China’s credit boom appears to be on its way out, and it may take its banks along with it. Chinese bank stocks have fallen substantially over fears that they are overexposed to bad loans and that tightening credit, falling real estate prices and a slowing of the economy will push them into the danger zone.
Bloomberg reported that the MSCI China Financials Index fell 24% in September; that’s lower than benchmark bank gauges for Europe, the U.S., Japan and emerging markets. And despite the fact that Industrial & Commercial Bank of China and Bank of China Ltd. reported record first-half profits and analysts increased 2012 forecasts, valuations fell last week for the first time to below those during the financial crisis.
Hedge fund manager Jim Chanos said in a Sept. 20 interview on Bloomberg Television that China’s economy might not be growing at all, saying, “A lot of people are assuming that half of all new loans in China are going to go bad. In fact, the Chinese government even said that last year relating to the local governments. If we assume that China will grow total credit this year between 30% to 40% of GDP, and half of that debt will go bad, that is 15% to 20%. Say the recoveries on that are 50%. That means that China, on an after-writeoff basis, may not be growing at all. It may be having to simply write off some of this stuff in the future so its 9% growth may be zero.” Chanos is shorting Chinese banks, property developers, and “anything related to property there.”
Edward Chancellor, who helps oversee about $106 billion as a strategist at Grantham Mayo Van Otterloo & Co. in Boston, also had cautionary words about China’s banks. “China’s economy is very distorted, and the banks, as ever, are at the epicenter of the distortions,” he said, adding, “If China runs into problems with the banking system, which I think it will, I cannot see a situation in which foreign investors are the main priority of Beijing.”
Equity analysts have been taken by surprise at the fall in Chinese bank stocks; there are more positive recommendations in that arena on China’s financial stocks than in any other of the 10 largest markets. The Chinese economy has exploded under government encouragement, responsible for over 30% of global growth in 2010. However, not everyone is encouraged by that. Charles de Lardemelle of the IVA International Fund was quoted saying, “The main concern we have, and the reason we’re not touching the banks, is we’re not sure that the Chinese economy is sustainable as it is.”
The doomsayers could be right. There are signs that both property developers and local government financing vehicles are having a tough time meetingg obligations and repaying loans, many of which are not even carried on Chinese banks’ books as such. And as banks cut back on lending on orders from Beijing, that tightens the noose even further.
While not all investors are bearish on Chinese banks—Stanley Li, an analyst at Mirae Asset Securities (HK) Ltd. in Hong Kong, was quoted saying, “The chance of having a banking crisis in China is rather low. If nonperforming loans shoot up, profit will fall, but we are likely to see a soft-landing scenario. The government will step in and won’t let the system collapse”—many are playing it safe.
Nicholas Yeo, the Hong Kong-based head of China and Hong Kong equities at Aberdeen Asset Management Plc, was quoted saying, “We’d rather stay away from the big four banks. There’s still a lot of overhang in the market.” And Chanos said, “The Chinese government’s balance sheet directly does not have a lot of debt. The state-owned enterprises of the local governments and all the other ancillary borrowing vehicles have lots of debt and its growing at a very fast rate. The assumption is that the state stands behind all this debt. We see that the debt in China, implicitly backed by the Chinese government, probably has gone from about 100% of GDP to about 200% of GDP recently. Those are numbers that are staggering. Those are European kind of numbers if not worse.”