China's Banks Report Slowest Growth in 10 Years

BEIJING—China's biggest banks posted their lowest annual profit growth in a decade, as bad loans mount in an ailing economy that is pushing lenders toward riskier avenues of expansion.

Three major banks reporting 2015 results on Wednesday said that they wrote off 142 billion yuan ($21.85 billion) in irrecoverable debt last year, 1.4 times the volume in 2014, an indication that their customers—many of them state-owned industrial companies—are struggling to repay loans.

Bank profits were nearly flat, compared with rates near 40% just three years ago, with banks building ever-larger capital buffers to cover bad loans as Chinese companies flounder under a severe overhang of real estate inventory and excess industrial capacity.

The prevalence of bad loans means booming business for asset-restructuring companies—state-owned "bad banks" set up to soak up and sell off soured debt—prompting conventional banks to explore ways to keep such deals for themselves.

Net profit among commercial lenders rose 2.4% last year, compared with 9.6% a year earlier. China's largest bank by assets, Industrial & Commercial Bank of China Ltd., posted 0.5% profit growth to 277.1 billion yuan ($42.8 billion).

Profit at Bank of China Ltd., China's fourth-largest lender, which for the third quarter reported its first profit declineÂ in six years, rose 0.7% for all of last year.

Industrywide, nonperforming loans rose to 1.67% of total loans last year from 1.25% in 2014, the China Banking Regulatory Commission said. Investment bank China International Capital Corp. estimated the true ratio could be as high as 8.1% this year; other analysts have projected even higher estimates.

Credit is souring so fast that commercial lenders are having a hard time expanding capital provisions to keep pace. Two years ago, China Construction Bank Corp., the second-largest lender, was setting aside a buffer that was more than twice the size of their bad loans. Last year, that ratio had fallen to 1.5 times, it said Wednesday.

Slowing profits have forced many Chinese banks, especially midsize lenders, to invest aggressively in shadow-banking assets such as trust and wealth-management products. Such assets, termed "investment receivables," are opaque cocktails of high-yield risk that could jeopardize liquidity should banks need to offload them if markets turn turbulent, analysts say.

"The disclosure for such investment receivables is quite poor, and it's very difficult to judge the quality of the portfolio," said Christine Kuo, senior vice president at Moody's Investors Service.

Investment receivables at China Citic Bank Corp. rose 70.4% to 1.1 trillion yuan in 2015, the bank said. China's seventh-largest lender attributed the year-over-year rise to more investments in directional asset-management plans, which allow banks to repackage loans as off-balance sheet investments, and wealth-management products. Similarly, China Merchants Bank Co., the sixth-largest lender, said its investment receivables rose 75% last year.

As profits at commercial banks flatline, the so-called bad banks are flourishing. The biggest among them, China Huarong Asset Management Co., said last week its 2015 profit rose 36% from 2014. China Cinda Asset Management Co. said Tuesday its profit was up 18% in the period.

Asset-management companies have been enjoying a buyers' market, acquiring bad loans at about 30 cents on the dollar, as China's ailing real estate sector and heavy industries feed a bad-loan pipeline that is proving lucrative business for those who can repackage and sell their components. Huarong said the property sector alone accounted for some 66% of its distressed-debt acquisitions last year.

At such prices, analysts say, a small number of commercial lenders are experimenting with complex ways to restructure bad loans themselves—in one case, by having a bank-related company broker a deal to subscribe to a debtor's issue of new shares, the proceeds of which are used to pay off the debtor's bad loans.

A more popular means of disguising bad debt is by parking them in a category labeled "special mentions," which effectively is "a vast warehouse for unrecognized nonperforming loans" that isn't subject to detailed audits, said Ted Osborne, a partner at PricewaterhouseCoopers in Hong Kong specializing in debt restructuring.

ICBC reported it had 520.5 billion yuan of special-mention loans at the end of 2015, an amount nearly three times as large as its nonperforming loans and 63% larger than in 2014. Bank of Communications Co. reported 118.1 billion yuan of special-mention loans in 2015, more than twice the volume of its bad loans.

Banks are facing more problems as Beijing plans to let companies repay distressed loans via equity transfers to lenders.

Analysts say allowing nonviable companies to take on more leverage would prolong inefficiencies in the broader economy. "Such a policy move will likely accelerate bad-loan exposures at banks and impact their near-term earnings and profitability," said Bernstein Research analyst Wei Hou.

Such transfers reduce nonperforming loans on paper but could end up inflicting greater damage on bank balance sheets. These plans require lenders to set aside four times the value of the equity investment in capital provisions, far higher than the equivalent value that needs to be set aside for a regular corporate loan.

Liyan Qi contributed to this article.

Write to Chuin-Wei Yap at chuin-wei.yap@wsj.com

(END) Dow Jones Newswires

March 30, 2016 09:25 ET (13:25 GMT)

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