China's shadow banking sleuth
Vancouver-born Jason Bedford, director of Asian financials research at UBS, was warning about the dangers in the shadows of China's banking system long before the world began to panic over the country's mounting credit
Jason Bedford's pulse ticks a beat faster when he finds out that some obscure Chinese bank has released new financial statements. The Vancouver-born director of Asian financials research at UBS Investment Bank is a committed reader of such documents, perhaps the most committed on earth. He digs through the financials of Chinese banks – a task that occasionally requires private eye skills to even track down the proper papers.
But institutions like Evergrowing Bank and China Bohai Bank Co. Ltd. give him a special thrill – unlisted institutions that offer a window into the deeper issues forming in the country's bank sector, as giant piles of credit amass in the shadows.
"When I get their financials, I print them out, leave the office and get a box of popcorn. They make for an amazing read," he says. "They really are. They are my crystal ball."
Mr. Bedford follows, in total, 167 Chinese banks. And long before the world began panicking over mounting Chinese credit, he was warning about the dangers in the shadows of the country's banking system.
China's bad debt is a secret no more: Hedge fund manager Kyle Bass has suggested that as much as $3.5-trillion (U.S.) in loans could go sour. China International Capital Corp., the country's joint venture investment bank, has estimated the number at $1.5-trillion; even that figure is equivalent to more than a fifth of China's gross domestic product.
It is frightening stuff, particularly in a world that has barely recovered from the last financial crisis.
Although Mr. Bedford's research underpins some of the nightmare visions – Mr. Bass draws on his work – his own conclusion is worth listening to, in part because he has looked deep into China's banks and does not see them collapsing.
Mr. Bedford, 37, spends much of his time researching Chinese financial institutions – going page by page through any information he can find, and it's often not easy to find – from goliaths like Bank of China to little-known rural lenders and firms with irresistible names, such as Great Wall Glorious Bank.
He has a long leash to "take a ridiculous amount of time looking into the financials of unlisted banks," he says. "I don't think anyone has gone into this level of depth."
What that means is that, as China's financial system enters precarious territory, Mr. Bedford offers a perspective few can match.
"Some of the stuff that the Chinese financial institutions are doing is really unique. So the background and technical knowledge he has to actually understand what he's reading – not many people out there have that," said Dinny McMahon, a fellow at the Washington, D.C.-based Wilson Center who is writing a book on mounting risk in the Chinese financial system.
Mr. Bedford has "come up with perhaps the single most comprehensive snapshot of what is actually going on in shadow banking in China."
The way Mr. Bedford sees it, China has entered the opening stages of a "credit cycle" that will, as it unravels, produce private-sector job losses and rising liquidations of state-owned companies.
Chinese banking regulators report a 1.59-per-cent non-performing loan ratio. But Mr. Bedford has spent years looking at the shadow portfolios at Chinese banks, where debt is dressed up as investments, a technique no foreign bank uses. Factor that in, and China's bad loans have likely already crested 5 per cent, and will only grow from there – perhaps doubling from current levels.
The amounts are already staggering.
He found that shadow loans at listed Chinese banks, excluding the big five state-owned lenders, grew by 1.4 trillion yuan ($290-billion) in the first half of last year – outpacing growth in formal loan books (1.2 trillion yuan). Shadow loans were the fastest-growing asset class in the country – and a bank reckoning is coming, says Mr. Bedford, a lanky Canadian with a hockey player's jaw and black-framed glasses.
He explains what he has discovered with the enthusiasm of an explorer finding new continents, a story he tells often these days as investors from around the world bang on his door, desperate to know what's really happening in China. We meet at Liberty Exchange, a Hong Kong pub next to the International Finance Centre, because it's convenient: Mr. Bedford has just finished another meeting with clients nearby.
He orders a pizza to share – half piggy with house-made sausage, half parma ham with shaved parmesan – and drains a Hoegaarden followed by a Peroni.
If it's typical bar fare, what he has to say is anything but.
"We're going through the first credit cycle in the modern Chinese banking sector," Mr. Bedford says. Take China Commercial Credit Inc., for example, which is deeply reliant on the country's suffering textile industry and saw its performing loan ratio – its good debt – crater from 94.3 per cent to 3.3 per cent in 18 months.
