Even with the recovery, the bad loan season in China could be really bad this time around
It happens again and again. Whenever Chinese banks start sweeping their bad debt books, investors believe it will be the end of a chronic problem. Somehow, they tell themselves, lenders are going to have to come out with a blank slate and be prepared to maintain credit. And the power of positive thinking dissolves apprehensions. At least for a while.
This time, however, it will pay off to be vigilant. Even with the outward signs of an industrial resurgence, the economic recovery from Covid-19 has been patchy. Fiscal stimulus measures have not been universally beneficial. Some provinces, but not all, were supported; some companies, but not all, are doing stronger. Small manufacturers, who accounted for a quarter of all yuan loans, are struggling to find a solid footing. Financial strains and credit events are increasing.
Indeed, like banks get rid of bad debts, more keep coming. The numbers are staggering: after have more than 3 trillion yuan ($ 465 billion) in loans corrected last year, non-performing assets continued to rise, up $ 281.6 billion, even as regulators authorized more lending forbearance to help companies come out of the virus crisis. This is compared to the nearly 4 trillion yuan in loans that banks cleared in 2018 and 2019 combined.
For now, investors are applauding – once again – the fact that the banks confess and delete their accounts. The non-performing loan assignment rate, or NPL, – measured as the ratio of NPL’s assignments to the previous year’s bad debt balance – reached its highest since at least 2017.
Facing the truth is good news. But here’s the thing: Businesses, provinces and assets that weren’t vulnerable before are now under pressure. The debt of the financing vehicles of local authorities and real estate developers seems precarious while several trust investment companies are on unstable ground. Dozens of small provincial banks continue to merge as their customers disintegrate; defaults and bankruptcies are increasing.
“The level of financial stress and the frequency of credit events in Chinese asset markets are much higher than what has occurred during” previous economic downturns and financial tightening, according to Rhodium Group analysts. They note that the significant growth in interest owed, relative to the economy’s ability to repay debt, has contributed to the situation.
There is no doubt that coping with this will largely fall to China’s 319.7 trillion yuan banking system. Lenders will need to continue building credit to support the economy while absorbing the costs of bad debt at a time when bank profits are already declining.
Much of the burden falls on the weakest Chinese lender. While the big banks managed to boost profit growth last year, the profits of their smaller peers fell from 3% to 15%. It is also the banks that have a much higher share of loans to small and medium-sized businesses with bad credit – almost 50%.
As the ability of lenders to generate capital from retained earnings diminishes, simply setting aside provisions and absorbing the deluge of bad debt will no longer reduce it. Building these tampons is expensive. In addition, banks must also return money to shareholders in the form of dividends to satisfy them.
To maintain the delicate balance, something will have to give: either dividend payments take a hit, bad debts stop showing up as quickly, or lenders turn to capital increases. There are few winners in these scenarios. Alternatively, the supply of credit shrinks and banks shy away from core businesses that don’t require as much capital.
In previous cycles, the outlook for earnings growth has helped ease asset quality and capital issues. This can no longer be taken for granted. Unless regulators decide bad debts can be continuously carried forward and forborne, there is little incentive for lenders to continue to deep clean their books.
Chinese banks’ price-to-book ratios have been rising since December as investors regain confidence in their balance sheets. It may be a little too early for that kind of optimism.
This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.
To contact the editor responsible for this story:
Howard Chua-Eoan at [email protected]