Moore Capital Summer 2014 China team presentation

Stress Testing China’s Banking System

Summer Research ProjectThomas Fu

InternMoore Capital Management

August, 2014

Global Financial Crisis (2008-2009)

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Global Market Cap ($tn)

58% peak to trough drop

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-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

14%

Global GPD Growth Rates

Eurozone China USABrazil India Average global growth

Credit Intensity of GDP Growth

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 20130%

5%

10%

15%

20%

25%

30%

35%

0%

50%

100%

150%

200%

250%

300%

350%

Everything comes with a price!

What was happening in China

2008, August 8, Beijing Olympics 2008, May 12, Sichuan Earthquake

2010, May 1, Shanghai Expo 2009, China High speed train

Steel, Infrastructure, cement

Where did the credit go?

Real Estate, 18%

"Overca-pacity" sectors, 28%

Other Corporates, 6%Consumer, 8%

Government, 40%

2008 Chinese System Credit (bn$)

Total= $7,293

Real Estate, 24%

"Overcapac-ity"

sectors, 34%

Other

Corporates, 10%

Consumer, 9%

Government, 23%

2013 Chinese system Credit (bn$)

Source: CICC, Goldman Sachs, Merrill Lynch, Barclays, Credit Suisse, HSBC, MCM Analysis

Total= $23,034

Shadow Banking • Banking regulation has forced credit off balance

sheet, exacerbating the credit intensity– Wealth Management Products– Trust Products– Entrust Loans

2007 2008 2009 2010 2011 2012 20130

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

Sources: Barclays Research, HSBC China Research, Credit Suisse Research, Merrill Lynch Research, MCM Analysis

China Shadow Banking System Credit (tn$)

2008 2009 2010 2011 2012 2013 $-

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

$7,000

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Sources: Barclays Research, Bloomberg, MCM Analysis

China Total Real Estate Credit (tn$)

2008 2009 2010 2011 2012 2013 $-

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Sources: Barclays Research, HSBC China Research , Credit Suisse Research . Merrill Lynch Research, MCM Analysis

China “Overcapacity” Sector Credit (tn$)

2008 2009 2010 2011 2012 2013 $-

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

$7,000

$8,000

$9,000

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Sources: Barclays Research, HSBC China Research, Credit Suisse Research, Merrill Lynch Research, MCM Analysis

“ Debt and overcapacity form a vicious spiral….As local governments and businesses borrow more in the name of new projects to pay interest on existing debt, they exacerbate the overcapacity situation. China must stop the debt-capacity spiral. Continuing it provides no way out.”

—Andy Xie (Former Morgan Stanley Chief Asia Pacific Economist)

“ Very rapid growth is often driven by the worsening imbalances, a rebalancing of China is necessarily going to experience much lower growth for many years.”

—Michael Pettis (Peking University)

Does the rapid growth in credit make China unstable?

This is Not News!

• China has a credit problem• What have I been doing all summer?• Creating detailed map of the credit

system by vintage!• Using the data to create a banking

system stress test

Data ResourcesPrimary • PBOC—Bank Loans• CBRC—NPL, RE, LGFV, Overcapacity • China Trust Association— Trust sector • China Bonds Association—Bonds

Secondary • Barclays (May Yan)—China Shadow Banking System, Property• CICC—LGFV Loans• Goldman Sachs (Roy Ramos, Ning Ma)• Merrill Lynch (Michael Li)—Bank Loans• Deutsch (Michael Zhang)—Banking system PnL• HSBC (Todd Dunivant)—Bonds and economic outlook • Credit Suisse (Steven Zhu)—Trust breakdown• JP Morgan—property, NPL • Bloomberg—NPL, Currency

China System Credit by Vintage 2008 2009 2010 2011 2012 2013

On Balance SheetLoans

LGFV 570 3,050 1,890 10 200 2,600Real Estate 342 1,830 1,134 6 120 1,560Others 228 1,220 756 4 80 1,040

Mining 103 184 211 236 262 160 Manufacturing 473 1,019 1,116 1,671 1,626 943

Construction 81 134 406 363 454 460Transportation 352 689 745 349 409 356Property 176 593 878 151 290 536All other 498 404 -174 2,152 1,089 1,604Total industry loans 2,253 6,073 5,072 4,932 4,330 6,659Total consumer loans 454 2,084 982 1,438 1,030 2,440

