Following on from today’s post on Gary Shilling’s warning that China is headed for a hard landing, credit ratings agency, Moody’s Investor Services, today released a report claiming that it has identified an additional 3.5 trillion yuan ($US540 billion) of potential problem loans that the Chinese National Audit Office (NAO) did not disclose in their 27 June report.
From the Economic Times:
China’s local government debt may be 3.5 trillion yuan ($540 billion) larger than auditors estimated, potentially putting banks on the hook for deeper losses that could threaten their credit ratings, Moody’s said on Tuesday.
Moody’s reviewed a report released by China’s state auditor last week, which found that local governments had chalked up 10.7 trillion yuan of debt. Moody’s said it identified more loans funded by banks after accounting for discrepancies in figures given by various Chinese authorities…
Investors worry the pile of loans, about half of which were racked up during a 2008 stimulus spending binge, could destabilise the Chinese economy in the long run. If banks have to absorb heavy losses, it could restrict lending.
“We assume that the majority of loans to local governments are of good quality, but based on our assessment of the loan classifications and risk characteristics…we conclude that banks’ exposure to local government borrowers is greater than we anticipated,” says Yvonne Zhang, a Moody’s analyst.
The ratings agency said a jump in local government loan defaults could push the non-performing loan ratio for Chinese banks as high as 12 per cent, well above its base-case scenario that envisions losses in the range of 5 per cent to 8 per cent…
Many investors have long eyed China’s mountain of local government debt as a major risk. The worry is that slower growth in the world’s second-biggest economy could set off a wave of loan defaults and hobble its banking system.
According to the Moody’s report, which I cannot attach since it is copyrighted, the $US540 billion of additional potential problem loans has been estimated from other Chinese government agencies, which reported larger loan exposures than the NAO. These loans are also considered to be of lower credit quality than those disclosed by the NAO.
In a report released on June 1 by the People’s Bank of China (PBoC), the central bank indicated that claims on local governments represented up to 30% of total bank loans, or about RMB 14 trillion. In contrast, the China Banking Regulatory Commission (CBRC) reported that such loans reached RMB 9.09 trillion at end-November 2010, or about 20% of the total loans in the system.
If we take the mid-point between these two regulators and assume that roughly 25% of total bank loans, or about RMB 12 trillion, are to local governments, then there would be a RMB 3.5 trillion difference between their calculations and that of NAO. Short of being ideal, this rough estimate has at least the merit of not ignoring a potential significant risk exposure.
This is because we believe that the loans not covered by the NAO report pose the greatest risk of delinquency, as these loans were presumably deemed by the audit agency as not being properly underwritten such that they could be categorized as local government obligations. As such, we prudently assume that the majority of these loans (50% to 75%) could become delinquent, or would need to be restructured.
When adding up all these tranches of local government loans — together with the other loans carried by banks (for which we generally assume a 5% NPL rate) — we assess that a 8% – 12% NPL range could best represent the amount of problem loans facing Chinese banks.
