Cross-posted from Investing in Chinese Stocks.
The China Banking Regulatory Commission’s (CBRC) Shanghai office is two for two in its previous warnings on the dangers of steel firm borrowing and copper borrowing.
Now Yicai is reporting that it’s the real estate sector’s turn. The CBRC’s Shanghai office is warning banks about risks in the real estate market, specifically in cities such as Changzhou and Wuxi. Changzhou is NW of Wuxi, which is NW of Suzhou (all in Jiangsu province). The Shanghai office is warning local banks, but if this problem exists here, it likely exists in many parts of the country.
The regulator warns that the project cycle is taking longer, there is downward pressure on prices and the risk situation is not optimistic. Growth is slowing in second tier cities near Shanghai and there is greater differentiation between projects. Additionally, credit risk is highly correlated with economic trends.
Although Changzhou and Wuxi’s real estate markets are still considered stable, prices are falling. The regulator warns that there is considerably large hidden risk and warrants the full attention of commercial banks. Specifically, longer project cycles may exceed the length of a loan and worse, sales may not cover the principal and interest. These projects will require support from the parent company or shareholders, and if they are nervous, the funding chain could be broken, leaving bank loans at risk.
The regulator recommends banks evaluate risk in local markets and of individual projects, don’t blindly extend credit, monitor cash flows and be on guard for regional and industry risk.
Aside from the risk of a real estate slowdown, banks are also at risk because they are lending to borrowers from other cities. Borrowers could be over-leveraged or misappropriating funds, for example. The credit relationship between a bank and non-local borrower is unstable, it is difficult for the bank to understand the firm’s true situation, financial condition and reputation, plus it is harder for the bank to track how loan proceeds are spent. The borrowers look good from the outside, a good business and clean balance sheet, but underneath business could be bad, the financial situation complicated with many investments and credit guarantees. Banks in other cities may be the last to find out of a changed situation, well after the local banks have already pulled their loans.
The CBRC Shanghai branch estimates loans to non-local borrowers are worth about ￥434 billion, or 14% of total loans. There may be another ￥176 billion of exposure through trusts and other shadow banking assets. Currently, bad debt from these loans only amounts to ￥1.1 billion, and NPL ratio of 0.26%.
Shanghai banks have extended about ￥475 billion in credit to out-of-market borrowers in the eastern part of China, with 44% in Jiangsu and Zhejiang province. This is a high concentration and both provinces have several cities in the midst of serious real estate slowdowns.
Some debts may be the result of bad debt cover ups. For example, take a case where company A (steel trader) cannot repay a loan of ￥10 million. The bank finds non-local company B (a real estate firm, either controlled by A or which has a secret relationship) and loans them ￥200 million at a preferential interest rate, so long as they agree to settle the debt of company A.
The implications of this news are not good. The Shanghai office of the CBRC has predicted trouble twice and been right. Even if they are wrong about the risk this time, banks will tighten credit in the wake of this warning, putting further pressure on some of the weakest real estate markets in China.