Mortgage 185 1,532 1,070 856 641 1,637Overseas loans 97 119 195 371 289 592Policy bank loans 1,366 1,353 1,702 134 2,547 -786Net new system loans 4,170 9,629 7,951 6,875 8,196 8,905

BondsMining(Materials) 56 295 108 139 265 118Manufacturing 75 146 246 288 561 0Property + Construction 40 127 163 135 394 326Transportation 31 159 138 69 143 111All other 568 393 385 506 426 681Net new private sector bonds 769 1,121 1,039 1,136 1,788 1,236

LGFV 107 338 315 355 962 1,100Railway 76 98 189 99 150 149Municipal 0 200 200 200 50 212FINS (policy banks) 877 900 736 1,518 1,741 1,263PBOC bills 1,234 -572 -354 -1,761 -784 -612Central government 118 674 702 419 515 916Net new government bonds 2,412 1,638 1,788 830 2,634 3,028Net new system bonds 3,181 2,759 2,827 1,966 4,422 4,264

Off Balance SheetFin guarantee 140 419 676 537 258 362NSCA of WMP 225 107 1,257 815 235 331Entrusted loan 426 678 875 1,296 846 2,980

LGFV -79 136 11 879 677 276Trust 319 841 999 1,771 2,660 3,436

Infrastructure 0 148 176 21 634 952Industrial and Commercial 0 245 292 410 914 1,039Real Estate 0 69 82 256 0 345Financial 0 2 149 439 123 524Bonds 0 38 75 113 307 155Stocks 6 15 18 24 41 89Other 313 324 208 508 641 332

Discounted bills repo 240 480 1,486 -444 1,146 -300Security firm's AMP 10 56 39 95 1,608 3,310All other 441 107 332 466 1,406 997Net new system shadow credit 1,801 2,688 5,664 4,536 8,159 11,116Net new system credit 9,153 15,076 16,443 13,377 20,777 24,285

% of GDP 28% 43% 41% 28% 40% 41%

China System Credit by Vintage 2008 2009 2010 2011 2012 2013Total

o/w RE 1,825 4,081 4,831 3,305 4,661 8,146o/w overcapacity 2,298 4,768 6,111 5,594 8,601 9,224o/w consumer loans 454 2,084 982 1,438 1,030 2,440o/w other corporate 904 1,490 1,344 2,431 2,267 3,333o/w other government 3,671 2,653 3,175 609 4,219 1,142

Total system 9,153 15,076 16,443 13,377 20,777 24,285

On Balance Sheeto/w RE 1,562 4,124 4,315 3,139 4,176 6,431o/w overcapacity 2,037 4,744 5,304 5,486 7,685 6,723o/w consumer loans 454 2,084 982 1,438 1,030 2,440o/w other corporate 768 1,399 1,147 2,238 1,965 2,635o/w other government 3,671 2,653 3,175 609 4,219 1,142

Total on balance sheet 8,492 15,004 14,923 12,911 19,074 19,37093% 100% 91% 97% 92% 80%

Off Balance Sheeto/w RE 263 -43 516 165 485 1,715o/w overcapacity 260 24 807 108 916 2,501o/w consumer loans 0 0 0 0 0 0o/w other corporate 136 90 197 192 302 698o/w other government 0 0 0 0 0 0

Total off balance sheet 660 72 1,520 466 1,703 4,915

Vintage Model

Total Credit to GDP ahead of Banking Crises

Indonesia 1998 Thailand 1997 Malaysia 1998 Korea 1998 China 2008 Japan 1990 China 2013 Hong Kong 1998

United States 2008

UK 2008

66%

147% 151%160% 160%

230%241%

287%

355%370%

Source: Goldman Sachs Equity Research, MCM Analysis

Roy Ramos, from “Parting Thoughts”, after 17 years covering Asian Banks at Goldman:

“…we have observed empirically…that every time interest expense for the aggregate private sector goes beyond 15% of GDP, a banking crisis has ensued for that particular sector/country…We point to several instances of banking crises ensuing at an even lower(10% to 11%) interest expense to GDP ratio—Indonesia. Japan, Korea.”

