China Lending-Binge Hangover Looms as Wen Spurs Construction

Workers Labor on a Social Housing Project
Construction workers labor on a social housing project in Chongqing on May, 23, 2011. Photographer: Nelson Ching/Bloomberg

China’s plan to rein in property prices with a record homebuilding program may worsen local debt risks even as it proves a boon to companies from domestic cement makers to Chilean copper exporters.

Premier Wen Jiabao aims to build 36 million low-cost homes by 2015, an initiative that will see 2 trillion yuan ($307 billion) added to local government borrowing by 2012, bringing it to a total 12 trillion yuan, Standard Chartered Plc estimates. The surge of loans to local authorities may spark a wave of bank bailouts that hobble economic growth.

“We’re going to see more financial shenanigans, we’re going to see more money pushed off balance sheets” as banks seek to mask the extent of their lending to local governments, said Singapore-based Fraser Howie, who co-wrote “Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise,” and has been an investment banker in Asia for almost two decades.

“We’re going to see some major recapitalization coming at some point” in the banking system, he predicted.

Local governments have created more than 8,000 investment companies that allow them to get around regulations prohibiting direct borrowing. Fitch Ratings cites lending to the vehicles and to property developers in a worst-case scenario predicting bad loans could reach 30 percent of the total at China’s banks.

Risks connected with the financing companies need “attention,” the central bank said in a report yesterday.

Catastrophic or Harmful?

Moody’s Investors Service also built a 10 percent bad-loan ratio into its stress tests on China’s banks, which the company says probably will provide most of the social-housing funding.

“Already banks are dealing with two years worth of questionable lending and now you are going to load this on top?” asked Patrick Chovanec, an associate professor at Tsinghua University’s School of Economics and Management. Bad debt is “just inevitable. The question is the dimension. Is it catastrophic or is it just harmful?”

The central government has offered no public sign it is prepared to absorb a share of any non-performing loans made to local authorities. Reuters reported this week that regulators aim to shift as much as 3 trillion yuan of debt off of local governments, citing people with knowledge of the plans.

One unidentified person said the program will be carried out by the end of September, while another said it may take longer.

Government Investigation

Xu Lin, head of the department of fiscal and financial affairs at the National Development and Reform Commission, which approves bond sales by the local financing vehicles, said he was unaware of such a proposal.

News website reported yesterday that China will investigate local-government debt over the June-to-September period, citing Wu Xiaoling, vice chairman of the finance and economy committee of the National People’s Congress. The government can’t complete a massive restructuring program within three months, said Wu, also a former deputy governor of the central bank.

Bank stocks have yet to show evidence of investor revolt. China’s CSI 300/Financials Index has fallen 5.6 percent over the past three months, less than the 7.8 percent decline in the benchmark Shanghai Composite Index. Shanghai’s benchmark slid 2 percent today as of 1:37 p.m. local time.

Stocks Outperforming

Equity analysts remain bullish: Among the 24 that have rated China Construction Bank Corp.’s Hong Kong-listed shares since April, not one recommends selling the stock, while 20 rank it buy, long-term buy, outperform, accumulate or overweight, according to data compiled by Bloomberg. None of the 27 analysts who have rated Industrial & Commercial Bank of China Ltd. since April advise selling.

The optimism reflects the perception that bad debts in the banking sector are unlikely to materialize for a few years, according to Charlene Chu, senior director, financial institutions at Fitch Ratings in Beijing.

“Investing for the long term in Chinese banks is risky,” said Chu, whose company in March said its gauge of systemic risk indicated a 60 percent chance of a banking crisis by mid-2013. “A case can be made to invest in some banks over the short-term, but investors should not blindly assume that this place has no issues.”

Fitch’s Concerns

Fitch cited concerns about the investment vehicles, used to fund stimulus spending from the 2008 global crunch, in lowering the outlook on China’s AA- long-term local-currency debt rating April 12.

Banks had a total of 50 trillion yuan of all loans outstanding in April. Standard & Poor’s has said the bad-loan ratio may climb next year to as high as 10 percent, from 1.1 percent now.

Social housing projects have “a pretty thin profit,” said Zhang Yi, senior analyst at Moody’s in Beijing. “It’s not like you are lending to highly profitable companies.”

