(Bloomberg) -- Chinese banks are packaging more of their non-performing loans as asset-backed securities, the latest wrinkle in the nation’s property debt crisis at the heart of its economic downturn. 

The ABS bond sales jumped 88% on year to 33.8 billion yuan ($4.6 billion) in the first 10 months, mostly by state-owned banks and their subsidiaries, according to data from cn-abs.com, which tracks the market. It’s the highest comparable-period total in the data going back to 2016. 

The surge tracks with rapid growth of bad loans in general this year in the country that’s mired a deflationary cycle and weak consumer demand. It’s also likely attributable to Chinese regulators’ policy shift in late 2022 to push more banks to remove non-performing loans from their books.  

Banks’ marketing of their ABS products — composed largely of bad mortgage loans — may not let up while the property sector continues to crater. Their increased dabbling in the products perceived to be risky also will likely raise eyebrows among country watchers.  

“Banks are under pressure to dispose non-performing assets. Asset securitization is one of the effective means,” said Liao Zhiming, an analyst at China Merchants Securities Co. “Banks still have a need to issue” more given mounting bad loans, he added.

Big Four

Chinese banks have recently cut back on lending as the economy and exports remain sluggish. But that’s done little to stem the piling up of bad loans in need of disposal. Chinese banks’ non-performing loans rose by 183.2 billion yuan so far this year to 4 trillion yuan as of the end of the third quarter, according to the National Administration of Financial Regulation.

The country’s “Big Four” banks that are largely state-owned — China Construction Bank Corp., Industrial and Commercial Bank of China Ltd., Bank of China Ltd., and Agricultural Bank of China Ltd. — were the top leaders in ABS issuance, by amount, in the first ten months, according to cn-abs.com. 

The property market also may be fanning banks’ rush to issue new ABS products. Mortgage defaults are still relatively low in China compared to other countries. But about half of total ABS issues in the first ten months were made of sour housing mortgage loans, cn-abs.com’s data show.

We “notice that China real estate market downturn brings an extra concern on the residential NPL ABS,” said Sun Jiaping, senior analyst of structured finance at Fitch (China) Bohua Credit Ratings Ltd.

Investors’ Attention

Perhaps reflecting the heavy involvement of state-owned entities, the rates offered by the ABS notes are relatively low in comparison to similar products elsewhere. Senior tranches of AAAsf-rated ABS products sold this year generally had a coupon range between 2.5% and 3%, according to Luo Weicheng, ratings director at China Lianhe Credit Rating Co. 

But senior tranches of AAAsf-rated ABS products backed by non-performing corporate assets can carry a coupon that’s more than 100 basis points higher than China’s AAA-rated medium-term notes, he said.

The yields have “attracted many investors’ attention,” he said, adding buyers typically include other banks, trusts and their subsidiaries. 

The governments’ role in shaping the ABS buyer-market may also explain why demand is sustained. A bulk of the buyers are state-owned entities that may have been encouraged by the Chinese authorities to help banks get NPLs off their balance sheets, said Benjamin Fanger, Guangzhou-based ShoreVest Capital Partners’ managing partner. 

“It did seem to be more of state-owned entities that were buying into these securities,” he said. 

China’s coordinated efforts in the ABS market underscore the country’s heightened attempts to deal with non-performing loans in recent years. 

Starting early 2021, the China Banking and Insurance Regulatory Commission began a program to facilitate transferring of financial institutions’ NPLs for asset management companies to deal with. In late 2022, the program was expanded to include some other banks and consumer finance companies.      

“Regulatory policies have encouraged social capital to participate in the disposal of non-performing assets and encouraged innovation in various ways,” Luo said.

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