Interest expense as % of GDP =

(Total Banking loans/GDP) Ratio x

Average borrowing cost

Roy Ramos—“Rule of 15%”Interest expense as % of GDP

China, with Shadow, 2008

Japan 1990 China, with Shadow, 2013

Indonesia 1998

Korea 1998 China, with Shadow, 2014

Malaysia 1998

China, with Shadow, 2014

Hong Kong 1998

UK 2008 United States 2008

Thailand 1997

6.1%

10.1%

12.2%13.1%

14.1% 14.3%15.0%

16.4% 16.7%

18.5%

21.3%22.1%

Sources: Goldman Sachs Equity Research, MCM Analysis

Assumes +100bps impact from inter-est rate liberalization

Banking System Profitability and Capital

2007 2008 2009 2010 2011 2012 20130.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

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3/1/2008

6/1/2008

9/1/2008

12/1/2008

3/1/2009

6/1/2009

9/1/2009

12/1/2009

3/1/2010

6/1/2010

9/1/2010

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6/1/2012

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3/1/2014

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17.0%

18.0%

China Banking System NPL Ratio

Total Credit to GDP ahead of Banking Crises

Indonesia 1998 Thailand 1997 Malaysia 1998 Korea 1998 China 2008 Japan 1990 China 2013 Hong Kong 1998

United States 2008

UK 2008

66%

147% 151%160% 160%

230%241%

287%

355%370%

Source: Goldman Sachs Equity Research, MCM Analysis

Japan Australia Hong Kong Singapore Korea Phillipines Malaysia China Thailand Indonesia 0%

10%

20%

30%

40%

50%

60% 1990's Global Peak NPL Ratios

Australia Hong Kong Indonesia Singapore Japan USA Spain Korea Phillipines Malaysia Ireland China Thailand0%

5%

10%

15%

20%

25%

30%

35%

2000's Global Peak NPL Ratios

Scenario 1: DoomsdayScenario 1

Loss Assumptions2008

Vintage2009

Vintage2010

Vintage2011

Vintage2012

Vintage2013

Vintage

FrequencyRE 40% 50% 50% 50% 40% 40%Overcapacity 40% 50% 50% 50% 40% 40%Consumer 10% 10% 10% 10% 10% 10%Other Corporate 5% 5% 5% 5% 5% 5%Government 0% 0% 0% 0% 0% 0%

SeverityRE 60% 70% 70% 70% 60% 60%Overcapacity 60% 70% 70% 70% 60% 60%Consumer 60% 70% 70% 70% 60% 60%Other Corporate 60% 70% 70% 70% 60% 60%Government 0% 0% 0% 0% 0% 0%

Loss rateTotal 11% 22% 24% 25% 16% 18%

Other AssumptionsDuration of loss recognition: 2Loss on pre-2008 vintage 7%Dividends cut? YDraw existing reserves? N

Bank Loss Model 2014 2015 2016 2017 2018 2019 2020System NIM 2.6% 2.6% NA NA NA NA NASystem PPP 2,884 2,929 NA NA NA NA NALosses on '08-'13 vintage 8,521 8,521 NA NA NA NA NALosses on pre-'08 vintage 1,166 1,166 NA NA NA NA NANet income -5,238 -5,203 NA NA NA NA NASystem tangible common equity 4,369 -834 NA NA NA NA NATCER 3.1% -0.6% NA NA NA NA NAROTCE -75.0% -294.4% NA NA NA NA NA

Cumulative loss 25%Current P / Burndown -12.8xCapital hole $bn -1,576Dilution to recap to 6.3% TCER -91%

• 25% cum. Loss• 2 years of loss

recognition and PPP• Dividends cut• No draw on existing

reserves• 0% avg asset growth• No NIM declines, no

interest rate liberalization

• Equity wiped out

Scenario 2: Doomsday lite• 20% cum. Loss• 3 years of loss

recognition and PPP• Dividends cut• No draw on existing

reserves• 0% avg asset growth• No NIM declines, no


• Low single digit ROTCE’s

• 2.2x 2016 burndown TBV

Scenario 2


Vintage2009

Vintage2010

Vintage2011

Vintage2012

Vintage2013

Vintage



Loss rateTotal 9% 20% 22% 14% 13% 15%

Other AssumptionsDuration of loss recognition: 3Loss on pre-2008 vintage 6%Dividends cut? YDraw existing reserves? N

