Chinese Banks’ Ratings Downgraded as Local Governments Struggle With Debt

Stocks down 14% from May high, market value evaporates by $77 billion

A Chinese bank employee counts U.S. dollar bills at a bank counter in Nantong in China's eastern Jiangsu Province on Aug. 6, 2019. STR/AFP via Getty Images

Shares in Chinese banks plunged after Goldman Sachs downgraded some ratings due to high local government debt.

According to a July 11 Bloomberg report, shares in China’s banking sector are on the cusp of historically low valuations. Bloomberg Intelligence’s index of Chinese bank stocks is down 14 percent from this year’s high in May, wiping out $77 billion in market value.

Goldman Sachs’ July 4 analysis of 12 listed Chinese banks had “sell” ratings on five, “neutral” ratings on three, and “buy” ratings on four.

The five Chinese banks with sell ratings are the Industrial and Commercial Bank of China, Agricultural Bank of China, Bank of Communications, Industrial Bank, and Huaxia Bank.

The three banks with “neutral” ratings are the Bank of China, China Merchants Bank, and Bank of Nanjing.

The four with “buy” ratings are China Construction Bank, Postal Savings Bank, Bank of Ningbo, and Ping An Bank.

The report highlighted the risks to bank margins posed by rising losses on local government debt and credit portfolios, which could dent earnings growth and pressure capital accumulation, thereby affecting dividend payouts.

A Bank of China branch in the City of London on May 13, 2016.  Dan Kitwood/Getty Images

China’s total local government debt reached 66 trillion yuan ($9.1 trillion) by the end of 2022, up from 40 trillion yuan ($5.5 trillion) in 2019, according to the International Monetary Fund’s estimate in February. The debt is considered the biggest financial risk in Asia in 2023.

In January, China’s Ministry of Finance made it clear that for local government debt risks, the central authorities should adhere to the principle of non-rescue. However, in the following months, Guizhou, Shandong, Yunnan, and other provinces successively broke news of local government bonds being difficult to be repaid when they mature.

China’s biggest state-owned banks are offering ultra-long-term loans and temporary interest relief to local government financing vehicles, preventing a credit crunch in an increasingly tight huge debts market, people familiar with the matter told Bloomberg.

People familiar with the matter said banks, including the Industrial and Commercial Bank of China and China Construction Bank, had begun to extend 25-year loans to creditworthy and eligible local government financing vehicles rather than the current 10-year loans for most companies. Some programs waive any interest or principal payments for the first four years, though interest accrues later.

Guo Jun, editor-in-chief of the Hong Kong edition of The Epoch Times, told NTD TV’s “Pinnacle View“ that forcing commercial banks to lend money to local authorities is in fact, giving the money to the latter. In addition, the fact that they do not have to pay back the interest for the first four years is tantamount to transferring the bank’s profits to the local finances, which could be fatal to the banks and even suicidal to the macroeconomy.

Ms. Guo explained that the local government’s hole is too big. If the bank gives the money to local authorities, they cannot lend it to enterprises. That would be tantamount to tightening the monetary system, which would negatively affect China’s economy.

Guo Jun, one of the co-founders of The Epoch Times and the head of the Hong Kong edition of The Epoch Times, on April 14, 2021. The Epoch Times

Guo said that if the Chinese government does this, it will put enormous pressure on commercial banks—profits would plummet, asset profitability would fall, and they might even lose money altogether.

She said the reduction in foreign capital’s stock holdings is only a mild reaction. Yet if the credit ratings of China’s banks are further downgraded, and the corresponding bonds become “junk” rated, the cost of overseas financing for China’s banks will rise dramatically.

Ms. Guo pointed out that Wall Street has a lot of business dealings with these commercial banks in China and that any major problems with the Chinese banks will trigger a reaction from U.S. capital.

Chinese bank stocks in the Hong Kong stock market have dropped since the Goldman Sachs report, with the Hang Seng Mainland China Banking Index (HSMBI) falling 3.6 percent on July 6. The corresponding share prices plummeted in the following few working days until July 11, when the decline eased.

As the report aroused market concern, Goldman Sachs responded on July 6 that the report involved ratings on 12 banks, only 30 percent of the 42 A-share-listed banks. In addition, there are seven banks with “buy” and “neutral” in total, which is not as pessimistic as the market rumors.

The logo for Goldman Sachs at the New York Stock Exchange (NYSE) in New York on Nov. 17, 2021. Andrew Kelly/Reuters

However, in a rare move, Goldman Sachs was criticized in a front-page article on July 7 by Securities Times, a subsidiary of the People’s Daily, for “misinterpreting the fundamentals of China’s banks.”

The authors said the market should not look at Chinese banks based on pessimistic assumptions, and the negative premise is a misinterpretation of the facts. According to the article, Chinese banks have been actively reducing their exposure to real estate lending while local authorities are stepping up their efforts to resolve debt risks.

This is not the first time a Wall Street research report has caused controversy in China. In March 2022, analysts at JP Morgan downgraded 28 Chinese technology companies, calling China’s Internet industry “uninvestable” in the short term. JP Morgan then lost its position as a senior underwriter for a company’s Hong Kong IPO.