What is the leverage effect of the Chinese economy?

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Leverage and lumps increase refinancing risk

From Dr. Oliver Everling | May 11, 2021

Refinancing risk for some Chinese financial companies is increasing due to increased leverage and inconsistent maturities, warns Moody’s. Recent bond sales by two Chinese financial firms, China Huarong Asset Management Co., Ltd. and Guangxi Financial Investment Group Co., Ltd. In the opinion of the rating agency's analysts, testify to the refinancing risk of some financial companies.

“Increased borrowing due to political incentives leads to an inconsistent maturity structure. The accommodative monetary policy, "argue Moody’s analysts Sean Hung, Young Le, Sophia Lee and Sally Yim," the development of the capital market and the expansion of business in recent years have underpinned the accumulation of leverage in Chinese financial companies. This is reflected in an increase in onshore corporate bond issuance by commercial leasing companies from RMB 33 billion in 2016 to RMB 131 billion in 2020. "

In addition, many leasing companies have used infrequent but large issues of bonds with terms between two and three years for funding. Moody's calculates that this will lead to maturity clusters for liabilities in the coming years, which increases the refinancing pressure of these companies.

Smaller businesses are at a disadvantage because of a two-tier regulatory regime: “Under current regulations, large financial firms, including distressed statewide asset management companies (AMCs) and finance leasing companies, can be classified as financial institutions, thereby allowing them to issue financial bonds in the interbank bond market. In contrast, small financial firms, including local AMCs, commercial leasing companies, investment companies and micro-lenders, are classified as corporations and are only allowed to issue bonds in the less liquid corporate bond market and the stock market. "

As a result, these companies are more prone to liquidity problems. Tighter monetary policy and increasing corporate defaults could drive up refinancing costs. "As the economy grew, the central bank has returned to a neutral policy," Moody's analysts observe, "which means an end to the very accommodative political environment in recent years that underpinned the financing boom for these companies."

"Despite China's recovering economy, risk aversion in the credit market will remain high as we expect," the Moody’s report said, "that there will be more corporate defaults in the coming quarters. The effectiveness of the mitigation measures varies. Using external credit enhancements such as Keepwell deeds, guarantee deeds and bank letters of credit to support the issuance of bonds can make certain refinancing phases easier, but does not change the credit strength and liquidity management of the receiving financial firms. ”On the other hand, some companies have strengthened their liquidity management to their Better align their liability structure with their assets, thereby reducing the volatility of net cash flows from their operations and the burden of refinancing their liabilities.

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