China Banks Said to See Risks in 23% of $1.1 Trillion Local Project Loans
July 23 (Bloomberg) -- Liao Qiang, a Beijing-based analyst at Standard & Poor’s, talks with Bloomberg's Linzie Janis about the health of the Chinese banking industry. Chinese banks face rising credit risks and their non-performing loan ratios are likely to climb as the nation’s economy slows and lending for government projects comes due for repayment, according to S&P. (Source: Bloomberg)
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Chinese banks may struggle to recoup about 23 percent of the 7.7 trillion yuan ($1.1 trillion) they’ve lent to finance local government infrastructure projects, according to a person with knowledge of data collected by the nation’s regulator.
About half of all loans need to be serviced by secondary sources including guarantors because the ventures can’t generate sufficient revenue, the person said, declining to be identified because the information is confidential. The China Banking Regulatory Commission has told banks to write off non-performing project loans by the end of this year, the person said.
Commission Chairman Liu Mingkang said last week borrowing by the so-called local government financing vehicles may threaten the banking industry. The nation’s five-largest banks, including Agricultural Bank of China Ltd., are raising as much as $53.5 billion to replenish capital after the sector extended a record $1.4 trillion in credit last year.
“Unfortunately this smells just like déjà vu of China’s last banking crisis a decade ago,” said Shen Minggao, Hong Kong-based head of China research at Citigroup Inc. “Non- performing loans will increase as a result of last year’s lending spree, which to a certain extent was a delayed form of fiscal spending, and eventually the central government will step in and share the costs.”
Decades of state-directed lending to unprofitable government companies and projects saddled China’s banking system with a non-performing loan ratio of more than 50 percent, according to a 2002 estimate by Standard & Poor’s. The government has spent more than $650 billion to clean up the banking industry since 1999, reducing its bad loan ratio to a low of 1.3 percent by June 30.
Highways, Airports
Local governments set up the financing vehicles to fund projects such as highways and airports due to limits on their ability to directly borrow money. The central government this year restricted borrowing on concern money isn’t being used for viable projects.
“The issue is symptomatic of the way the stimulus package was rolled out in 2008,” said Nicholas Consonery, Asia specialist at the Eurasia Group. “It is difficult for local governments to finance these projects. It is written under the Chinese constitution that local governments cannot offer their own debt.”
Only 27 percent of the loans to the financing vehicles can be repaid in full by cash generated by the projects they funded, the person said.
Central bank governor Zhou Xiaochuan said in March that the failure by such financing vehicles to repay debt may lead to “fiscal risks” as local governments will become liable.
Guarantees Banned
“Some of the infrastructure projects may not be commercially viable per se, but we should recognize that the benefit they bring to the local economy will enable governments to repay the debt,” said Xing Ziqiang, a Beijing-based economist at China International Capital Corp. “That will reduce the likelihood of loans turning bad.”
Calls to the banking regulator’s press office in Beijing after business hours weren’t answered.
China last month ordered local governments to ensure repayment and to concentrate on completing projects already under way. Financing units that fund only public projects and rely on the fiscal income of local governments to repay debt should stop spending, the State Council said June 13. Local governments have also been barred from guaranteeing loans taken by their financing vehicles.
To minimize losses, the banking regulator has ordered lenders to create teams to discuss loan repayments with local governments and protect the rights of creditors, the person said.
Fitch Weighs In
The government may have to handle the issue in a “careful and gradual” manner as China’s economy slows, Citigroup’s Shen said. Growth eased to 10.3 percent in the three months to June from a year earlier, from a pace of 11.9 percent in the first quarter.
The government has been grappling with how to rein in the credit-fuelled stimulus before it leads to overheating, according to a July 14 report by Fitch Ratings analyst Charlene Chu. Lending hasn’t slowed as much as official data suggests because Chinese banks are shifting loans off balance sheets by repackaging them into investment products that are sold to investors, the report showed.
“The growing popularity of this activity is increasingly distorting credit growth figures at an institutional and system level,” Chu wrote. “Consequently, Chinese banks’ loan loss reserves and capital are more exposed to credit losses than current data suggests.”
Chairman Liu said in April that inspectors would visit banks in the third quarter to check on loan reports that had to be submitted by the end of June. Those reports showed the banks had 7.7 trillion yuan of outstanding loans to the local financing vehicles at the end of last month, the person said.
--Andreea Papuc. With assistance from Laura Keeley in New York. Editors: Malcolm Scott, Joost Akkermans
To contact Bloomberg News staff of this story: Andreea Papuc at +852-2977-6641 or apapuc1@bloomberg.net
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