The Chinese Credit Situation

When you hear "Credit" and "Situation" with a negative connotation, it's hard not to think about Bear Stearns and that period of dismal lies in 2008 in which banks said they had no more exposure to sub-prime only to declare a month later another multi-billion dollar write off.

You may recall about 3-4 weeks ago China pushing massive liquidity in to their system as the threat of the first Trust default was looming large, then a week or so later at one of their regularly scheduled PBoC monetary operations (Tuesdays and Thursdays) they suddenly withdrew an unprecedented amount of liquidity from the market and had warnings over the copper and coal mining industries regarding potential defaults.

For years Bond/Credit investors in China have had a sort of Bernanke put covering their positions that caused them to ignore risk and that was any problem companies had with debt payments were taken care of by municipal governments in China or the banks themselves so the threat of default seemed very low causing investors to take excessive risks, this is somewhat akin to the US sub-prime market in some ways, at least the massive risk taking without appreciating the potential downside, well all of that suddenly changed as China just had its first ever mainland default in Chaori Solar that missed a Bond interest payment overnight.

However this is not new, the credit markets in China have been roiled for the last three months since the issue popped up on the radar.

Upon the Chaori default, upwards of a dozen deals that were set to go to market have been cancelled today and many others over the last several weeks for lack of funding. I'm guessing at this, but Chinese credit creation is now the main driver of growth moving forward and it has now been utterly stifled, I'm guessing that they would not allow this to happen over a simple interest payment unless they were worried about something bigger, namely the hot money flows in China that are driving inflation, it may be possible they are trying to reset the credit markets and make investors reprice risk which they are doing as external money is flooding out of the country as I write this. This of course is just a guess, but this is a BIG DEAL along the lines of Bear Stearns.

This new dynamic of the Chinese not bailing out companies at all costs seems to not be coincidental, especially because Chaori's debt payment wasn't that large that it couldn't have easily been taken care of.

Obviously as a result (and one that has been ongoing for several months, the credit markets in China are falling and stocks are following, remember the maxim, "Credit leads, stocks follow".

The problem is apparently not in the banking sectors available liquidity as evidenced by Shibor at multi month lows/ very low repo rates, the money is available in the banks, they aren't lending which is a huge risk to Chinese growth as it depends on an expanding credit model. 

It's clear by the numerous deals that have been cancelled just in the wake of the Chaoori default that companies CAN'T ACCESS CAPITAL. In addition commodities that have been long used as collateral are falling in price. Iron ore prices are collapsing. Copper which has also been used as collateral for cash is seeing a huge unwind and copper prices have seen the largest drop since late 2011 as borrowers are forced to sell copper to meet cash calls, exacerbating the credit crisis even more as investors are fleeing the credit sector.

We don't know how much worse this may be yet, but to say it may be China's Bear Stearns moment is not hyperbole.