The successor to Anthony Bolton on the £875 million Fidelity China Special Situations trust, Citywire AA-rated Dale Nicholls, has lent his voice to those worried about China’s banks – but stopped short of predicting a systemic meltdown.
Since 2009, shadow banking has surged in China: according to Morgan Stanley, quasi-loans have ballooned at a compound annual growth rate of 43.3% and non-bank loans at 25.2%.
‘It is the overall growth in credit that we need to watch, and I do believe this is going to lead to fairly significant non-performing loan problems,’ Nicholls (pictured) acknowledged. ‘They are probably understated and they are probably going to increase more than people expect.’
Nicholls added that although a lot of these loans did not officially lie on banks’ balance sheets, it would be the banks that ultimately had to assume the credit risk. ‘We need to factor in what’s off balance sheet,’ he said.
He therefore owns no Chinese banks. ‘The premise there is that although on the surface valuations look relatively cheap, we still have a period going forward when we’re going to see non-performing loans rise more significantly than many people are expecting.’
China Special Situations is 15.9% underweight the index in financials, with the bulk of its weighting to the sector through insurers.
However, Nicholls expressed confidence that the bad debt would not prompt a ‘Lehman-style banking crisis’. He noted that China’s 75% cap on loan-to-deposit ratios would provide a substantial buffer.
‘In terms of what defines a crisis, liquidity is key,’ he argued. In previous financial crises, loan defaults forced banks to stop lending into the economy, exacerbating the problems.
Nicholls doubted that that would happen in China, where loan-to-deposit ratios – even allowing for shadow finance – are still around 80%. In Europe and the UK they are above 120%, and in Britain peaked around 160% before the crunch.
And in China further liquidity could also be provided by the government, he remarked.
Another source of anxiety for China bears is the country’s property market. ‘It is definitely an issue, but when I look at it relative to other property cycles, it doesn’t look that different to me in terms of how it gets dealt with,’ Nicholls reckoned. If anything, he felt China would be more resilient given the lower levels of consumer leverage than in the US before its property market crashed.
‘Although prices have moved up in a number of cities, so have incomes,’ explained Nicholls. ‘Affordability has been pretty stable or actually improved.’
He also dismissed claims that China was riddled with ghost cities. ‘You get extreme views, and the truth is probably somewhere in the middle.’ Nicholls recalled a recent visit to Zhengzhou, often cited as emblematic of the problem: ‘It’s not Causeway Bay in Hong Kong, but there is definitely activity.’
Nicholls took sole responsibility for China Special Situations on 1 April, but had been working closely with Bolton on the trust since 1 January. The manager has a longer track record on the open-ended Fidelity Pacific fund, for which he is Citywire rated.
Over the past three years the £890 million Fidelity Pacific fund has returned 20%, compared with 7.4% from its MSCI AC Paciﬁc index. That is also top decile within its peer group, where the average fund has lost 1.7% through the period.