Moody's: $540 Billion In China Local Government Debt Unaccounted For Understates Bank Exposure

qianmen 3.3 (3rd time this road has been rebuilt in the last 2 years)
Road Construction in China via Tricia Wang (Flickr)
Moody's reported today that China's National Audit Office may have understated total local government debt by $540 billion, which could affect banks if these loans go sour. On June 27, China's NAO released a report that said $1.3 trillion of total local government debt outstanding ($1.7 trillion) was funded by banks, but China's Central Bank said there was $2.2 trillion in local government debt outstanding. Read more about about the NAO report at NYT. In addition to this hidden $540 billion, this is going on:

"In its report Monday, the national audit office said it had found many irregular activities. For instance, many local governments were using “unreal” or illegal collateral to secure the loans, the report said, and some of the money they borrowed was funneled into the stock and property markets. At other times, the auditor said, the local governments were “overestimating the value of the collateral” — which was often tied to land values." (NYT, 6/27/2011)"

If all else fails and there's a hard landing in China (as Soros says), the People's Bank of China will just print more renminbi right? Marc Faber thinks so. Here is today's announcement by Moody's Investors Service (7/4/2011):

Beijing, July 05, 2011 -- Moody's Investors Service says that the potential scale of the problem loans at Chinese banks may be closer to its stress case than its base case, according to an assessment that the rating agency conducted following the release of new data by China's National Audit Office (NAO).

When considering the apparent absence of a clear master plan to deal with this issue, Moody's also views the credit outlook for the Chinese banking system as potentially turning to negative.

"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, as provided by the NAO and other Chinese agencies, we conclude that the banks' exposure to local government borrowers is greater than we anticipated," says Yvonne Zhang, a Moody's Vice President and one of the authors of the report.

Of the RMB 10.7 trillion (about $1.6 trillion) of local government debt examined by the Chinese audit agency, RMB 8.5 trillion ($1.3 trillion) was funded by banks. However, Moody's has identified another potential RMB 3.5 trillion ($540 billion) of such loans that the Chinese auditors did not discuss in their report.

"When cross-examining the findings by the June 27 NAO report -- in conjunction with reports from Chinese banking regulators -- we find that the Chinese audit agency could be understating banks' exposures to local governments by as much as RMB 3.5 trillion," says Zhang.

"Since these loans to local governments are not covered by the NAO report, this means they are not considered by the audit agency as real claims on local governments. This indicates that these loans are most likely poorly documented and may pose the greatest risk of delinquency," the analyst adds.

Moody's report estimates that the Chinese banking system's economic non-performing loans could reach between 8% and 12% of total loans, compared to 5% to 8% in the rating agency's base case, and 10% to 18% in its stress case.

In the report, the rating agency examines various scenarios as to how banks could tackle problem loans, including some where the government provides assistance, but Moody's generally expects the Chinese authorities to implement gradual discipline.

This would involve the authorities leaving the banks manage a portion of the problem loans on their own.

The report is entitled, Growing Size of Local Government Debt Burden Challenges Chinese Banks. It can be found at www.moodys.com


Source: http://www.moodys.com/research/Moodys-Scale-of-problem-loans-to-Chinese-local-governments-greater?lang=en&cy=global&docid=PR_222068

Hat tip Zero Hedge

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