Deep in the Chinese Ponzi Economy, Bad Loans Trade on Alibaba

December 21, 2015 10:54 am Last Updated: December 27, 2015 1:37 pm

The official data doesn’t look that bad—this is normal in China. Bad loans are only about 1.6 percent in total, compared to 1.18 percent in the United States. But then, the questions start: What is the real number?

The answer can only be higher, a lot higher. Investment bank CLSA estimates it could be as high as 8.1 percent for all bank loans. Compare this to bad loans in the United States of about 3 percent at the height of the financial crisis.

(St. Louis Fed)
(St. Louis Fed)

Chinese banks carry assets of $30 trillion of which up to $21 trillion could be loans. In other words, banks could be sitting on as much as $1.7 trillion of bad debt.

Of course, it wouldn’t be China if the state did not invent different ways to conceal the real figure, come up with a doctored one of 1.5 percent, and pretend nothing bad is happening. It would not be China if the whole process did not look like a Ponzi scheme.

And it wouldn’t be China if Alibaba’s trading platform Taobao was not involved.

China has experience in managing a banking crisis. It restructured as much as 50 percent of loans and offloaded them onto state-funded “Asset Management Companies” (AMCs) at the turn of the millennium.

“They rolled over the bad bank debts from 15 years ago, they are still there, believe it or not. When you keep rolling, you get to the stage where they are now a much smaller portion of the economy. So in that sense they have succeeded, they have grown their way out of the problem,” says Fraser Howie, author of “Red Capitalism,” one of the first publications to spell out China’s debt problem in 2011.

(Royal Bank of Scotland)
(Royal Bank of Scotland)

China is doing the same thing again in 2015, so far avoiding a restructuring of the state-owned banks and keeping the official bad loan ratio low.

But this time, the AMCs can’t just hold onto the bad debt and wait until it disappears in the ocean of a larger economy, because debt is growing faster than GDP. So they have to sell it on Taobao.

According to local media, China Huarong Asset Management Co. Ltd. plans to list 51.5 billion yuan ($8 billion) worth of bad loans on Taobao.

“AMCs in general will more frequently resort to a ‘wholesaling model’ for distressed asset disposal (i.e. a quick sale of acquired non-performing loans to other parties, thereby earning slimmer margins as opposed to gains on asset value appreciation), given the increasing non-performing loan supply in the current credit cycle,” wrote Barclays in a note.

China Cinda Asset Management Co. Ltd. sold as much as 4 billion yuan ($620 million) of bad loans on Taobao since May this year.

Normally the AMCs would just wait and see whether the underlying assets would return to profitability and directly sell those assets. This only works in a growing economy, however.

“Rates have been falling for a number of quarters and yet the share of firms borrowing has been dropping despite that. Capital expenditure is falling,” says Leland Miller, president of research firm China Beige Book.

The fact that AMCs have to auction off bad loans wholesale means there are just too many of them around and they don’t see much hope for economic improvement.

(Barclays)
(Barclays)

Barclays also has interesting estimates regarding the credit quality of the loans that AMCs buy from the estimated pool of $1.7 trillion of bad debt. It believes AMCs buy the assets for a maximum of 30 percent of book value.

Under these assumptions, this would leave banks with a total loss of $1.2 trillion. But in China, when everything is said and done, this number could be far higher.