Report Warns of Risks to China's Bank System


New Member
May 10, 2010
A week after the Agricultural Bank of China raised nearly $20 billion from global investors in one of the biggest stock offerings in history, analysts are warning about growing risks to China's banking system.

A report released on Wednesday by Fitch, the credit ratings agency, said Chinese banks were increasingly engaging in complex deals that hid the size and nature of their lending, obscuring hundreds of billions of dollars in loans and possibly even masking a coming wave of bad real estate and infrastructure loans, The New York Times's David Barboza reported.

The report also said that Chinese regulators understated loan growth in the first half of the year, by 28 percent, or about $190 billion, and that many banks continued to secretly shift loans off the books, creating a "pervasive understatement of credit growth and credit exposure."

"The growing amount of credit moving out of the banking system through these channels is one of the most disconcerting trends we've seen in China in recent years," Charlene Chu, a Beijing-based banking analyst at Fitch, said of the practice of repackaging loans and moving them off bank balance sheets.

While China's economy remains robust, the report is troubling because the country's recovery has been fueled by aggressive lending and soaring property prices. Lending by state-run banks was one of China's most aggressive forms of stimulus last year, but analysts constantly warned that banks could face the risk from overbuilding and nonperforming loans.

Beijing is trying to tame housing prices, rein in overly aggressive lending and stop banks from shifting loans off their books.

China's biggest banks, like Bank of China and China Construction Bank, are relatively healthy, analysts say. But many banks could face sizable risks if borrowers failed to repay loans.

Analysts say that trying to rein in growth is a delicate and precarious balancing act and that even regulators are struggling to keep up with the rapid innovation in the banking system.

Chinese banks reported a sharp drop in lending in the first half of the year after record amounts in 2009, suggesting that the economy was growing at a strong clip with more normalized lending.

But Fitch said on Wednesday that lending had continued to be aggressive — powering the economy, but raising the risk of nonperforming loans.

Much of the lending through off-balance-sheet channels is fueled by trust companies, mostly privately owned, that are partnering with banks and engaging in complex deals that involve repackaging loans into investment products — akin to an informal type of securitization.

The deals are essentially disguised loans, analysts say. Beijing has tried repeatedly to stop the practice, but analysts say that banks and trust companies have come up with innovative ways around the rules.

Last week, the China Banking Regulatory Commission ordered banks to stop working with trust companies to securitize or repackage loans, according to industry analysts. But the regulator made no official announcement.

A spokesman in Beijing for the commission declined to comment on Wednesday, insisting that senior officials needed to be alerted to the request for an interview.

Stephen Green, a Shanghai-based analyst at Standard Chartered Bank, said trust companies in China were acting as intermediaries and partnering with banks to raise and then lend money to a variety of projects.

According to his estimate, trust companies raised hundreds of billions of dollars in 2009 and the first five months of 2010, partly because depositors were frustrated by low interest rates at banks, and trust companies were willing to offer double that amount with principal guaranteed.

Mr. Green called the practice troublesome.

"There's limited transparency, so obviously that's a red flag," he said in a telephone interview.

Worries about a potential wave of bad loans have led regulators to pressure Chinese banks to raise more capital and strengthen their balance sheets.

Banks have also been pressed to lower their exposure to local government debt — money often raised for huge infrastructure projects.

But analysts now say they believe that banks are lowering their exposure to local debt and hiding the size of their lending by working even more aggressively with trust companies.

Analysts say that last year the process worked something like this: a bank would hand over a big loan, say $50 million, to a private trust company in exchange for $50 million in cash. Then the trust company would create a wealth management product out of the loan and give it to the bank to sell to investors and depositors. The money raised would be given back to the trust company.

Investors would receive as much as double the regular saving rate and their principal when the loan was repaid.

That $50 million would then be given to the trust company as if it were an investment; in fact, it was a short-term, high-interest loan to finance a real estate project.

Now, analysts say, to get around new regulations, the transactions are much more complex, but have the same aim — to pretend that a loan is an investment.

If the developer or trust company fails and cannot repay the loan, analysts say the banks could face huge, unrecognized risks. But curtailing the practice will not be easy, Ms. Chu at Fitch Ratings said.

"Before, banks were trying to create these things with trust companies to get them out," she said. "But now, with inflation and interest rates so low, and property prices low, bank customers are going into banks and demanding this option."
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New Member
May 10, 2010
State-Owned Groups Fuel China's Real Estate Boom
WUHU, China — The Anhui Salt Industry Corporation is a state-owned company that has 11,000 employees, access to government salt mines and a Communist Party boss.

Now it has swaggered into a new line of business: real estate.

The company is developing a complex of luxury high-rises here called Platinum Bay on a parcel it acquired last year by outbidding two other developers to win a local government land auction.

Anhui Salt is hardly alone among big state-owned companies. The China Railway Group is developing residential complexes in Beijing after winning the auction for a huge piece of land there.

Likewise, the China Ordnance Group, a state-led military manufacturer best known for amphibious assault weapons, paid $260 million for Beijing property where it plans to build luxury residences and retail outlets.

