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Chinese asset-backed issuance challenges lenders
By Katie Chen |
August 16, 2012, Thursday
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Print Edition
Print Edition
ASSOCIATE analyst, Moody's Investors Service
three Chinese local government infrastructure firms this month became the first batch to issue asset-backed notes (ABNs) in China following the National Association of Financial Market Institutional Investors releasing new guidance on August 3 that allows non-financial institutions to issue ABNs.
The three firms, Shanghai Pudong Road & Bridge Construction Co, Ningbo Urban Construction Investment Holding Co, and Nanjing Public Holdings (Group) Co, offered 2.5 billion yuan (US$392 million) in ABNs with maturities from one to five years in private placements, with interest rates that are lower than benchmark loan rates. This is a credit negative development for Chinese banks that illustrates, and adds to, a trend toward financial disintermediation in China.
More companies in China are seeking direct funding from capital markets. According to the second-quarter Monetary Policy Execution Report published on August 2 by the People's Bank of China, corporate bond issuance in the first half of 2012 had strong year-over-year growth of 37 percent, and about 10.6 percent of total financing came from the corporate bond market, up 2.1 percentage points from the same period in 2011.
Whereas large, strong corporations are responsible for the robust growth in corporate bond issuance so far, we believe the ABN market opening will provide an additional funding channel for corporations with lower credit ratings but with assets that have strong cash flows.
All this indicates that banks will see their strongest traditional customers increasingly turn to non-bank channels to meet their funding needs, potentially reducing banks' loan volume and yields in this credit category. This raises the risk that banks will be forced to adjust their loan portfolios and enter new areas such as small- and medium-size enterprise lending or emerging industries. Because Chinese banks are less familiar with these sectors, risk management and pricing will be challenging.
The newly-opened ABN market raises the risk of structural subordination for existing bank loans, since cash flows originated from the underlying assets will be restricted to servicing only the ABN. This will decrease cash flow available to service existing bank loans.
Lower quality
And because assets being used to back ABNs are generally those with more stable cash flows and better quality, in the case of default, banks could be subordinated or have no claim rights on the securitized assets, leaving them with recourse only to assets of lower quality. In addition, because ABN issuers will not divert their entire issuance proceeds to pay down existing bank loans, their overall leverage will likely increase, creating a weakening borrower profile for banks.
Given ABN guidance largely targets the corporate sector, we expect its effects will be more pronounced among banks with a higher focus on corporate lending. The ABN guidance states that underlying assets can be assets with predictable cash flows, property rights, or a mix of both. We believe assets in transportation and logistics, power generation and supply and public utilities, and infrastructure projects are most likely to back ABN issuance owing to their relatively predictable cash flows, at least in the beginning phase of this market development.
Although the issuer's liquidity and funding options improve with ABN issuance, which could, in turn, strengthen their capacity to service their bank loans, and banks can gain fee income by providing underwriting services for these securities, an overall increase in corporate leverage and structural subordination for existing bank loans outweigh these positive factors.
The article was extracted from the "Moody's Credit Outlook" note dated August 9, 2012.
three Chinese local government infrastructure firms this month became the first batch to issue asset-backed notes (ABNs) in China following the National Association of Financial Market Institutional Investors releasing new guidance on August 3 that allows non-financial institutions to issue ABNs.
The three firms, Shanghai Pudong Road & Bridge Construction Co, Ningbo Urban Construction Investment Holding Co, and Nanjing Public Holdings (Group) Co, offered 2.5 billion yuan (US$392 million) in ABNs with maturities from one to five years in private placements, with interest rates that are lower than benchmark loan rates. This is a credit negative development for Chinese banks that illustrates, and adds to, a trend toward financial disintermediation in China.
More companies in China are seeking direct funding from capital markets. According to the second-quarter Monetary Policy Execution Report published on August 2 by the People's Bank of China, corporate bond issuance in the first half of 2012 had strong year-over-year growth of 37 percent, and about 10.6 percent of total financing came from the corporate bond market, up 2.1 percentage points from the same period in 2011.
Whereas large, strong corporations are responsible for the robust growth in corporate bond issuance so far, we believe the ABN market opening will provide an additional funding channel for corporations with lower credit ratings but with assets that have strong cash flows.
All this indicates that banks will see their strongest traditional customers increasingly turn to non-bank channels to meet their funding needs, potentially reducing banks' loan volume and yields in this credit category. This raises the risk that banks will be forced to adjust their loan portfolios and enter new areas such as small- and medium-size enterprise lending or emerging industries. Because Chinese banks are less familiar with these sectors, risk management and pricing will be challenging.
The newly-opened ABN market raises the risk of structural subordination for existing bank loans, since cash flows originated from the underlying assets will be restricted to servicing only the ABN. This will decrease cash flow available to service existing bank loans.
Lower quality
And because assets being used to back ABNs are generally those with more stable cash flows and better quality, in the case of default, banks could be subordinated or have no claim rights on the securitized assets, leaving them with recourse only to assets of lower quality. In addition, because ABN issuers will not divert their entire issuance proceeds to pay down existing bank loans, their overall leverage will likely increase, creating a weakening borrower profile for banks.
Given ABN guidance largely targets the corporate sector, we expect its effects will be more pronounced among banks with a higher focus on corporate lending. The ABN guidance states that underlying assets can be assets with predictable cash flows, property rights, or a mix of both. We believe assets in transportation and logistics, power generation and supply and public utilities, and infrastructure projects are most likely to back ABN issuance owing to their relatively predictable cash flows, at least in the beginning phase of this market development.
Although the issuer's liquidity and funding options improve with ABN issuance, which could, in turn, strengthen their capacity to service their bank loans, and banks can gain fee income by providing underwriting services for these securities, an overall increase in corporate leverage and structural subordination for existing bank loans outweigh these positive factors.
The article was extracted from the "Moody's Credit Outlook" note dated August 9, 2012.
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