Chris Ruffle, who helps manage $19 billion for Martin Currie Inc. in Shanghai, said, “it’s not a great situation and I wouldn’t want to be an investor in banks” after the record boom in lending.

The government hasn’t spelled out how construction of low-income housing will be financed over the full five years or how local governments will recoup their costs.

Special Case

The central and local governments combined will provide 500 billion yuan of a total of at least 1.3 trillion yuan to build 10 million homes this year, Vice Minister of Housing and Urban-Rural Development Qi Ji said March 9, without saying how they will come up with the money. The central government will provide about 121 billion yuan.

While officials have pressed banks not to expand lending to local government financing vehicles, China Banking Regulatory Commission Chairman Liu Mingkang said that credit dedicated to affordable-housing developments with “repayment capability” was exempted from the push, the China Securities Journal reported March 7.

By building cheaper homes, either for rent or sale below market prices, Wen seeks to prevent social unrest caused by record property prices. He’s also countering rising prices in major cities with curbs on lending and mortgages, and a trial property tax in some cities. The risk is a slowdown in land sales that contribute about a third of local government revenue.

Wang’s New Home

For Wang Shanli and her husband the program means 660 yuan ($102) in monthly rent for a 60-square meter, two-room apartment in a suburb of Chongqing. Growth in the central Chinese city has lured companies from Hewlett-Packard Co. to BASF SE. The 25-year-old housewife moved May 1 into a unit at Minxin Jiayuan, a 54-block development.

“The government’s policy is precisely to kill two birds with one stone: satisfy demand for lower cost housing but also to keep the economy buzzing,” said Mark Mobius, the executive chairman of Franklin Templeton Investment’s Emerging Markets Group. “It’s the raw materials angle that I think would be most interesting” for investment, he said, citing a likely boost in demand for copper, aluminum, concrete and cement.

Chilean copper producer Antofagasta Plc, platinum and metals producer Anglo American Plc and Shanghai-based Lonking Holdings Ltd., a maker of wheel loaders, may benefit from China’s affordable housing plan, said Singapore-based Mobius, who oversees more than $50 billion. Templeton holds shares in the three companies.

‘Strong Institutions’

The World Bank in April endorsed China’s social-housing plans, while saying the financing would need to be managed to prevent stretching local-government finances.

“Successful, sustainable social housing requires strong institutions and clear rules, including on a sustainable financing model and the funding of the subsidy element” for low-income renters and buyers, the Washington-based lender said in a quarterly report on China April 28.

The program is front-loaded, with 10 million units planned for this year, a 170 percent surge from the 2010 total. Vice Premier Li Keqiang said Feb. 24 that the 2011 target is “mandatory” and local governments must increase funding for the plan.

A “financing hole” of between 817 billion yuan and 1.4 trillion yuan this year alone means most of the construction will probably be funded through bank loans, said Stephen Green, head of China research at Standard Chartered in Shanghai. He estimates that construction this year may cost as much as 1.9 trillion yuan.

Debt Financing

A plan to build 800,000 apartments over three years in Chongqing will rely on debt to finance 70 percent of the 100 billion yuan cost while construction will be handled by state-owned developers led by local government investment vehicle Chongqing City Construction, according to data compiled by Standard Chartered.

China’s last banking crisis was in the late 1990s, when years of state-directed credit left lenders saddled with bad loans. The government spent more than $650 billion over a decade in bailouts.

The nation’s fiscal strength means the central government could similarly absorb a bad-loan crisis while retaining a relatively low public debt-to-gross domestic product ratio. Fitch sees as much as 30 percent of GDP support needed to address any future banking difficulties.

With China’s 2010 debt-to-GDP ratio about 19 percent, according to the International Monetary Fund, such an increase would still leave it better off than the U.S., at 93 percent last year; Japan, at 226 percent; or Spain at 64 percent.

At the same time, working out the debt crisis may damp the nation’s economic growth, which could ease to between 5 and 7 percent annually over the coming decade, said Michael Pettis, a finance professor at Beijing’s Peking University.

“Five or six years ago people were saying that one of the great glories of the U.S. real estate market is that now all of these people who couldn’t afford to buy houses could buy houses,” said Pettis. “That didn’t work out so well.”

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