China Speeds Up Bad-Loan Help for Banks

BEIJING—Chinese regulators are speeding up ways to help banks shed bad loans, but some of the measures risk keeping "zombie" companies afloat while making lenders even more strapped for capital.

The deepening economic slowdown has heightened the need for banks to have more funds to lend out. A main feature in a plan outlined by central-bank and regulatory officials over the weekend would be to let banks sell dud loans to investors either by repackaging them as securities or transferring them to special asset-management companies that handle distressed debt.

Senior executives at China's Big Four state-owned banks say regulators are also exploring ways for banks to exchange bad loans for equity in certain too-big-to-fail companies—a potentially controversial step that they say could saddle banks with near-worthless stock and squeeze their liquidity.

Bank of China Ltd., one of the top four lenders, recently agreed to become the largest shareholder in a publicly traded shipbuilder under the yet-to-be-disclosed plan, people close to the bank say. Officials at the central bank and banking regulatory agency declined to comment.

The steps come as Chinese banks are seeing a surge in nonperforming loans and a sharp decline in profitability, as they absorb the effects of a yearslong lending binge. To make their books look healthier, many banks have extended new credit to corporate borrowers to repay existing debt.

Shang Fulin, chairman of the China Banking Regulatory Commission, indicated at a news conference on Saturday that policy makers see such rollover practices as a problem because the funds aren't used to invest in new projects and create fresh demand. "Through securitization and transfers of nonperforming assets, the hope is to increase the turnover rate of bank lending, thereby improving [banks'] ability to support the real economy," Mr. Shang said.

Total soured loans in China's banking system reached 1.27 trillion yuan ($195.5 billion) as of December, the highest level since mid-2006. Even as the official bad-loan ratio remains relatively low, at 1.67% as of year-end, it has been steadily climbing in the past three years. That is largely because Chinese steelmakers, coal miners and other manufacturers find it increasingly difficult to pay off debts because of weak demand and excessive industrial capacity.

Nonperforming loans could peak at around 7% of all loans in China in the current credit cycle, according to a recent analysis by J.P. Morgan Chase & Co., meaning the entire banking sector would need about $600 billion to replenish its capital. In a crisis scenario, China's bad-loan ratio would hit 20% and the banking system would require five trillion yuan ($770 billion) of capital, according to the report.

"The key question is, what is the roadmap out of a credit cycle or crisis?" asked the J.P. Morgan analysts.

Officials at the country's central bank, in particular, are wary of risks associated with securitization of loans, pointing to how risky securities tied to home mortgages helped trigger the 2008 global financial crisis. For now, the central bank has picked six large Chinese banks for a trial run of securitizing tens of billions of dollars of loans, according to people familiar with the matter. The banks include the Big Four—Industrial & Commercial Bank of China Ltd., China Construction Bank Corp., Agricultural Bank of China Ltd. and Bank of China—along with Bank of Communications Co. and China Merchants Bank.

Zhou Xiaochuan, China's central-bank governor, said Saturday that such securities could attract investors who specialize in buying troubled assets, but he stressed the need to draw lessons from the global financial crisis in developing the market.

Regulators are also refining a practice pioneered by former Premier Zhu Rongji, who in the late 1990s set up four state-owned asset-management companies to take over large amounts of bad loans from Chinese banks and resell them to other investors. Under the new plan, the range would be expanded from the four to include other institutional investors.

Meanwhile, as illustrated by the Bank of China example, regulators are starting to open the door to more debt-for-equity restructurings. Under the deal, the bank will hold about 14% of equity in China Huarong Energy Co., listed in Hong Kong and based in eastern China's Jiangsu province, in exchange for more than six billion yuan of loans owed by the struggling shipbuilder.

Current banking rules generally forbid commercial banks from taking stakes in nonfinancial entities. But regulators, led by the powerful government commission overseeing state assets—known as the State-owned Assets Supervision and Administration Commission, or SASAC—are pushing for changes in the rules to help heavily indebted state companies cut debts. Corporate debt now amounts to 160% of China's gross domestic product, according to Standard & Poor's Ratings Services. That is up from 98% in 2008 and compares with a current U.S. level of 70%.

Blessed by the leadership's goal to help companies deleverage, SASAC is compiling a list of big companies that could be slated for debt-for-equity swaps, according to officials close to the agency.

But many bankers think such swaps should only be allowed on a limited scale. By exchanging loans for equity that would be worth little if the companies already are struggling to pay off debts, banks would be required to sharply bump up the amount of capital they set aside against such equity holdings, which are considered more risky than loans. That would strain their liquidity.

"It doesn't sound like a great idea to save zombie companies with zombie banks," said Larry Hu, China economist at Macquarie Securities, a Sydney-based investment bank.

Write to Lingling Wei at lingling.wei@wsj.com

(END) Dow Jones Newswires

March 13, 2016 20:35 ET (00:35 GMT)

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