At Leshan City Commercial Bank Co. Ltd., the non-performing loan ratio has already reached 31 per cent. At micro-lender United Asia Finance, the mainland China charge-off ratio rose from 7.1 per cent at the end of 2014 to 19.1 per cent for the first six months of 2015.
But China will not, Mr. Bedford insists, fall into a credit crisis and, unless things take a dramatic turn, he sees no reason for the kind of contagion that spread from the U.S. in 2008 and 2009.
He believes the best Chinese banks have gained a degree of savvy few properly appreciate – "who is the more efficient lender, CIBC or ICBC? I might be inclined toward ICBC."
However, it's hard to spend much time with Mr. Bedford without feeling a rising dread. Now the world's second-largest economy, China's every wobble sends the world reeling. And there is worse to come.
"A credit cycle is something I would never associate with a soft landing," Mr. Bedford says. "Credit cycles are painful. Companies get shut down. People get fired. You're seeing a lot of banks taking quite drastic actions against deadbeat borrowers – seizing collateral, shutting down factories. It's happening," he says.
In his early days, Mr. Bedford dreamed of becoming a diplomat. He studied political science, but struck out on jobs at home. So he applied for a position at the Canadian embassy in Beijing – one open only to local hires. He flew to China for an interview, but didn't get the job, leaving him stranded in a foreign country with nothing to do.
"I had no interest in China. I didn't even know they didn't speak English," he says. "The Chinese people in Vancouver speak English."
But he set to figuring things out, a trait that has come to define his work.
He found a local girlfriend, learned Chinese and eventually talked his way into an entry-level position at KPMG. He had, it turned out, come to China at exactly the right time: By 2006, business for foreign companies was growing so fast that even a Big Four accounting firm was relegated to hunting warm bodies – including a person like Mr. Bedford, with smarts but no accounting credentials.
When a partner asked him, a year later, to join the firm's audit division, he was again unqualified for a job that required getting out to meet and, often, socialize with clients. For one thing, he hated the things Chinese businessmen love best: karaoke and cigarettes. He got by on Hey Jude – "it's the easiest" – and a bit of playacting. "What was the famous quote by Bill Clinton? I didn't inhale."
What Mr. Bedford did possess was a willingness to get out of the office – and a refusal to take things at face value.
"He's a bit like a detective – he's good at seeing through and getting to real data. He just won't believe it when people tell him something," said Simon Gleave, partner in charge of financial services at KPMG in Beijing.
Sometimes, that requires a bit of spycraft.
Mr. Bedford once found a bank statement in a PDF that consisted of low-resolution scans of dirtied papers. It took specialized software to make it legible.
"He's quite unique. I don't know any other Western researcher looking into China who does it natively in Chinese," Mr. Gleave said.
Mr. Bedford gained prominence by writing an annual report on the Chinese trust sector, a little-understood facet of the country's financial system. More recently, he has sought to illuminate the world of shadow lending, an element of the Chinese financial system that is allowed by regulators but nonetheless contains some of its most questionable practices.
On bank shadow books, loans are classified as structured investment products, which are subject to lower provisioning requirements – and less transparency. That opens avenues for misuse, providing an avenue for banks to cloak questionable lending.
And because the bad debt erodes the value of the overall shadow holdings, "the only way to keep it profitable is if it's ever-growing. It's almost a little bit like a Ponzi scheme," Mr. Bedford says.
Shadow loans, what Mr. Bedford calls "miscategorized credit," have now grown to 12.1 trillion yuan, equivalent to 16.5 per cent of China's commercial banking sector and 21 per cent of its GDP.
At banks like Evergrowing, shadow loans have swollen to 167 per cent the size of the formal loan book. The shadow loan book at China Industrial Bank is now bigger than the banking sector in the Philippines, a country of 100 million.
"It's a huge issue" – one Mr. Bedford first warned about in 2012. "I've felt like the crazy old cat lady going around saying, 'Watch out for those shadow loans.' And it's only now that people are really paying attention because these assets are growing so fast."
But if he's right that China will avoid a doomsday scenario, there is even more reason to keep listening to him. "A credit crisis wipes you out. A credit cycle, you can profit incredibly well," he says.
But to do that, someone needs to figure out when things have hit bottom.
Mr. Bedford hopes it's him.
"If I have one ambition, it's that I'm going to be the person who calls the China credit cycle," he says.