Chinese Banks Worry Bad Loans Could Rise; Slower Economic Growth, Borrower Overcapacity Weigh on Asset Quality

August 29, 2013, 12:29 p.m. ET

Chinese Banks Worry Bad Loans Could Rise

Slower Economic Growth, Borrower Overcapacity Weigh on Asset Quality

DINNY MCMAHON

BEIJING—Chinese bank executives signaled concern that bad loans could rise, as earnings continued to slow in the face of declining economic growth. China’s biggest bank by assets, Industrial & Commercial Bank of China Ltd. 601988.SH +0.38% said Thursday its first-half net profit rose 12.4% from a year earlier to 138.35 billion yuan ($22.62 billion). Bank President Yi Huiman said the bank would remain cautious against a potential pickup in bad loans after its non-performing loan ratio increased marginally over the first half of the year.

Bank of China Ltd. said that its net profit for the first six months was 80.72 billion yuan, up 12.7% from a year earlier.

China’s banks massively expanded their lending in recent years, an effort that sustained the economy’s rapid economic growth and kept bank profits expanding by more than 20% annually. However, industries ranging from solar component makers to shipbuilders and car manufacturers used the readily available credit to expand their operations, resulting in overcapacity.

Furthermore, a more sluggish economy has resulted in slower growth of tax revenue, complicating local governments’ efforts to repay the debts they have rung up to fund infrastructure construction.

“Though our nonperforming loan ratio has been held below 1%, we still face big pressure from rising bad loans,” China Construction Bank Corp. 601939.SH +0.24%Chairman Wang Hongzhang said earlier this week.

Agricultural Bank of China Ltd. 601288.SH -0.41% President Zhang Yun warned Wednesday that asset quality of China’s banks would come under pressure as the government pushed forward with interest rate liberalization.

Chinese banks’ nonperforming loan levels are still extremely low. According to data from the banking regulator, bad loans in China’s banking sector accounted for only 0.96% of all lending at the end of June, largely unchanged from 0.95% at the end of last year.

Still, analysts say bad debts might be greater than reported, with banks issuing fresh credit to cover maturing loans that borrowers would otherwise struggle to repay.

Standard & Poor’s Ratings Services said in a report Thursday that banks may be understating the true extent of their nonperforming loans by disguising “their sizable corporate credit exposure as investments in wealth management products,” which are a type of off-balance-sheet investment fund.

The credit-rating firm said that it expects that the amount of bad loans the banks hold could substantially increase in coming years.

Those banks that disclosed the geographical distribution of their bad loans said they were particularly concentrated in the Yangtze Delta, an area including the city of Shanghai as well as Jiangsu and Zhejiang, two provinces known for their entrepreneurial, private companies, unlike many other provinces where state-owned firms dominate the local economy.

China Construction Bank said that 2.33% of loans it had made the region had gone bad at the end of June, up from 1.97% six months earlier.

Both Bank of China President Li Lihui and Mr. Yi, the ICBC president, said that their banks’ nonperforming loans were concentrated in the Yangtze River Delta provinces.

In a report issued in July, the China Banking Association, a government-backed industry group, said that in the Yangtze region in particular steel traders had been using their inventories as collateral to borrow from banks, only to use the funds to make loans to other borrowers at higher interest rates.

“The Yangtze Delta–an area where informal lending is more developed–is where nonperforming loans are rising the most, becoming a bad loan disaster area,” the report said.

ICBC said that its nonperforming loans increased by 7.19 billion yuan. However, as a proportion of total lending bad loans stood at only 0.87%, up from 0.85% at the end of last year.

“The rebound of NPLs was attributed to the rising pressure of macro-economic downturn…[causing] bigger operation difficulties to some enterprises, particularly small and medium enterprises,” the bank said in its earnings report.

ICBC on Thursday also said it injected liquidity into China’s financial system during a June credit crunch. ICBC Chairman Jiang Jianqing said that his bank lent more than 1 trillion yuan in the interbank market, in which banks lend to each other to meet daily needs.

On Wednesday, Agricultural Bank of China said it had injected a net 840 billion yuan during the squeeze. Neither bank said whether they had been asked by the central bank to ramp up their lending when the interest rates banks charge each other for short-term borrowing spiked in mid-June.

China banks seek to shake off bad loans

By Paul J Davies in Hong Kong

Many of China’s banks have taken more aggressive steps to write off or sell bad loans in the first half as slowing economic growth and overcapacity in some industries put pressure on struggling borrowers.

China Construction Bank, Bank of Communications, Citic Bank, China Minsheng and Ping An Bank all took more losses on non-performing loans than in previous years.Bank of China, which reported its half-year results on Thursday, said it had “expanded the channels” for bad loan disposals, but gave no further details.

These write-offs and the moves by some to dispose of bad loans in the markets help to explain why the overall level of non-performing loans being carried by the industry have remained lower than many investors or analysts expected.

In spite of the bad debt write-offs, profits for the sector overall still came in better than expected, providing a lift to some banks’ shares.

Bank of Communications, in which HSBC holds a near 20 per cent stake, sold a Rmb5.1bn ($833m) pool of bad loans to one of the big-four asset management companies. These businesses were set up in the late 1990s to take on the bad debts of the four large state-owned banks, which did not include BoComm. Two of those companies, Cinda and Huarong, are now seeking foreign investors to give them capital to play a bigger role in buying fresh bad loans from a wider group of banks.

Citic Bank said during its half-year results that it was actively talking to the four asset management companies to sell them packages of bad loans in the second half. However, CCB, for whom Cinda was set up in the 1990s, said it was not selling bad loans to the bad banks.

“It has not disposed of NPLs to asset management companies in the past few years as the recovery rates were low compared with resolving the NPLs one by one by itself,” said May Yan, analyst at Barclays.

Bad debts at Chinese banks rose for a seventh straight quarter to hit Rmb540bn in the second quarter, according to the latest official figures, however that still represents less than 1 per cent of outstanding loans.

Analysts expect the number of problem loans to continue to rise as a result of a credit boom on the mainland since 2008, which will mean some have to raise fresh capital. Investors are taking a pessimistic view on bad loans with share prices suggesting a much bigger rise in bad loans than most analysts expect.

“We forecast the Chinese banks will face NPL formation of 9 per cent cumulatively over the coming 3-4 years, much lower than the scenario currently being priced into the Chinese banks’ [shares],” said Mike Werner of Bernstein Research in Hong Kong.