And in one of China's biggest land deals yet, the state-run shipbuilder Sino Ocean paid $1.3 billion last December and March to buy two giant tracts from Beijing's municipal government to develop residential communities.

All around the nation, giant state-owned oil, chemical, military, telecom and highway groups are bidding up prices on sprawling plots of land for big real estate projects unrelated to their core businesses.

"These are the ones that have the money to buy the land," says Prof. Deng Yongheng at the National University in Singapore. "Because in China, it's the government that controls the money supply and the spending."

By driving up property prices, the state-owned companies, which are ultimately controlled by the national government, are working at cross-purposes with the central government's effort to keep China's real estate boom from becoming a debt-driven speculative bubble — like the one that devastated Western financial markets when it burst two years ago.

Land records show that 82 percent of land auctions in Beijing this year have been won by big state-owned companies outbidding private developers — up from 59 percent in 2008.

A recent study published by the National Bureau of Economic Research in Cambridge, Mass., found that land prices in Beijing had jumped by about 750 percent since 2003, and that half of that gain came in the last two years. Housing prices have also skyrocketed, doubling in many cities over the last few years.

The report pegged a big part of the increase to state-owned enterprises that have "paid 27 percent more than other bidders for an otherwise equivalent piece of land."

Critics say the central government in Beijing unwittingly propelled the land frenzy by pushing a huge $586 billion economic stimulus package last year and encouraging state-owned banks to lend more aggressively.

And as the prices of new apartments soar — in Shanghai, for instance, they often exceed $200,000, while the average disposable income is about $4,000 a year — the trend also threatens to undermine the central government's goal of affordable housing for the rising middle class.

In some cases, local governments — which earned over $230 billion from land auctions in 2009 — are also being accused of demolishing old neighborhoods and unfairly compensating residents. In a recent poll conducted by China Youth Daily, a state-run newspaper, more than 80 percent of the respondents said local governments were a "major driving force" behind the skyrocketing property prices.

All of this is happening to the chagrin of private developers that dominated China's property market for more than a decade but are now feeling squeezed out of a game that favors developers with state-backed financing.

"It's a little like a son who borrows money from his mother," says Yang Shaofeng, head of the Conworld Real Estate Agency in Beijing.

Last year, state banks made a record $1.4 trillion in loans, nearly twice as much as the year before. Analysts say they believe much of that money was diverted into the property market through off-balance-sheet maneuvers, leading to the record land bids and soaring property prices. That belief is adding to concerns that some of China's biggest state-owned banks may be sitting on enormous unreported debt.

Beijing is now struggling to rein in credit without slowing the nation's roaring economy. And regulators are trying to stop state banks from using clever maneuvers to secretly lend money to overly aggressive state-owned developers.

State Dominates Beijing Land Auctions
Beijing also wants to restrain state companies that have little or no expertise in real estate. Last March, the State Assets Supervision and Administration Commission — one of the national government's most powerful bodies — ordered 78 state-owned companies to shed their real estate divisions.

But analysts say the government will have difficulty stopping hundreds of state-owned companies and their various subsidiaries from participating in what has become one of the country's hottest industries. Experts say that more than 90 of the 125 state-owned companies directly under Beijing's control still have property divisions. And local and provincial governments control many additional developers.

The national government is grappling with a complex set of incentives that drive state-run companies to speculate in the property market with the aid of local governments.

Rosealea Yao, an analyst at Dragonomics, a research consultant in Beijing, says a growing number of municipalities have formed local investment vehicles that borrow heavily from state-owned banks to pay to relocate residents and build infrastructure around big plots of land they intend to sell at auction. (In China, local governments cannot directly borrow from banks or issue bonds for real estate development.)

Those off-balance-sheet debts are essentially bets on rising land prices, she says, which could become big liabilities if land prices were to decline sharply or the auction market were to dry up.

"This is why local governments are so enthusiastic about infrastructure," Ms. Yao says. "They borrow to build something that raises the value of the land they want to sell at auction."

Here in Wuhu, a sleepy industrial town about 70 miles west of Nanjing, Anhui Salt is breaking ground on its high-rise project in the center of town — next to a hotel operated by Anhui Conch Holdings.

The land was put up for auction in May 2009, and there were just three bidders — another of which was also a state-owned company. Anhui Salt, which also boasts of operating a steel trading arm, a financing vehicle and even two Honda dealerships, says it is eager to expand beyond industrial products and table salt.

"Platinum Bay is Anhui Salt Industry's first luxury project and targets the very rich, the very elite class of Wuhu," said Su Chuanbo, marketing manager.

Asked why Anhui Salt wants to be a developer, Mr. Su said the central government had encouraged state companies to be more profitable, and that real estate was incredibly lucrative.

And so the government, he added, is actually behind its push into real estate.

"Even though many central government-controlled state companies are banned from the real estate sector," Mr. Su said, "local state-owned companies like Anhui Salt can still develop its projects within reasonable bounds. The situation is the same all over China."

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