Thread by @BaldingsWorld

At the risk of touting my own research, let me explain how China does some of the crazy stuff it does in banking and capital markets to the uninitiated some of which comes from a paper I wrote 7 years ago now about some of the games they play 1/n papers.ssrn.com/sol3/papers.cf…

At least historically, when Chinese banks went public in Hong Kong they were stunningly honest in the IPO prospectuses probably because HK was still a pretty honest market, the lawyers were good, costs to non-compliance were not insignificant and they figured no one read them 2/n

Consequently, if you get hopped up enough on meth of get through 1,000+ pages you learn amazing stuff. The two things that I want to highlight here are what are Chinese lending standards and how do they bailout/disguise bad debt? Even most savy investors think these concepts 3/n

Translate relatively easily. Newsflash: They do not. Just as an example, one bank classifies a loan as "doubtful" if "“the borrower’s operations have been suspended." If operations have been suspended it's a pretty good bet the bank won't be getting its money back. 4/n

One bank even had an paragraph on loan classification when they have no documentation about the loan. In short, Chinese banks go to GREAT lengths to avoid recognition of bad assets. This matters because Chinese banks, especially outside the big 4 1/2 are enormously capital 5/n

Fragile or hungry. In other words, they do not have nearly the capital they should have and even their official capital levels overstate the reality of health of those banks. Over the past couple years Chinese banks have been and still need to raise VAST sums to shore up 6/n

Their balance sheet. Especially the smaller banks that might be exposed to Evergrande simply cannot absorb those losses. Look for any losses from Evergrande to be shuffled, disguised, recategorized etc etc. This leads to the second point of how they disguise these bad debts 7/n

When one these banks went public a number of years ago, a major chunk of the proceeds from the IPO were being turned over to the local province to payoff them assuming a major bad debt from a decade earlier. The agreement back in 2004 if I recall correctly read that the 8/n

Local government would buy the bad assets at par (bank carry value so the bank didn't incur a loss) then sell them back to the bank or get paid back from IPO proceeds at some point in the future with a baseline and ceiling value. Roughly a decade later the bank went public 9/n

In that specific case, China basically grew/inflated away the bad debt. There are a couple of reasons that repayment model is unlikely to work going forward. Growth is trending down even believing official figures and will not spike again in the forseeable future 10/n

Financing from investors like NY and even HK is becoming increasingly hard. Inflation is well let's not go down that road. Furthermore, many of these bad debts have never been written down or paid off. The bad banks set up to deal with the mid 2000s bad debt are clogged with 11/n

Worthless assets and they need to refinance one of the reasons the bad banks are setting up a bad bank^2. I should not that the hiding or disguising of bad debts in China is truly Russian nesting doll epic. Some of the unrepeatable stories are amazing. What is notable is 12/n

Bank managers know the "game" and help competitors bury bad deals knowing they will be asking for favors in the future. This raises a question nobody knows is how widely dispersed these bad debts are throughout the entire system. Bank managers know how to game the system 13/n

So that bad assets are recorded as good assets. To bring this back to the here and now, with regards to Evergrande do not expect a press release about a bailout but rather how the debt and projects will be dispersed and hidden but not addressed. So when we think about 14/n

A bailout, we need to apply two tests about whether any imposed losses are material and how wide spread any losses would be. As I have already covered, any standard for something not being a bailout is imposing material losses. The other standard would be how wide spread 15/n

Any losses would be. For instance, let's assume out of the $300b in liabilities (round number) a major loss was imposed on one creditor or class but was concentrated upon a small total dollar amount and the rest were protected, that would likely still qualify as a bailout. 16/n

To sum up, look at the details and how everything is disguised and who ends up being involved and taking parts of everything. That is where the cool stuff happens.