China Banks Can Absorb Government Loan Loss, Bernstein Says

China’s largest publicly traded banks will be able to absorb credit losses even if 27 percent of their loans to local governments go bad, according to brokerage Sanford C. Bernstein & Co.

Industrial & Commercial Bank of China Ltd., Agricultural Bank of China Ltd. and Bank of Communications Co. may need to raise a combined 100 billion yuan ($15 billion) to cover a capital shortfall if the seven largest Hong Kong-listed banks are forced to write down debt and meet Basel III requirements this year, the U.S. firm said in a note to clients.

China’s first audit of local government debt found liabilities of 10.7 trillion yuan at the end of last year with 79 percent being bank loans, the National Audit Office said last week. As much as 30 percent of the local government financing vehicles’ loans may sour and become the biggest contributor to banks’ bad debts, Standard & Poor’s has said.

“The listed banks’ exposure to LGFVs will not be as negative as the market is currently pricing in,” analysts led by Mike Werner in Hong Kong wrote. “We do not expect the LGFV loan issues for the unlisted banks will result in systemic risk for the banking sector as the government is unlikely to let the policy banks default.”

Local government financing vehicles account for about 9 percent of domestic loans for the seven biggest banks listed in Hong Kong, Werner wrote.

City Bank Concerns

Chinese regulators are most concerned with the high levels of local government debt held by the nation’s unlisted policy banks, which are state-owned lenders established to fund government strategies and projects, and smaller city lenders, Werner wrote. Those banks lack access to equity markets to cover losses, according to the note.

ICBC, Agricultural Bank and Bank of Communications raised about $35 billion last year through share sales, according to data complied by Bloomberg.

Loans to local government financing vehicles account for about 40 percent of outstanding debt at China Development Bank Co., the nation’s largest policy lender, the brokerage estimated. That’s the most among any Chinese banks. The lender is mandated to finance long-term infrastructure projects.

Such loans account for 25 percent of advances from Agricultural Development Bank of China and other city and rural lenders, the brokerage estimated.

Government Solution

Under a “bear case” scenario in which 27 percent of local government loans soured, China Citic Bank Corp.’s 2011 earnings would be almost completely erased, while China Merchants Bank Co. and China Construction Bank Corp. would have about half of their profit eliminated, the brokerage said.

“The low valuations of the Chinese banks more than discount their exposure to local governments,” according to Werner’s note. “But, it’s probably the case that the market does not get comfortable with the banks’ LGFV exposures until the government provides a comprehensive solution,” it said.

Shares of Beijing-based ICBC are traded in Hong Kong at 8.5 times its estimated earnings, the cheapest level in more than two years, according to data compiled by Bloomberg. The stock rose 1.9 percent to HK$6.02 as of 11:59 a.m.

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