China pledges to clean up local government debt (Reuters)

BEIJING (Reuters) – China pledged on Wednesday to take steps to clean up hundreds of billions of dollars in local government debt, seeking to defuse concerns that a wave of defaults could derail the world's No.2 economy and hobble its state-run banks.

Described by the cabinet and the head of China's No.2 bank as a big issue, the country's mountain of local government debt has long been seen as a major risk by investors. Ratings agency Moody's Investor Services this week said the problem could be bigger than estimated, threatening banks' ratings.

A meeting of the State Council led by Premier Wen Jiabao would establish a mechanism to rectify any bad loans and tackle financing vehicles run by local governments, according to the official Xinhua news agency. The council reiterated a ban on local authorities providing guarantees for debt.

"The size of local government debt being formed over the past several years is relatively big and some risks loom, as the some regions and industries are weak in repaying the debt," Xinhua said, citing a statement after the meeting. "Local governments must continue to clean up and standardize the financing vehicles in a timely manner," it said, adding that the cabinet is paying close attention to the debt issue.

China's state auditor has estimated that local Chinese governments have borrowed a total of 10.7 trillion yuan ($1.6 trillion) by the end of last year.

But ratings agency Moody's said this week that likely understated banks' holdings of local government debt by 3.5 trillion yuan, potentially putting banks on the hook for deeper losses that could threaten their credit rating.

Moody's said it was hard to judge which banks had taken on the most local government debt, but Bank of China and China Citic Bank were among those that had lent more aggressively than their peers during China's bank lending spree in 2009. A worst case envisaged non-performing loans could reach 12 percent, compared with 1.1 percent at the end of March.

SMALLER BANKS MORE EXPOSED

Guo Shuqing, chairman of China's largest mortgage lender China Construction Bank, called the problem a "big issue" but downplayed the risks from the debt for his bank.

"For my bank, I don't think it's a big problem," Guo told an academic forum in English.

"We just choose the good projects, good companies. We also have a lot of measures to control the risk. Also these projects usually have very good cash flows," Guo said.

Many smaller lenders, while still large on a global scale, have a higher proportion of problematic loans made to local government financing vehicles (LGFV), potentially threatening their survival if defaults spiral and Beijing doesn't step in.

Shenzhen Development Bank, for example, had more than 20 percent of its loans with LGFVs as at the start of the year.

That was worse than numbers reported by major lenders such as Industrial and Commercial Bank of China and Bank of China, which said their LGFV lending stood at 13 and 9 percent of total outstanding loans, respectively.

"Any default will likely hit smaller banks more than the big national lenders," said Sheng Nan, an analyst at UOB-Kay Hian in Shanghai.

"Many of these banks have their operations only in one single geographical area, which makes them more susceptible to pressure from local governments into extending loans for projects that national banks may not want to take on."

Many executives at mid-sized banks may also have relatives or friends in local governments, and may face undue influence when extending loans, Sheng added.

RENAMING LOANS

To get around investor fears over their high levels of local government debt, many banks have taken to re-categorizing loans as lending to a public or commercial entity rather than a financing vehicle.

For example, only about 5 percent of Shenzhen Development Bank's loans are now classified as being local government financing vehicle lending, a stunning turnaround from the 22 percent it had just a year ago.

"I don't believe this is going to be a major problem for our country or the industry," bank president Richard Jackson said. "I do think it's correct to keep reducing the exposure (to local government financing vehicles)."

China's banking regulator has been allowing loans backed by an underlying asset or cashflow to be re-classified as lending to commercial projects. Such projects are typically infrastructure projects such as highways or toll roads.

"These are the healthier LGFV loans, with cashflow in the underlying project adequate to repay to loan," said Sanjay Jain, an analyst with Credit Suisse in Singapore. "As usual, the key is how valid those cash flow assumptions are."

Already, local media reports say that a Chinese highway builder backed by the Yunnan government is struggling to repay almost $15.5 billion in loans, highlighting the risks of lending to infrastructure projects that were once seen as reliable.

If the government does step in, it would be the second time since the late 1990s, when Beijing transferred the banks' bad debts to asset management companies backed by sovereign bond issues in preparation for their eventual listings.

However, such a scenario is unlikely until the current administration steps down at the end of its term next year, said Stanley Li, an analyst at Mirae Asset Management in Hong Kong.

"I'm worried the leadership has no strong incentive to tackle the issue because it's like recognizing that their fiscal stimulus was wrong," he said. "They may push it to the next government. If we do not see a clear master plan this year, we won't be seeing one next year."

(Additional reporting by Kevin Yao and Koh Gui Qing; Writing by Kelvin Soh; Editing by Lincoln Feast)

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China vows to clean up local government debt (AFP)

BEIJING (AFP) – China said it is looking into ways to regulate local government borrowing after ratings agency Moody's said the proportion of bad loans could be higher than previously thought.

