Bad Debts in China Could Almost Double With Coronavirus

Bad debts could virtually double at Chinese banks due to the coronavirus outbreak, according to a stress test run by S&P Global Ratings, while banks lower their lending standards. That poses long-term problems for the creditworthiness of Chinese businesses.

China skeptics have been warning about its bad debts for years. But the country has always had the financial clout to prop up the system when necessary, even if policymakers are increasingly willing to allow overextended companies to default. It could be that the huge expense to combat the virus will soak up any excess capital in the system, leaving businesses to fend for themselves at a time they can ill afford to do so.

If the virus does not peak until April, China's economic growth will slow to 4.4%, S&P predicts. That would drive nonperforming loans in China to 10.1 trillion yuan ($1.45 trillion). That's an increase of 7.7 trillion yuan ($1.10 trillion) over current levels.

It's likely that China's official figures for nonperforming loans would not reflect the true picture on the ground.

The China Banking and Insurance Regulatory Commission on Jan. 26 asked Chinese banks to give "special consideration" to companies that are struggling to repay loans, such as declaring a moratorium on repayments. The banking regulator also asked banks to support companies in Hubei Province and the parts of China hit hardest by the outbreak.

As a result, the official nonperforming loans may remain at 2%. But that's only because the bulk of loans that are actually not performing are being given "special consideration." The banking regulatory is also likely to go easy on banks in terms of the rules for recognizing bad debts.

Bad loans would actually peak at 7.8% of total loans, S&P projects, in its worst-case scenario. Together with other problem loans masked for "special mention" or "special consideration," the questionable loan ratio could peak at 13.3%, according to S&P.

It may take years for lending standards to improve once again. China would not be alone in relaxing lending standards in response to a natural disaster, but the track record in Asia has been to allow debts racked up during such a period to fester.

"We see a risk that companies may exploit relaxed standards to drag out repayments for years," S&P's primary credit analyst Ming Tan states in a report. "We saw some instances of this in Japan and Taiwan following natural disasters."

In response to the 2011 Fukushima earthquake, tsunami and nuclear disaster, Japan allowed banks to reduce or release victims from their individual debts, such as mortgages and individual business loans, settling them out of court. Big companies received government support, and they as a result made good on most forborne loans.

After a devastating earthquake in Taiwan in 1999, the Ministry of Finance let disaster-hit companies and mortgage borrowers extend loan repayment periods by up to five years. Some Taiwanese banks then spent years "amortizing" their losses, S&P notes, "effectively kicking the can down the road, and in so doing undermining loan-classification standards."

China has been on the warpath over the last three years, in a bid to improve credit standards, remove dodgy "shadow banking" debt, and restrict over borrowing by companies, particularly in non-core businesses. But last year Beijing was forced to bail out Baoshang Bank in Inner Mongolia, the first bank failure in more than 20 years. The state then also took over two other regional banks, the Bank of Jinzhou and Hengfeng Bank, resulting in public nervousness about other small lenders.

Less-creditworthy banks and companies are now likely to be allowed to drift along for years to come. The Chinese leadership is desperate to redeem itself after perceived failings in its slow response to the virus, and attempts to cover up early cases. So Beijing is starting to roll out hefty stimulus measures to improve financial and social stability.

It rings true that the official nonperforming loans may remain at 2% while the actual figure is far higher.

China always hits its "forecasts" for economic growth, one way or another. The Communist Party has delayed its major meeting slated for March, in which it normally "predicts" growth for the year. At the National People's Congress, when China's rubber-stamp parliament meets, the top brass was expected to mandate growth of "around 6.0%." But the meeting will not take place as scheduled. Beijing currently mandates a 14-day quarantine period for anyone arriving from outside the city.

The death rate from the Covid-19 disease has also stayed remarkably consistent. Authorities have walked it slightly higher over the last few days, now standing at 2.96% for cases within China's borders. Up from 2.1%, and with the method of categorizing cases already changed twice, it will be interesting to see if it is allowed to rise above 3.00%.

The death rate is higher within Hubei Province, the epicenter, where it's killing 3.4% of infected patients. That's likely due to lower health-care standards, as hospitals and medical professionals struggle to get supplies, even enough protective clothing. Three provinces, including Hubei, are starting to report cases within their prison system, which is already notorious for poor standards of medical care.

Besides the National People's Congress, its flagship political event of the year, China has also delayed the Boao Forum, its version of Davos, at which it brings together movers and shakers from around Asia. The congress was slated to start March 5, and the Boao Forum on March 24, but it's not yet clear when either event will now take place.

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