Bank Loss Model 2014 2015 2016 2017 2018 2019 2020System NIM 2.4% 2.3% 2.1% NA NA NA NASystem PPP 3,032 3,236 3,450 NA NA NA NALosses on '08-'13 vintage 4,665 4,665 4,665 NA NA NA NALosses on pre-'08 vintage 666 666 666 NA NA NA NANet income -1,771 -1,614 -1,449 NA NA NA NASystem tangible common equity 7,836 6,222 4,774 NA NA NA NATCER 4.9% 3.5% 2.4% NA NA NA NAROTCE -20.3% -23.0% -26.3% NA NA NA NA

Cumulative loss 20%Current P / Burndown 2.2xCapital hole $bn -1,226Dilution to recap to 6.3% TCER -71%

Scenario 3: More realisticScenario 3


Vintage2009

Vintage2010

Vintage2011

Vintage2012

Vintage2013

Vintage



Loss rateTotal 6% 10% 11% 11% 10% 9%

Other AssumptionsDuration of loss recognition: 4Loss on pre-2008 vintage 6%Dividends cut? NDraw existing reserves? N

Bank Loss Model 2014 2015 2016 2017 2018 2019 2020System NIM 2.6% 2.6% 2.6% 2.6% NA NA NASystem PPP 3,086 3,354 3,644 3,959 NA NA NALosses on '08-'13 vintage 2,133 2,133 2,133 2,133 NA NA NALosses on pre-'08 vintage 500 500 500 500 NA NA NANet income 349 555 779 1,021 NA NA NASystem tangible common equity 9,358 9,316 9,497 9,920 NA NA NATCER 5.9% 5.5% 5.2% 5.1% NA NA NAROTCE 3.7% 5.9% 8.3% 10.5% NA NA NA

Cumulative loss 13%Current P / Burndown 1.1xCapital hole $bn -392Dilution to recap to 6.3% TCER -23%


recognition and PPP• Dividends not cut• No draw on existing

reserves• 7% avg asset growth

to support economy• No NIM declines, no


• Mid single digit ROTCE’s


Scenario 4: Base caseScenario 4


Vintage2009

Vintage2010

Vintage2011

Vintage2012

Vintage2013

Vintage



Loss rateTotal 5% 6% 7% 7% 6% 7%

Other AssumptionsDuration of loss recognition: 5Loss on pre-2008 vintage 5%Dividends cut? NDraw existing reserves? N

Bank Loss Model 2014 2015 2016 2017 2018 2019 2020System NIM 2.4% 2.3% 2.2% 2.1% 2.0% NA NASystem PPP 3,032 3,236 3,507 3,800 4,117 NA NALosses on '08-'13 vintage 1,146 1,146 1,146 1,146 1,146 NA NALosses on pre-'08 vintage 333 333 333 333 333 NA NANet income 1,196 1,353 1,562 1,787 2,031 NA NASystem tangible common equity 10,205 10,960 11,924 13,114 14,548 NA NATCER 6.2% 6.0% 6.0% 5.9% 6.0% NA NAROTCE 12.1% 12.8% 13.6% 14.3% 14.7% NA NA

Cumulative loss 9%Current P / Burndown 0.7xCapital hole $bn -119Dilution to recap to 6.3% TCER -7%


recognition and PPP• Dividends not cut• No draw on existing

reserves• 10% avg asset

growth• 80bps gradual NIM

decline on interest rate liberalization

• Low to mid teens ROTCE’s


Takeaways

• In our base case China takes 5 years to clean up the NPL’s – we think the gov’t can manage this with their liquidity resources

• ROTCE’s sustain in 14-15% range• If COE = ~12% in this setup, stocks would be

fairly valued at ~1.3x TBV

Takeaways cont’d

• In the absence of more clarity on– Real estate prices– The impact of fiscal, monetary, SOE reforms– Corruption crack down– FAI decrease– LOSS RECOGNITION AND NPL FORMATION

• …we think trading the banks in a range of 0.85x – 1.3x TBV makes sense

ICBC P/TBV range

Current range = 0.9x –

1.25x TBV

“ China’s future problem is not about questioning its growth potential. It is how to reform its social and economic structure. “

— Andy Xie

Moore Capital Summer 2014 China team presentation

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Transcript of Moore Capital Summer 2014 China team presentation