The National Audit Office last week said authorities owed 10.7 trillion yuan ($1.65 trillion) as of the end of 2010, equivalent to about 27 percent of China's 2010 gross domestic product and warned of a risk of some default.

But on Monday Moody's said the NAO may have understated the debt burden by as much as $541.6 billion and the ratio of bad loans could be as high as 8-12 percent, compared to its own previous calculations of 5-8 percent.

State Council, or cabinet, issued a statement saying it would continue to "clean up local government financing platforms" and look at setting up a mechanism to regulate the way authorities raise money.

"The ability of some areas and industries to repay debt is weak and there are hidden risks," said the statement, which was dated Wednesday and released after a meeting chaired by Premier Wen Jiabao.

"These problems have exposed system and management loopholes and need close attention."

Excessive borrowing by authorities to fund infrastructure and other projects has sparked concerns among China's leadership about the risks the loans pose to the financial stability of the world's second-largest economy.

Moody's -- which had checked the NAO figures against reports by Chinese banking regulators -- said it was concerned by the differences between figures given by government agencies and the banks' publicly stated lack of concern.

The NAO had said 108.3 billion yuan of total loans had been issued or used improperly, citing methods such as providing fraudulent collateral or diverting the funds raised into capital or real estate markets.

Chinese banks last year loaned huge amounts to provincial financing vehicles -- intermediary agencies through which local governments take out borrowings because they are officially banned from assuming debt directly.

The credit was used to fund construction projects after Beijing called for nationwide efforts to spur the economy after the global financial crisis.

The massive debts have hampered official efforts to rein in inflation, which hit a near three-year high of 5.5 percent in May and is expected to pass six percent in June.

Although Beijing has raised interest rates five times since October -- the latest coming on Wednesday -- it has done so with some reluctance partly because it is worried about local governments defaulting on their loans.

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Chinese local debt understated by $540 billion: Moody's (Reuters)

BEIJING (Reuters) – China's local government debt burden may be 3.5 trillion yuan ($540 billion) larger than auditors estimated, putting banks on the hook for deeper losses that could threaten their credit ratings, Moody's said on Tuesday.

Addressing the estimate by China's state auditor that its local governments have chalked up 10.7 trillion yuan of debt, Moody's said it found more potential loans after accounting for discrepencies in figures given by various Chinese authorities.

"The potential scale of the problem loans at Chinese banks may be closer to its stress case than its base case," Moody's said in a statement.

In view of that, the non-performing loan ratio for Chinese banks could be as high as 8-12 percent, compared with 5-8 percent in the base case and 10-18 percent in the stress case.

Unless China comes up with a "clear master plan" to clean up its pile of local government debt, the credit outlook for Chinese banks could turn negative, the ratings agency said.

In a bid to assuage investor worries about the potential souring of its massive local government debt, different Chinese authorities including the state auditor, the bank regulator and the central bank have tried to assess the situation.

But all three agencies have used different definitions and accounting methods to review the debt, resulting in a hodgepodge of official forecasts.

Moody's said it derived the additional 3.5 trillion yuan of debt after comparing the estimates of China's state auditor with that of the bank regulator's.

The ratings agency said the Chinese state auditor likely omitted the 3.5 trillion yuan of debt from its assessment because they were not considered as real claims on local governments.

"This indicates that these loans are most likely poorly documented and may pose the greatest risk of delinquency," said Yvonne Zhang, a Moody's analyst.

Moody's said it expects Beijing to "implement gradual discipline" over the stock of government debt, and that would involve the Chinese government leaving banks to manage a part of the problem loans on their own.

(Reporting by Koh Gui Qing; Additional reporting by Kim Coghill in Singapore; Editing by Jacqueline Wong)

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China understating local govt debt: ratings agency (AFP)

SHANGHAI (AFP) – China may have understated the debt burden of local governments by as much as $541.6 billion, and the proportion of bad loans could be higher than previously forecast, ratings agency Moody's said Tuesday.

In a stern warning, Moody's warned the lack of a plan to tackle bad loans to local governments meant it could downgrade its outlook for Chinese banks to negative.

The agency's findings came after it analysed an audit released in June by China's National Audit Office (NAO), which put the debt held by local governments at 10.7 trillion yuan ($1.65 trillion) as of the end of 2010.

The figure released by the NAO was the equivalent to about 27 percent of China's 2010 gross domestic product of 39.8 trillion yuan.

"We believe that the NAO report is understating the size of the local government loans that could become problematic," the Moody's report said.

