China’s $77 Billion Bank Rout Shows Who Pays Price for Rescues

(Bloomberg) — Investors in Chinese bank stocks are getting a painful reminder of who’s likely to bear the brunt of government efforts to shore up the embattled real estate sector and revive economic growth.

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A Bloomberg Intelligence stock index of Chinese lenders has tumbled 14% from this year’s high in May, erasing $77 billion of market capitalization and leaving the industry’s shares on the cusp of their lowest-ever valuations.

Already under pressure from China’s monetary loosening and tepid demand, banks are facing renewed scrutiny after authorities asked the sector to extend debt relief to developers as the nation’s housing crisis continues. Some Wall Street analysts also have turned cautious, with Goldman Sachs Group Inc. taking a bearish view on the industry, a move that drew a rare rebuttal from a state-run Chinese newspaper last week.

The Bloomberg Intelligence gauge of Chinese bank stocks is trading at 0.27 times book value, just a whisker away from late October’s record low. That compares with 0.9 times for an index of global peers. The China gauge was little changed on Tuesday after registering mild gains early in the trading session.

The extension of relief measures for developers “will likely provide more of a sentiment boost to investors without fundamentally easing investors’ concern on commercial banks’ credit risk on troubled developers,” Citigroup Inc. analysts including Griffin Chan and Judy Zhang wrote in a note. Banks with high mortgage exposure could be more vulnerable, they added.

Regulators said late Monday they have asked banks to ease terms for real estate firms by encouraging negotiations to extend outstanding loans, a move that aims to ensure the delivery of homes still under construction. Some outstanding loans — including trust loans due by the end of 2024 — will be given a one-year repayment extension.

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Chinese lenders’ risk exposure to property amounted to about 20 trillion yuan ($2.8 trillion) as of the end of last year, including loans and bonds, accounting for about 5% of their total assets, according to estimates by China International Capital Corp. analysts including Lin Yingqi. Meantime, the non-performing loan ratio of real estate debt was about 4% at that time, they added.

The sector also stands conspicuously at the receiving end of risks from the $9 trillion debt pile among China’s local government financing vehicles as an economic recovery falters. Worries about their balance-sheet health have grown after Bloomberg News reported that top state lenders are offering LGFVs loans with ultra-long maturities and temporary interest relief to prevent a credit crunch.

Goldman estimates that 34 trillion yuan of local government debt sits on the balance sheets of banks it covers. These lenders’ combined assets account for 61% of the banking system’s total, according to the brokerage.

Chinese commercial banks’ net interest margin slid to a record low of 1.74% in March, according to data from the National Financial Regulatory Commission, below the 1.8% threshold that analysts and industry practitioners deem necessary to maintain reasonable profitability.

The lenders have seen their margins squeezed as they were urged by authorities to provide cheap loans to small businesses and home buyers to help prop up the economy. Loan demand from businesses and households, however, has weakened as a property bubble deflates and companies scale back investment.

“Since it’s hard for developers to improve their liquidity, banks still have to suffer the high possibility that most of their lending could turn into bad loans,” said Shen Meng, a director with Beijing-based investment bank Chanson & Co. “The latest policy can only help banks postpone their risk exposure.”

It’s a different picture in credit markets, where Chinese lenders’ bonds have been a sanctuary for investors even as the nation’s housing crisis unfolded and during the recent global banking turmoil.

Yield premiums over Treasuries for Chinese investment-grade dollar bonds, which are dominated by banks and financial institutions, reached a three-year low late last month and have since been hovering near the level, according to a Bloomberg index.

“Chinese bank bonds trade at very tight levels and inside of global banks as their debt is used as a proxy for the sovereign,” said Pri De Silva, a Bloomberg Intelligence analyst. “All banks are majority government-owned anyway and are crucial to public policy in China. So, they are basically treated as an extension of the central government.”

–With assistance from Dorothy Ma.

(Updates prices for stocks and bonds, as well as analyst comments)

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