China Banks Said to See Risks in 23% of $1.1 Trillion Infrastructure Loans

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.

The estimate implies $261 billion of debt may go sour, almost five times the $53.5 billion the nation’s five largest banks are raising to replenish capital. China’s banks advanced a record $1.4 trillion of credit last year to support the economy, raising concern that bad loans will surge and force the government to add to the more than $650 billion spent to clean up the banking industry since 1999.

“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.”

Highways, Airports

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. Government bailouts helped bring the industry’s bad loan ratio to a low of 1.3 percent by June 30.

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 number of non-performing loans to such vehicles likely won’t be “too high” at the end of this year as most such credits, many issued last year, are long-term debts, said Sanford C Bernstein & Co. analyst Michael Werner. “We may not see trouble with these loans begin to pop up until two or three years down the road.”

27 Percent

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.

“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.”

An official at the banking regulator’s press office in Beijing declined to immediately comment when contacted today.

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.

Fitch Weighs In

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.

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.

“They have to walk a fine line between making sure that these banks provision adequately and making sure these banks can still generate capital to grow their capital adequacy ratio,” Werner said.

China Citic Bank Corp. would be the “most negatively impacted” by provisions against such loans, Werner wrote in a report today. China Merchants Bank Co. would be the least affected, he wrote.

China Citic Bank

Citic Bank dropped 1 percent to 5.88 yuan in Shanghai trading as of 11:29 a.m. local time. China Merchants fell 1.2 percent, extending this year’s loss to 17.6 percent. The Industrial & Commercial Bank of China Ltd., the nation’s biggest, slid 1 percent.

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

Press spacebar to pause and continue. Press esc to stop.

Bloomberg reserves the right to remove comments but is under no obligation to do so, or to explain individual moderation decisions.

Please enable JavaScript to view the comments powered by Disqus.