China Again Tightening Lending Requirements

In a bid to further tighten lending, China’s central bank increased the reserve requirement for the nation’s banks to 16%. The 50bps bump represents the first increase in the country’s reserve ratio since mid 2008 and suggests that officials may be setting the path for further adjustments. As highlighted by the Wall Street Journal (“China Cuts Amount Banks Can Lend, in Sign of Inflation Worries”), bankers expect Chinese authorities to target roughly an 18% increase in bank loans this year, slowing from the 30%-plus surge in 2009, with total new lending of around 7.5 trillion yuan compared to more than 9 trillion yuan last year.

I also noticed an off the run article yesterday (“China Cracks Down on Banks' Loan-Sale Practice”) that highlighted how China’s banking regulator is cracking down on banks selling loans to off-balance trust companies. Similar to the SIVs and securitization markets that artificially bolstered the US banks capital ratios, Chinese banks have recently begun employing these off-balance vehicles to mask their aggressive lending activities. One article I read suggested that approximately 734 yuan ($108 million) of bank loans were packaged into trust products in 2009, with 80% of it issued in the second half of the year. With the recent crackdown, only seven new trust products backed by banks loans have gone on sale this month, compared with 465 for the whole of December (see chart below). One can only imagine the quality of the loans that sit in these off-balance vehicles.

Tighter lending standards in China, coupled with several negative earnings surprises (i.e. Alcoa, Chevron, Electronic Arts), are weighing on the markets today. As I have suggested in prior posts, both the equity and credits markets (particularly the latter) have rallied too hard too fast. While sustained zero percent interest rates could provide further impetus to the rally, an argument supported by valuations and improving fundamentals is getting increasingly difficult to make.

October 2008 through July 2009 was a time of “sowing” new ideas and new investments. As we enter 2010, it is prudent to start “harvesting” those ideas. While one is guaranteed to miss the crest of the market (just as no one can catch the absolute bottom when building said positions), it is a very precarious investment thesis that relies on trying to get out before the music stops. This is particularly the case in the credit markets where liquidity can literally dry up over night. As the new issue backlog begins to massively build in the US and Europe, I think one would be absolutely crazy to enter the next few months fully invested (which I believe most credit funds are).