Chinese banks' loans to local governments are about 3.5 trillion yuan ($540 billion) more than the national auditor's estimate, and the industry's credit outlook could decline, Moody's Investors Service said.
"The Chinese audit agency could be understating banks' exposure to local governments," Yvonne Zhang, a Moody's analyst in Beijing, said in the report today. The "apparent absence of a clear master plan to deal with this issue" is likely to exacerbate problems and lenders may be left to manage a portion of the souring loans on their own, it said.
Bank shares fell and bond risk rose on concern that the banks will be unable to absorb losses on defaults should property prices drop. Moody's estimates that local governments' debt is about a third more than the audit office's findings last week of 10.7 trillion yuan. Non-performing loans could reach as much as 12 percent of total credit, it said.
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"This type of negative news will dampen sentiment on the outlook of Chinese banks, particularly on small and mid-sized Chinese banks," said Banny Lam, an associate director at CCB International Securities in Hong Kong. "The pressure may ease when the Chinese government unveils more details on how these loans could be treated."
China's three biggest banks dropped in Hong Kong trading. Industrial & Commercial Bank of China Ltd., the world's most profitable lender, fell 0.5 percent to HK$5.93, reversing earlier gains of as much as 0.7 percent. China Construction Bank Corp. shed 1.2 percent while Bank of China Ltd. lost 0.3 percent.
Risk of Defaults
The nation's first assessment of local government debt showed that 79 percent of the liabilities are bank loans and 8 billion yuan is overdue, Auditor General Liu Jiayi said June 27.
The audit office's estimates are similar to those of the China Banking Regulatory Commission, Wan Li, a Shanghai-based banking analyst at BoCom International Holdings Co., said by telephone today. Loans that weren't accounted for by the audit office would be those extended at the county level, which pose a limited burden for the banks, he said.
"There shouldn't be a serious understatement from the NAO figures," Li said. "They should more or less reflect the real situation."
'Stress Case'
The additional 3.5 trillion yuan of loans, which account for about 7 percent of China's 50.8 trillion yuan in outstanding local-currency loans, aren't considered by the audit office as real claims on local governments, Moody's said. That indicates the debt may be poorly documented and at greater risk for defaults, it said.
Non-performing loans may be higher than a "base case" estimate of 5 percent to 8 percent, and closer to the "stress case" scenario of 10 percent to 18 percent, the ratings company estimated following an assessment of the new data.
The cost of insuring debt of Bank of China, the nation's third-largest lender, from default rose 8 basis points to 168, near a two-year high of 175 set last week, according to data provider CMA, which compiles prices quoted by dealers in the privately negotiated market. An advance suggests deteriorating perceptions of creditworthiness.
Fitch Ratings lowered its outlook on China's AA- long-term, local-currency rating to negative from stable on April 12 because of the risk the government would have to bail out banks. As much as 30 percent of loans to local government entities may go bad, accounting for the biggest source of banks' non- performing assets, Standard & Poor's said that month.
China's largest publicly traded banks will be able to absorb credit losses even if 27 percent of their loans to local governments go bad, Sanford C. Bernstein & Co. estimated this week. The central government is also unlikely to let its unlisted policy banks, which are state-owned lenders set up to fund government projects, default on the debt, it said.
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