China’s Non-performing Loans Could Hit Historic Peak of 3 Trillion Yuan by 2020

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The head of China’s biggest financial asset management company in terms of total assets sees the country’s non-performing loans rising to a record high by the end of the decade, as well as warned of a bubble in the market for NPL-backed securities.

Speaking at Caijing’s Third Chinese Non-performing Asset Sector Summit (第三届中国不良资产行业高峰论坛) Lai Xiaoming (赖小民), chairman of China Huarong Asset Management, said that the total volume of China’s non-performing loans is forecast to rise to 3 trillion yuan by 2020 based on current growth rates.

According to Lai between 700 billion and 1 trillion yuan of special-mentioned loans held by Chinese banks are converting into NPL’s each year.

Data from the China Banking Regulatory Commission indicates that commercial banking sector NPL balances and percentages have risen steadily since the third quarter of 2012, to 1.67 trillion yuan and 1.74% respectively by the end of the third quarter of 2017.

This rising volume of NPL’s has translated into a rapidly expanding non-performing asset market ever since the sale of NPL-backed securities kicked off in 2013.

The market has expanded from over 70 billion yuan in 2013 to over 500 billion yuan in 2016.

According to Lai the development of China’s NPL-backed securities market can be divided into two phases, with the first phase involving the establishment of the country’s four big asset management companies, who focused their efforts on unburdening the big-four state-owned banks of their bad loans.

The primary market for NPL-backed securities remains dominated by the four big asset management companies, who have purchased nearly 1.2 trillion yuan in unsound debt, accounting for around 80% of the total market.

Lai credited Huarong’s innovative business model and disposal methods with its success in the sector, grabbing 650 billion yuan in NPL’s in total, and retaining a market share of over 50% for three successive years.

The second phase began in 2014, with a large increase in NPL’s due to easing economic growth as well as structural adjustments, and certain over-capacity industries serving as an ample source of dud assets.

Chinese regulators have also pushed for diversification and expansion of market participants, rescinding the restriction of one asset management company per province in October 2016.

Since the start of 2017 a total of 18 new regional asset management companies have been established, bringing the number of regional asset management companies to 55 by the end of October this year.

In addition to the big four asset management companies and the 55 regional asset companies, the past two years have seen a massive increase in the number of private and un-licensed asset management companies, to nearly 3,000 in total.

Foreign funds have emerged as key participants in the market, including Goldman Sachs, KKR, Shoreline Capital, and Oaktree Capital Management, which established a joint-venture company with China Cinda Asset Management in 2013 that has invested over USD$6 billion in non-performing assets.

According to Zhang Xiaolin (张晓琳), chief investment officer of Hu’an Investment and chair of the China Non-performing Asset League (中国不良资产行业联盟), Chinese private capital has emerged as a “new force” during the current phase of market development, with most buyers being domestic private investors since 2014.

Lai Xiaomin said that this enthusiasm has translated into bubble on the market for NPL-backed securities that is widely recognised within the sector.

“There are two main reasons for the consistent high-prices of NPL-backed securities,” said Lai.

“The first is that the quality of NPL-backed securities in this current phase is different from the last phase, when NPL-backed securities were basically derived from state-owned companies, and the NPL’s were mainly loans without collateral or guarantees.

“Following increases in the risk-control levels of banks, some of the NPL-backed securities of this current phase come with collateral, with the rise in NPL quality inevitably bringing a rise in the prices of NPL-backed securities.

“The second is that following the increase in the number of market participants, intensifying competition has caused imbalances in market supply and demand…further driving gains in prices.”

Analysts say that the increasing ability of banks to dispose of NPL’s themselves is also making them less willing to sell NPL-backed securities, helping to drive prices higher.

 

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