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Debt woes at top Chinese banks may keep growing

Chinese banks face a rising tide of NPLs during the next few years but the underlying financial structure is better equipped to manage them.

An upward trend in nonperforming loan ratios at top Chinese banks may be here to stay, as they boost lending under loose monetary policy at a time when an economic slowdown is escalating default risks.

NPL ratios at the four largest banks in China — Industrial & Commercial Bank of China Ltd., China Construction Bank Corp., Bank of China Ltd. and Agricultural Bank of China Ltd. — have been on the rise in recent years.

At the end of March, Agricultural Bank of China had the highest NPL ratio of 1.65% among the four banks, followed by Bank of China with 1.33%, China Construction Bank with 1.30% and ICBC with 1.29%. On an annual basis, the metric climbed for two consecutive years through 2014 at ICBC and Bank of China. At all of the banks except for Agricultural Bank of China, the figures were at five-year highs at the end of 2014, company data compiled by SNL Financial show.

Loan growth at the banks has slowed but may pick up speed again as China's central bank intensifies monetary easing. The People's Bank of China in May cut its benchmark rates for the third time since November 2014 when the central bank started easing to revive economic growth, which in the first quarter slowed to the lowest rate since 2009. In April, the central bank also lowered reserve requirements for banks by 100 basis points, the second industrywide easing since February and the first reduction of that magnitude since the fourth quarter of 2008 when the financial crisis was in full swing.

Banks stepping up lending

The amount of new loans issued by Chinese banks hit a six-year high in February, although credit growth slowed in the subsequent two months, part of which can be attributed to seasonality. Lending will likely get a boost in May, with the impact of the latest easing of reserve requirements becoming fully apparent, Julian Evans-Pritchard, a China economist at Capital Economics, said in a May 13 note, adding that restoring growth is a bigger priority for Chinese policymakers than containing credit risks.

"Banks are more willing to lend, as the government is trying to release more liquidity in the banking system to help support the Chinese economy," Avis Mak, vice president at KGI Securities, told SNL.

Some Chinese banks are offering mortgage rates at just 0.85x the benchmark, a development that may yield upside surprises in lending data, an analyst at a regional bank told SNL.

Troublesome for lenders is that bad debt will likely grow as well. Growth in NPLs at Chinese banks, including "special mention" loans, or assets that could turn sour, began accelerating in the first quarter of 2012 and will continue to gain momentum in 2015, Sophie Jiang, head of Hong Kong and China banks at Nomura, wrote in an April 15 note.

"As the Chinese economy's debt burden may keep building, China's NPL formation may continue to pick up in 2015," she said.

In a high-profile case of borrower distress in China, property developer Kaisa Group Holdings Ltd. defaulted on a HK$400 million loan from HSBC. In April, the company also became China's first real estate company to miss payments on U.S. dollar debt.


NPL ratios surging to 5%?

The bad debt problem may not go away anytime soon. Chinese banks will be in the "most challenging cycle" from 2015 through 2018, facing a downturn that has not been experienced by their peers in other large economies, as growing bad debt combines with pressure on margins stemming from measures to free up deposit rates and tightening capital requirements under Basel III, Jiang said. By the end of the period, NPL ratios at Chinese banks could peak at as high as 5%, she said.

Yet, the situation will not likely be as bad as in 2001 when the figures shot up to 30% at the height of a five-year cyclical slump through 2002, because credit quality controls at Chinese banks have improved since the commercialisation of the sector began in 1999, Jiang said.

But increasing NPLs do not necessarily mean a bigger drag on Chinese banks as they can off-load them to other entities. For that reason, some analysts are not so pessimistic about Chinese banks.

"If the banks are selling their NPLs to asset management companies, the situation may not be that bad. I am not too bearish about the NPL development at Chinese banks," the regional bank analyst said.

At least in the short term, growing loan volumes are not a bad thing for Chinese banks, helping them lift their bottom lines. At all of the four biggest Chinese banks, net interest margins contracted at the end of March, but they eked out small gains in first-quarter net profit. Their shares are also sharply up from where they were at the start of 2015.

"With the monetary loosening continuing, banks are more willing to lend at lower rates and this could benefit the Chinese economy," the analyst said.

As of May 15, US$1 was equivalent to 6.21 Chinese yuan.

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Hamish Mali co-authored this article with Susanna Tai.

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