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Chinese Banks’ Bad Debt May Hit 60% of Equity Capital, Credit Suisse Says

Loan losses at Chinese banks may climb to levels equivalent to 60 percent of their equity capital as real-estate companies and local governments fail to repay debts, according to Credit Suisse Group AG.

Nonperforming loans will probably increase to 8 percent to 12 percent of total debt in the “next few years,” causing losses amounting to 40 percent to 60 percent of Chinese banks’ equity, Hong Kong-based analysts led by Sanjay Jain at Credit Suisse wrote in a research report dated Oct. 12. Jain cut 2012 and 2013 profit estimates by as much as 25 percent and maintained an “underweight” rating on the industry.

Chinese bank stocks have tumbled this year, sending the MSCI China Financials Index down as much as 43 percent, amid growing concern that slower economic growth will spur bad debts after a three-year credit boom. The retreat sent price-to- earnings ratios on bank stocks to record lows and prompted the government to begin buying shares in the four biggest lenders this week. The MSCI gauge gained 9 percent in the past two days.

“Any sustained outperformance will be likely only after banks effectively tackle issues related to asset quality,” Jain wrote. Lending to real estate companies, manufacturers, local governments and small and medium enterprises may cause more than four fifths of the total bad debt, the analyst said.

Jain had previously estimated that Chinese banks’ bad debt ratio would be 4.5 percent to 5 percent. The projection compares with a “base case” forecast of 5 percent to 8 percent by Moody’s Investors Service in July. Nonperforming loans were 1 percent of total debt as of June, according to the People’s Bank of China.

Buying Spree

Central Huijin Investment Ltd., an arm of China’s sovereign wealth fund, said Oct. 10. it began buying shares of the four biggest Chinese banks and that it will continue with “related market operations,” without providing details on how much it will buy. Huijin’s purchases haven’t changed the bearish outlook for the industry, said Jim Chanos, founder of New York-based hedge fund Kynikos Associates, who has been short-selling Chinese banks, property developers and construction companies.

“The fact that people are even talking about the government stepping in to shore up the banks, when two months ago people thought there was nothing wrong with the Chinese banks, should tell you just how seriously this situation is deteriorating,” Chanos, who bet on a decline in Enron Corp. shares before the company filed for bankruptcy in 2001, said in an interview with Bloomberg Television Oct. 11.

ICBC, China Construction

Credit Suisse has given “outperform” recommendations on Industrial & Commercial Bank of China (601398) Ltd. and China Construction Bank Corp. (939), the world’s two biggest lenders by market value. Agricultural Bank of China Ltd. (601288), the nation’s third-biggest lender, China Minsheng Banking Corp. and Chongqing Rural Commercial Bank (3618) Co. were rated “underperform.”

Shares of ICBC gained 1.2 percent in Hong Kong trading yesterday. The increases in the past five days have helped trim its loss this year to 25 percent. China Construction rose 2.5 percent yesterday, after it reached the lowest level in 29 months on Oct. 4.

Stocks in the MSCI China Financials Index traded at 6.8 times earnings yesterday, according to Bloomberg data, after the multiple plunged to a record low of 5.6 on Oct. 4.

China’s banking watchdog ordered “systemically important” lenders to have bad-loan provisions that are no less than 2.5 percent of total outstanding credit by the end of 2013, or 150 percent of non-performing debt, according to a statement on the agency’s website Oct. 8. The nation’s lenders increased their provision coverage ratio for bad loans to 249 percent in the second quarter from 124 percent for the three months ended March 2009, China Banking Regulatory Commission data showed.

Bad Debts

Agricultural Bank said bad debts accounted for 1.67 percent of total loans at the end of June in its semi-annual report, the highest non-performing loan ratio among the biggest lenders, compared with ICBC’s 0.95, Bank of China’s 1 percent and Construction Bank’s 1.03.

The banking regulator told lenders in July to tighten lending for real estate to guard against the risk of bad loans should government efforts to cool the market cause property prices to fall, a person with knowledge of the matter said.

China’s property market is in the “first parts of a very serious pullback,” Chanos said. “The property market is what investors ought to be watching, because that drives everything in China.”

Home transactions in the world’s second-largest economy fell during last week’s public holidays after residential prices posted their first monthly decline in a year, according to Soufun Holdings Ltd. (SFUN), China’s biggest real estate website owner.

To contact the reporters on this story: Belinda Cao in New York at lcao4@bloomberg.net; Michael Patterson in London at mpatterson10@bloomberg.net

To contact the editor responsible for this story: David Papadopoulos at papadopoulos@bloomberg.net

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