More Signs of China’s Hissing Bubble: Four Biggest Banks Post Biggest Surge in Bad Loans

China’s central bank the People’s Bank of China (PBoC) reportedly suspended reverse repo operations which allegedly led to a spike in China’s interest rate markets as previously discussed here and here.

The other day, the PBoC reportedly re-entered the market but appear to have failed to bring down high rates in the Shibor which has spilled over to the yields of China’s 10 year bonds. 

Only stocks (as shown by the Shanghai Index above) responded positively to the PBoC’s intervention with the Shanghai index jumping by 1.48% yesterday.

Today fresh reports indicate why yields have remained high, and why the continued stress in the Chinese interest rate markets despite the PBoC’s interventions: Increasing incidences of souring loans from China’s biggest banks.

From Bloomberg:

China’s top four banks posted their biggest increase in soured loans since at least 2010 as a five-year credit spree left companies with excess manufacturing capacity and slower profit growth amid an economic slowdown.

Nonperforming loans at Industrial & Commercial Bank of China Ltd. (601398), China Construction Bank Corp. (939), Agricultural Bank (1288) of China Ltd. and Bank of China Ltd. (3988) rose 3.5 percent in the three months to Sept. 30 from June to a combined 329.4 billion yuan ($54 billion), according to data compiled by Bloomberg News based on third-quarter results. Profit rose to 209 billion yuan.

The rise in defaults adds to concerns bank profitability may decline as policy makers seek to trim production at cement makers to paper manufacturers that have gorged on credit since 2008, while urging lenders to build buffers to cover loan losses. China’s biggest state-run banks are trading near record-low valuations as investors brace for a surge in bad debts and slower credit growth.

Interest rate payments soar…

Interest owed by borrowers has risen to 12.5 percent of Chinese gross domestic product in 2013 from 7 percent in 2008, Fitch Ratings estimated in a report last month. The figure may rise to as high as 22 percent by the end of 2017, which could “ultimately overwhelm borrowers,” the agency said.

When the markets begin to question the ability of firms or nations to service their debt/s, where the cost of servicing debt (interest and principal) overcome the profit centers, then confidence to refinance existing bad loans will grind to a screeching halt. This leads to more accounts of bad loans and more bankruptcies.

So the bad loans from the periphery has now reached and exacerbated conditions at the core. As I earlier noted:

Fourth some major Chinese banks have been bruised from the recent losses in the bond markets. With $175 billion of maturing debt in 2014 amidst rising interest rates the S&P warns of an escalation of bad loans. So rising rates have begun to bite on China’s real economy. As to how credit will continue to expand in a system inundated with debt as rates continue climb is like water flowing uphill.

The question now is how policymakers will address this.

So far as of this writing Shibor rates have been mixed, with some maturities going up and while others marginally down. Overall, they have been trading at proximately  at recent highs.

Yields of Chinese 10 year bonds at new highs (since 2007), again as of this writing.

If Chinese financial markets unglues or crumbles, will there not be a contagion?