Beijing faces bank bailout as regional debts go bad
Ghost towns built to stimulate economy to blame for trillions of yuan in unviable loans, say analysts
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Ghost towns built to stimulate economy to blame for trillions of yuan in unviable loans, say analysts
Naomi Rovnick
06 July 2011
The numbers are massive, but no one can quite agree on the amounts.
Moody’s ratings agency has claimed mainland local governments have built up a potential 4 trillion yuan (HK$4.8 trillion) in bank debts after spending exuberantly on unviable projects, such as towns no one wants to live in, deserted financial centres in rural areas, empty shopping malls, and airports that have never been used.
Theirs is just the latest in a string of estimates from banks and credit ratings agencies attempting to guess the value of the mainland’s next banking bailout. They all tend to agree on one thing, however, that local authority borrowing for projects designed to stimulate the economy will be to blame.
Stephen Green, Standard Chartered’s head of Greater China research, reckons the value of debts Chinese lenders have doled out to local governments that will turn bad could be 4 trillion to 6 trillion yuan
Analysts at Credit Suisse put the figure at 1.2 trillion yuan.
China has become littered with commercially unviable projects that local authorities initiated to keep people employed during the 2008-09 recession. The China Banking Regulatory Commission said last July that 70 per cent of local government-funded projects were not producing enough cash flow to repay debts.
Questionable projects for which municipal authorities borrowed money to build include Ordos, a new town in Inner Mongolia that was built for a million people but remains almost empty; and Shaoguan Guitou airport, which was given 300 million yuan by the Guangdong government for a major upgrade in 2008. A high-speed rail link that opened in 2009 and covers the 1,000 kilometres from Guangzhou to Wuhan in three hours turned out to be more appealing.
China’s National Audit Office and the People’s Bank of China have provided contradictory figures in recent months about the total value of municipal debts to which mainland banks are exposed.
The audit office says the figure is 10.7 trillion yuan, while the PBOC puts it at 14.4 trillion yuan. Neither has provided official estimates of how much of that debt will probably not be repaid, though the commission released a figure last July of 1.7 trillion yuan.
Due to the lack of clear official guidance, researchers at banks and credit ratings agencies are producing their own numbers, and coming up with different results because they are using different research methods. The resulting asset writedowns would wreak havoc on bank balance sheets and means they may have to be bailed out by the government.
Shares in the nation’s four largest banks - Agricultural Bank of China, Bank of China, China Construction Bank and ICBC - have slumped an average 11 per cent in the last three months.
According to Moody’s analyst Yi Zhang, 12 to 18 per cent of the loans in the mainland banking system could be non-performing.
“There is a serious problem, no matter whose estimate one believes,” said Phil Groves, founding partner of Hong Kong-based fund manager and non-performing loans consultant DAC Management. “There will have to be a bailout.”
Green said: “No one expected many of the loans to be paid back from the projects they were used for.”
Municipal governments have not borrowed to fund projects directly. Instead, they set up approximately 10,000 arms-length investment vehicles that are responsible for borrowing from banks and repaying the loans. Local authorities have guaranteed that they will repay certain investment vehicles’ loans. Other investment vehicles’ debts carry no such guarantees.
Moody’s calculates that between 2.4 to 3.975 trillion yuan of the loans governments have extended to such investment vehicles may end up in default. The figure is based on estimating the amount of non-guaranteed loans that will be in default.
If the governments cannot or will not repay, Green says: “The banks will take a haircut.”
Credit Suisse, meanwhile, bases its 1.2 trillion yuan estimate of local government debt that will default on figures reported in mainland media.
China has been here before.
From 1998-2004, Beijing pumped hundreds of billions of US dollars into its four biggest lenders to buy back bad debts built up by failed state-backed companies and prepare the banks for Hong Kong IPOs.
The bad loans were shifted into four so-called asset management companies, which were set up in 1999 and backed by the Ministry of Finance. They were given the difficult task of selling the failed state-owned enterprises’ bad loans to investors, and told to finish that job by 2009.
The asset management companies, however, are still operating. They mostly stopped holding loan auctions after the first few years. Foreign investors who were initially interested in buying the non-performing loans wanted to restructure the state-owned borrowers by closing unprofitable operations and shedding jobs. That approach did not coincide with the central government’s policy of maintaining social stability.
There is also a history of international analysts disagreeing with the mainland government about the total value of bad loans sloshing around the banking sector.
In May 2006, just before Bank of China was set to IPO in Hong Kong, Ernst & Young published a report stating the four largest state-controlled banks had US$358 billion worth of non-performing loans on their books - almost three times the official tally of US$134 billion. The report was withdrawn after the People’s Bank of China issued a statement calling it “ridiculous”. But that calculation was in fact lower than an estimate of US$500 billion released by rival big four accountant PricewaterhouseCooper earlier that year.
No official numbers have been released on the bad debt taken off the books.
Of this new batch of doubtful and bad debts created by local government borrowing, Moody’s Zhang writes that “for now, very few of these loans are recorded as [non-performing] by the banks, and it is unclear as to how they, or the Chinese authorities, intend to address the problem”.