China banks borrow Western tricks to combat spike in bad loans

By Engen Tham and Lawrence White

SHANGHAI/HONG KONG (Reuters) - Chinese banks are increasingly drawing on Western ways of selling off bad loans, after four of the largest five lenders reported a spike in defaults in an economy stuttering at its slowest growth rate in 25 years.

The lenders - bellwethers of the world's second-largest economy - plan to expand the practice of selling bad loans bundled into financial products, to reduce the amount of unpaid debt on their books, according to banking insiders.

The practice, though common in the West, was mostly unheard of in China just a year ago. Its uptake reflects government policy of relaxing restrictions on financial markets to attract investment, as well as banks' hunger for ways to deal with a worsening bad loan situation as profit growth flags.

But analysts say the practice masks the true extent of a situation exacerbated by so-called zombie loans neither in default or written off, languishing with cash-strapped local authorities. Central bank encouragement to increase lending and support the economy could only compound matters, they say.

Banks generally reported bad loan ratios - or the percentage of total lending which has soured - of 1 percent to 1.5 percent. "I think the real level is around 2 to 3 percent," said Jiahe Chen, chief strategist at Cinda Securities in Shanghai.

Hong Kong-based Leon Goldfeld, investment director at Amundi Asset Management, estimated the true bad debt ratio would reach 9 percent if economic growth slowed to 6 percent, rather than the government's target of around 7 percent.

REPACKAGING

Industrial and Commercial Bank of China Ltd (ICBC) (SS:601398) (HK:1398), Agricultural Bank of China Ltd (AgBank) (SS:601288) (HK:1288), Bank of China Ltd (BoC) (SS:601988) (HK:3988) and Bank of Communications Co Ltd (BoCom) (SS:601328) (HK:3328) this week each booked marginal profit growth or contraction for the fourth quarter, with China Construction Bank Corp (SS:601939) (HK:0939) reporting on Friday.

ICBC also booked a rise in bad loans to small businesses struggling with weaker overseas demand, and from coal-related enterprises in Western China suffering from falling coal prices.

AgBank reported its highest non-performing loan ratio in three years, primarily due to manufacturers as well as wholesalers and retailers, whereas bad loans rose at their steepest pace in more than three years at BoC. At BoCom, soured debts reached their highest since 2010.

Faced with mounting bad debt, Chinese banks have been grouping soured loans and selling them as potentially high-risk derivatives to local asset managers, bankers said.

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Last year, there was a "significant" increase in such repackaging, said Augustus Cui, partner at Grandall law firm, which represents two of the top banks. There is likely to be a similar increase this year, Cui and other bankers said.