Excessive borrowing by authorities to fund infrastructure and other projects has sparked concerns among China's leadership about the risks the loans pose to the financial stability of the world's second-largest economy.

Moody's said it uncovered an additional 3.5 trillion ($541.6 billion) in debt after checking the NAO's figures against reports by Chinese banking regulators.

The agency said the ratio of loans that cannot be paid back could be as high as eight to 12 percent, compared to its previous calculations of between five to eight percent.

"The potential scale of the problem loans at Chinese banks may be closer to our stress case than our base case. This is clearly a negative trend for creditors," Moody's said.

"But, for now, very few of these loans are recorded as NPLs (non-performing loans) by the banks, and it is unclear as to how they, or the Chinese authorities, intend to address the problem."

The ratings agency said it was concerned by the differences between figures given by government agencies and the banks' publicly stated lack of concern about bad loans.

The NAO had said 108.3 billion yuan of total loans had been issued or used improperly, citing methods such as providing fraudulent collateral or diverting the funds raised into capital or real estate markets.

Chinese banks last year loaned huge amounts to provincial financing vehicles -- intermediary agencies through which the governments take out borrowings because they are officially banned from assuming debt directly.

The credit was used to fund construction projects after Beijing called for nationwide efforts to spur the economy on the back of the global financial crisis.

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China audits local government finances in debt clean-up (Reuters)

BEIJING (Reuters) – China released a comprehensive review of the massive debt of its local governments on Monday and curtailed their future borrowing, taking its first major step to prevent widespread defaults from destabilizing its vast economy.

Releasing its first audit of local government debt, which amounts to 27 percent of the economy, China's chief state auditor Liu Jiayi said local government financing vehicles would be cleaned up and regulated depending on the type of debt they hold.

The results, presented to the Chinese parliament by Liu, showed local Chinese governments had chalked up about 10.7 trillion yuan ($1.65 trillion) of debt as of the end of 2010.

The audit and the proposed measures, the most comprehensive so far, underscored Beijing's determination to head off credit risks that may destabilize growth in the world's second-largest economy ahead of a leadership change in 2012.

Although the estimated figure for local government debt was in line with market forecasts and short-term risk appeared contained, some analysts were still worried local governments would struggle to repay their loans.

"The property sector is feeling the pinch from government policy tightening, and it takes time for government-invested projects to generate returns," said Hua Zhongwei, an analyst with Huachuang Securities in Beijing.

"These will create big pressures on local governments to repay their debt."

To contain the problem, the audit office said financing vehicles would be "firmly" barred from incurring new debt, while local governments would be allowed to sell bonds, but only with approval from Beijing.

FINANCING VEHICLES

The audit office said about half of local government debt, or 4.97 trillion yuan, was held by financing vehicles, well under market estimates for the vehicles to have borrowed 10 trillion yuan.

Analysts welcomed the surprisingly low estimate for debt incurred by these vehicles, but many warned against reading too much into what may well be an understated figure.

Different definitions for what makes a financing vehicle, and a recent consolidation in the sector in the face of tighter regulation by Beijing have skewed the picture, they said.

"The lower-than-expected figure should alleviate some worries on a surge of new crop of bad loans in the banking system," said Li Xunlei, an economist at Guotai Junan Securities in Shanghai.

"But we need to note that the way of calculating the debt varies from one ministry to the next."

Local government debt has long been identified by analysts as a weak spot in China's economy, responsible for a covert and fervent borrowing spree that has generated wasteful spending, with some loans believed to be in default.

About half of all local government debt was taken up during the 2008 financial crisis when Beijing unleashed a 4 trillion yuan fiscal stimulus to foster economic growth. This group of post-crisis loans is due to mature in 2013.

The audit office did not say what proportion of loans was in default or was at risk, except to say that of over 6,500 financing vehicles reviewed, around 2 percent, or 148 of them, had a default rate of 16.3 percent.

WELL-CAPITALISED BANKS

Monday's release of the audit findings confirms a Reuters story last month when sources said Beijing wants to start overhauling its local government debt mess by June to have the house in order by the next leadership reshuffle in late 2012.

To clean up the debt mess, the sources said Beijing would shift 2-3 trillion yuan of debt off the books of local governments. They said Beijing and China's "Big Four" banks will be forced to take some losses on bad debt.

Liu from the audit office said efforts would be made to "clean up and regulate" financing vehicles and that "the borrower must bear responsibility."

But analysts thought any losses that Chinese banks may suffer would be manageable.

"These are among the best-capitalised banks in the world. Disaster isn't going to happen, not this year, not next year," said James Antos of Mizuho Securities Asia.

The performance of bank shares suggested investors agreed, with most either steady or marginally lower.

To be sure, not all local government borrowing has gone to waste. Much has been used to fund the building of roads and railways, investment which many economists argue that China needs and is of value even if loans are not repaid on time.

