely reticent about buying negotiable certificate of deposits (or NCDs), on which Chinese small and medium-sized banks depend heavily for refinancing.

Smaller banks cancelled their issuance plans in the week after Baoshang’s bailout. As for double-A rated banks, they issued just 8.4% of their target in the week after the takeover, compared with 56.7% the week before. For AA- banks, the figure dropped from 52.1% to nothing at all.

Change of lists

The main problem, says a managing director at a large onshore investment bank, is that Chinese investors’ long-lasting belief that no bank — no matter how small — will be allowed to fail, has been proven false.

“As a result [of Baoshang’s fall], we changed our strategy from having a black list to having a white list,” says the banker. “Previously, we had a few city-level commercial banks that we did not do deals with. Now we have a few that we can do deals with.”

Rumours soon spread that other small banks are at risk. HengFeng Bank and Bank of Jinzhou were two of those under scrutiny, multiple bankers confirmed to Asiamoney. Neither has filed financial statements in 2018.

Bank of Jinzhou was also largely shut off from the NCD market until the central bank stepped in to help. The bank was able to issue two NCDs on May 27, the Monday after the Baoshang takeover. Both NCDs were poorly received, covering less than 20% of the books; in the ensuing two weeks, the bank did not even attempt to issue NCDs.


The state takeover of Baoshang Bank suggests China will have to face the consequences of years of rapid debt accumulation, but the impact of this particular case should not be exaggerated
 - Ting Lu, Nomura

The PBoC stepped in again on June 10. Bank of Jinzhou issued a notice saying that it was looking to sell a Rmb2 billion ($289 million) NCD note the following day. At that time, there was no mention of the PBoC’s support. But in the early morning of June 11, Bank of Jinzhou updated its issuance notice, adding that the central bank would support the trade with a credit risk mitigation tool.

According to the updated filing, if the bank fails to redeem its NCD note in full at the expiration date, China Bond Insurance Co, a PBoC-backed credit insurance provider, will make up the balance and transfer the money to Shanghai Clearing House the next trading day.

The move worked: Bank of Jinzhou was able to successfully raise the full amount from the deal, pricing a six-month NCD at 3.21%.

Consequences

While offshore bankers and analysts felt the central bank’s move regarding Baoshang was a one-off, onshore commentators focused on a potential ripple effect and Baoshang’s intriguing reputation.

“The state takeover of Baoshang Bank suggests China will have to face the consequences of years of rapid debt accumulation, but the impact of this particular case should not be exaggerated,” says Ting Lu, chief economist at Nomura.

Baoshang is not a typical medium-sized Chinese bank, say analysts. It took up only about 0.1% of China’s outstanding deposits in 2016, Lu points out. The bank is 70% owned by Tomorrow Group — whose founder, Xiao Jianhua, disappeared from the Hong Kong Four Seasons Hotel in February 2017.

Baoshang’s nickname roughly translates as ‘The friend of non-banking institutions’ because it was more willing than other banks to lend to securities houses and small corporations, say onshore bankers and securities house analysts. That may have been its downfall.

While the Chinese authorities may want most banks to not take such an eager approach to lending, the government is also clearly worried about the risks of lending becoming too tight as well.