JP MORGAN: 1 in 12 Chinese loans will hit trouble when the bubble bursts

There’s a lot of excess debt in China. And the JP Morgan Asia financials analysis team led by Josh Klaczek think they know just how it will end.

They estimate that the peak of China’s credit cycle will see about 1 in 12 loans, or 8.2%, becoming “non-performing,” which is when borrowers are late with their interest payments and don’t have a plan to pay them.

That figure drops to around 5.5%, or a bit more than one in 20, if you take out the shadow banking system.

To put it in to perspective, US had a non-performing loan ratio of about 7% in the run up to the 2008 financial crisis and Japan was up at 11% for its 1990 bust.

It means that the problems in China, and Asia as a whole, still have a while to play out.

Here’s what the analysts have to say (emphasis ours):

These ratios don’t indicate a crisis, but do argue for patience in calling an end to recent stress. NPL cycles typically take 11 quarters from trough-to-peak, and we’re about one-third of the way through in Asia.

JP Morgan think is it will be a while before China’s stock market recovers, because all this bad debt will have to be worked through the system and losses taken by banks before investors will get back on board.

The Shanghai Composite is down about 41% from its peak and, if this graph is correct, there’s further to fall:

China’s debt level has a lot to do with hot money that has flowed in from abroad. It’s given the country a temporary boost and allowed its companies to borrow, but international creditors are always looking for the next big thing and can withdraw quickly.

It happened in Spain, Japan and south east Asia, all of whom met a bad end when the bubble finally burst.

Here’s the JP Morgan chart:

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