Why China insurers should be vigilant over infra debt

The willingness of China’s state-owned insurance companies to funnel assets into infrastructure debt to support government projects is understandable, and offers them some benefits.

But the sheer scale of investing also offers some risks, particularly as quality assets becoming harder to find. As a result, it’s increasingly imperative that the companies continue to focus on raising their due diligence levels, say industry experts.

Over the past several years the country’s largest insurers have invested huge amounts of their capital into non-standard infrastructure debt instruments, to support central government efforts to stimulate the slowing economy.

Following the release of interim results of major Chinese insurance companies, AsianInvestor understood that the likes of China Life and China Pacific Insurance (CPIC) have allocated between 13% to over 25% of their assets into these non-standard debts. The bulk of these debts are sourced from the infrastructure sector. 

Non-standard debts are defined by the insurers as “debt-type financial products”, and typically comprise of a wide range of vehicles such as debt investment plans, trust schemes, asset-backed securities and asset management products. These loans are often linked to infrastructure, real estate, and energy projects, to name a few.

“The idea is, they [the life insurers] are going to follow along with the government related to all the new [infrastructure-related] borrowing that's happening right now to stimulate the economy,” said Sam Radwan, chief executive of Enhance International, a US-based investment consultant.  

This tide of investment is part of a broader set of plans to encourage more infrastructure. China has reportedly planned to ease capital requirement for infrastructure projects in the second half of this year, and the country's year-to-July total fixed-asset investment in transport infrastructure hit Rmb$1.21 trillion ($168.85 billion).

As a result, China’s leading insurers now have sizeable exposures to non-standard debt instruments has become. China Life, for example, had over Rmb$344 billion invested in these assets as of the end of June this year, while CPIC’s exposure totalled about Rmb$476 billion during the same period.

In China Life’s case, the transportation sector alone took up 19.9% of its non-standard debts allocation, based on the presentation at the insurer’s interim result announcement. In addition, another 43.3% of the exposure was sourced from infrastructural projects and communications and transport for CPIC.

A Hong Kong-based head of multi-asset products for a UK-headquartered asset manager said that he has seen Chinese insurers investing between 10% and 40% of their assets in non-standard loans. He believes it’s a sensible strategy, noting that infrastructure debt “is much more diversifying than equities from an asset allocation perspective”.

The long duration of these assets also helps insurers with liability duration management. Zhao Lijun, a vice president of China Life, said the duration of non-standard debts is above seven years at the insurer’s 2018 annual results. That average maturity helps the insurer lengthen its overall asset duration.

STRINGENT DUE DILLIGENCE

While non-standard debts do offer insurers some real benefits, by buying them in such bulk they are effectively going all-in on government-driven policies to prop up the economy. And that’s where political versus fiduciary concerns collide.

The risk of this approach is that the central government may have non-economic priorities for cheerleading some of these infrastructure projects. If these projects falter, so may their payments to credit-holders, such as the insurers. 

Some Chinese business leaders are also more concerned over their local infrastructure. Nearly a quarter of respondents to a research paper in August by consultancy firm Grant Thornton cited transport infrastructure as a constraint on growth.

As a result, the life insurance investment teams need to ensure they conduct stringent due diligence, particularly as quality assets have become harder to come by.

It is telling that Ping An, which is China’s second-largest insurer and widely seen as the most sophisticated investor, slightly dropped its allocation to non-standard debt from 15.8% to 15.1% as of the end of June this year, amid an alternative assets shortage.

“There will definitely be more of a flight to quality [for no-standard loans] in the coming months especially under this type of condition,” the Chicago-based insurance specialist told AsianInvestor.

In fairness, the biggest insurers have focused on highest-rated tranches of debt in their portfolios. Triple-A debt accounted for over 90% of the non-standard loans allocations of China Life, People's Insurance Company of China (PICC) and CPIC at the end of June, based on their interim results.

Source: China Life, Ping An, PICC and CPIC

To make sure these assets are secure, PICC has, for example, put into place credit enhancement measures, including guarantees, repurchase, and short fall compensation. Meanwhile Ping An has established a framework to monitor these loans through asset allocation, selection and post-investment management.

Adding to the challenge of the dwindling supply of these assets is their illiquidity.

“Imagine if, for some reason, the investments fall in value. If it's equity or bonds, these can be liquidated pretty quickly without incurring significant transaction costs, but these assets cannot,” the asset management executive said.

Ultimately, it all comes down to the viability of the underlying assets.

The executive noted that many infrastructure projects are backed by government entities, and so they should not carry major credit risks. But it varies from project to project and the legal structure.

“That’s why due diligence is so important to understand what you are buying into,” he cautioned.

*Based on the aggregated allocation to long-term debt investment scheme (11.3%) and other fixed-income investments (10.4%)

Company definition: Other fixed-income investments primarily consist of Tier 2 capital instruments, wealth management products, capital guarantee deposits, policy loans, trust products and asset management products.

**Based on the aggregated allocation to debt investment schemes (11.1%), wealth management products (9.9%) and other fixed income investments (4.4%)

Company definition: Private financing instruments include wealth management products issued by commercial banks, debt investment schemes, collective trust plans by trust firms, special asset management plans by securities firms and loans backed securities by banking institutions, etc., the same as “non-standard assets”.

***Based on the presentation of China Life’s 2019 interim result announcement.

Investors interested in the strategies of China’s asset owners can learn more at AsianInvestor's sixth Institutional Investment Forum China on September 18 in Beijing. Please click here for more details.