(Clarifies description of the company, legal status in headline
* Local bank suing local govt property firm over bad debt
* Bank, firm based in same city; borrower owns bank shares
* Highlights divergence of interests between banks,
By Pete Sweeney
SHANGHAI, July 1 A Chinese bank is suing a local
government-controlled property investment firm over a bad loan
in a rare public display of a deepening rift between lenders and
borrowers in China's murky $3 trillion local debt market.
The unusual step also highlights growing strains in the
market confronted by slowing economic growth and a property
sector that has started to cool off after decades of runaway
Qilu Bank, based in the city of Jinan in the coastal
province of Shandong, announced in its 2013 annual report -
published online in Chinese and English - that it was suing the
Urban Construction and Comprehensive Development Company of
Licheng District over unpaid debt.
The bank said the company had failed to make payments on a
35.4 million yuan ($5.71 million) outstanding loan, along with
6.1 million yuan in unpaid interest.
"To the best of our knowledge, this is the first official
disclosure of a LGFV (local government financing vehicle)
default on a bank loan," wrote Nomura analysts in a research
note distributed to clients on Monday.
Qilu Bank, in response to emailed questions from Reuters,
said it planned to make a public announcement regarding the case
but did not give a timeline.
Calls to the Licheng District company were not answered.
Much of China's massive debt overhang and its accompanying
industrial overcapacity was incurred by local governments using
such vehicles, known as LGFVs, and other companies they control.
Such entities, financed by local banks, were linked to the
local governments and conducted investment activities on their
behalf, dabbling in real estate, battening on subsidies to
strategic industries like solar power, and otherwise helping
contribute to China's industrial overcapacity and its real
estate asset price bubble.
Until recently banks have been willing to roll over their
debts indefinitely, avoiding write-downs and keeping reported
non-performing loan (NPL) ratios at levels well below what
analysts considered realistic -- a strategy analysts say worked
fine so long as China maintained double-digit economic growth.
Chinese banking sources agreed that while de-facto defaults
by LGFVs are common, the public nature of the disclosure was
unusual given the fraternal relationship between the two
entities. Both are headquartered in Jinan, and according to the
Qilu report the Licheng District company is one of its
shareholders, holding 0.08 percent of its shares.
"LGFV defaults are to be expected and are inevitable," said
a loan officer at a Shanghai-based Chinese bank, who spoke on
condition of anonymity, but said in most cases the defaults were
hidden from public view using accounting methods.
However, pressured by regulators to clean up their books,
banks have grown less willing to roll over the loans and more
sceptical about local governments' readiness to bail out their
failing financing arms.
A senior bond trader at a major Chinese state-owned bank in
Shanghai noted that while investors still largely considered
debt issued by provincial-level financing vehicles to be
effectively guaranteed, that no longer held true for lower level
"Bonds issued by provincial LGFVs are privately guaranteed
by related local governments, but I don't think lower-level
LGFVs' debt is guaranteed in a similar way."
Beijing has said it is trying to move away from the
investment-intensive economic model that spurred the development
of local financing vehicles, and the central bank announced in
January that it would move to eliminate those with "unclear
functions" and unsustainable finances.
The local government financing vehicle bond market has yet
to experience a public default. Beijing did allow China's first
default of a publicly traded bond in March, and since then other
firms have also defaulted, but none of them have been operating
under presumed government guarantees the way LGFVs do.
($1 = 6.2000 Chinese Yuan Renminbi)
(Additional reporting by Lu Jianxin and the Shanghai Newsroom;
Editing by Tomasz Janowski)