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China's US$3.8t wealth products reel as bond binge unwinds

[SHANGHAI] China's bond market is facing more turbulence as banks scramble to avoid losses on wealth management products that raised US$3.8 trillion from the nation's savers.

The investment plans typically use leverage to boost returns on the 56 per cent of their holdings parked in fixed-income securities. That model is under threat after Chinese corporate notes plunged the most in nine years in the fourth quarter. Banks may have to use their own money to repay holders of maturing WMPs because it will be hard to sell bond holdings during an extended rout or to raise cash by issuing new products, Citigroup Inc wrote in a Dec 21 note.

The risk of a vicious cycle of bond losses, cash shortages, payment failures and further debt-market declines has prompted China's policy makers to step in. President Xi Jinping pledged last month to make controlling financial risk a top priority for 2017 and the central bank said it will count WMPs when assessing bank risks."The government's recent comments on preventing financial risks sent a signal that liquidity is set to be tightened and there's no chance of a bull market," said Oliver Rui, professor of finance at the China Europe International Business School in Shanghai. "So a natural reaction is to dump bond holdings as soon as you can, especially for those with high leverage." What makes such products particularly risky are their short time frames. Chinese company bonds have an average maturity of 7.7 years, while the most-recent government data show a typical WMP matures in 127 days. China International Capital Corp estimates such plans hold more than 50 percent of all outstanding Chinese corporate bonds. The ability of lenders to step in with bailouts depends on their capital buffers."Small banks will be tested in the next six months by liquidity problems," said He Xuanlai, a Singapore-based analyst at Commerzbank AG. "In next six months there might be industrial consolidation." Rural and city commercial banks, with less access to deposits to fund their businesses, are the most aggressive WMP issuers, according to PY Standard, a Chengdu-based research firm. They also have the weakest finances and are the most exposed to surging money market rates.

Signs of financial stress, including a payment failure involving alleged fraud, caused the three-month Shibor borrowing rate to surge 55 basis points in the past six weeks to 3.55 percent. That fed through to the bond market with the Bank of America Merrill Lynch benchmark for corporate notes losing 3.1 per cent in the fourth quarter, while government debt dropped 2 per cent, amid signs of global reflation.

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The central bank said last month it plans to include off-balance sheet WMPs in measuring banks' credit growth this quarter under its so-called Macro Prudential Assessment, because such products are often similar to loans and offer guaranteed payments."The risks of deleveraging in the financial system will eventually spread to WMPs," said Larry Hu, a Hong Kong-based head of China economics at Macquarie Securities Ltd. "The government would rather deal with it while it still can instead of waiting for it to get out of control." Fitch Ratings estimates an additional 1.7 trillion yuan (S$352.7 billion) of capital would need to be set aside if banks had to account for WMPs in their balance sheets. Natixis SA estimates that banks' assets to equity ratio would increase to 16 times if WMPs were included as of June 30, up from 14 times without.