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S&p Issues Mainland China Credit Warning

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S&P warns of rising credit risk in mainland

Jane Cai in Beijing

Jul 23, 2010

Credit risks are rising in the mainland banking system, but lenders have sufficient strength to warrant a stable outlook, ratings agency Standard & Poor's said yesterday.

Some loans to the financing vehicles of local governments would probably turn sour over the coming years, but the delinquencies would be absorbable due to banks' good operating profitability, the ratings agency said in a report.

The remarks came amid rising concerns over the quality of loans extended to local governments' financing vehicles, which accounted for 30 per cent to 35 per cent of the 14.2 trillion yuan (HK$16.26 trillion) of new loans disbursed over the past 18 months.

The financing vehicles were set up to facilitate local governments' funding needs because legally such governments are not allowed to issue debt or secure bank loans. Responding to the central government's call to stimulate the economy, local governments unveiled various construction projects and borrowed aggressively from banks by using these funding vehicles.

"It is highly likely that some of these loans will turn bad over the next few years, given the questionable credit quality of many of the borrowers," said Liao Qiang, a credit analyst with S&P.

Lending to local governments' financing vehicles represents 18 to 20 per cent of total loans in the banking system. These vehicles typically have a high debt or operational leverage. Their lack of disciplined financial policies makes it uncertain whether they will stick to any capital expenditure and funding plans. Moreover, they often generated inadequate cash flow from operations, Liao said.

Mainland banks' non-performing loan ratio was 1.3 per cent at the end of June, down 0.28 percentage point from the beginning of the year, the China Banking Regulatory Commission said yesterday. Non-performing loans as of the end of June totalled 455 billion yuan, while bad-loan coverage ratio was 186 per cent, the regulator said.

S&P expects the non-performing loan ratio to be 3 per cent to 4 per cent until the end of this year due to the relatively long tenor of loans to government vehicles. It estimates that local government lending could add 4 to 6 percentage points to the mainland's overall bad loans.

Other sources of problem debts may come from developer loans after the government tightened measures to cool property prices and exporters that face higher wage costs and yuan appreciation, according to S&P.

With the pace of economic growth slowing, the non-performing loan ratio would rise but stay below 10 per cent until the end of 2012, Liao said. A non-performing loan ratio level under 10 per cent was moderately high, but one mainland banks could handle due to a healthy net interest spread under a regulated interest rate regime, he said.

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course, the law changes making ratings agencies ACCOUNTABLE for their ratings might have a bearing on the sudden change in heart.

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