Still, ambiguity around just how much debt Chinese local governments have chalked up has fed the overall investor concern about China's problem of bad debt.

Various Chinese government bodies, including the central bank and the bank regulator, have all provided varying estimates for the amount of outstanding debt.

China's central bank created a stir earlier this year when it estimated that local government debt accounted for less than 30 percent of total Chinese bank lending.

That led Chinese media to extrapolate that local governments had borrowed as much as 14 trillion yuan.

But given China's audit office was authorized by China's cabinet to investigate the debt mess of local governments, it is likely to have the final say on this issue.

"The audit office has a much more narrow definition. My understanding is that the debt as defined by them are those that are government guaranteed, or are backed by government revenues," said Wei Yao, an economist at Societe Generale in Hong Kong.

"But I think in terms of the size of the debt, it's largely consistent with the previous reports."

All said, few see a widespread banking fallout as they believe cash-rich Beijing will step in to absorb losses if needed.

As the owner of $3.05 trillion of foreign exchange reserves, the world's largest, Beijing has deep pockets to recapitalize its banks.

And despite the eye-watering amount of debt that has been incurred by local Chinese government, China's total government debt stands at 44 percent of its gross domestic product, well under the debt-to-GDP ratio of other major economies.

Japan's ratio is over 225 percent; the U.S. ratio is 93 percent, and Germany's debt-to-GDP is 75 percent.

($1 = 6.475 yuan)

(Additional reporting by Wang Lan, Kevin Yao, Terril Jones, Kelvin Soh, Langi Chiang, Emily Kaiser; Editing by Vidya Ranganathan)

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China reports local governments owe $1.6 trillion (AP)

BEIJING – China's local governments have piled up debts of $1.6 trillion, the national audit agency announced Monday, amid mounting concern Chinese banks might be hurt if borrowers cannot repay loans.

It was the first public accounting of massive borrowing by local governments to pay for construction and other spending. The announcement, following months of speculation about the scale of the debt, might help to mollify worries about possible risks facing banks that also lent heavily to help China ward off the 2008 global crisis.

Analysts say some local governments might be unable to repay loans but a banking crisis is unlikely because China's state-owned lenders are flush with cash and avoided the mortgage-related turmoil that battered Western institutions.

Beijing has flexibility because economic growth is strong and its total government debt is well below that of the United States, Japan and some European economies, said Zuo Xiaolei, chief economist for Galaxy Securities in Beijing.

"But the government must bear the risks in mind and try to prevent the local debts expanding too fast," she said.

The National Audit Office report gave no indication what portion of local government debt might not be repaid. Its total figure was in line with estimates by outside analysts but it was unclear whether that included all government debts.

The audit office said local governments owe 9 trillion yuan ($1.4 trillion) to banks and other lenders and might be responsible for an additional 1.6 trillion yuan ($200 billion) in debt. The disclosure came in a report to China's legislature that was released on the agency website.

"Due to inadequate repayment ability, some local governments can only pay their debts by taking on still more debt," the report said.

UBS economist Tao Wang, in a report this month, said local governments eventually might be unable to repay 2-3 trillion yuan ($300-$450 billion) in loans, equivalent to 4-5 percent of total lending by Chinese banks.

Many local Chinese governments created investment agencies over the past decade to invest in construction and other projects, financed by borrowing from state banks.

An American researcher, Victor Shih of Northwestern University, has estimated total local government borrowing in 2004-09 at 12 trillion ($1.6 trillion).

Bank lending was a key element of Beijing's 4 trillion yuan ($586 billion) stimulus that helped China rebound from the global economic crisis. Beijing provided only about 25 percent of the total. The rest came from local governments, state companies and bank loans.

Regulators began to tighten controls early last year amid warnings local governments were borrowing too much.

A central bank deputy governor, Su Ning, said in March 2010 that banks might face risks if local governments defaulted. But the Finance Ministry and bank regulator later issued a statement saying risks were under control.

Many loans are likely to be repaid because they were invested in projects that will produce taxes and other revenues, analysts say. But they say some were given without required collateral, some borrowing was used for regular spending instead of investment and some governments committed the same future revenues to multiple projects.

China's top state-owned banks are among the world's biggest, with several having more than $1 trillion in assets.

Beijing injected tens of billions of dollars into China's biggest banks over the past decade to clear away mountains of unpaid loans.

"It can't be excluded that the government might remove bad debts from the banks again if there were debt defaults," said Zuo. "But that would be no good for the development of the economy and the banks as well."

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AP researcher Yu Bing contributed.

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National Audit Office report (in Chinese): http://www.gov.cn/zwgk/2011-06/27/content(underscore)1893782.htm

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