BEIJING (BLOOMBERG) - Soured loans at Chinese commercial banks rose to the highest level since June 2006 as the nation's economic expansion slowed to the weakest pace in a quarter century.

Non-performing loans rose 7 per cent from September to 1.27 trillion yuan (S$273.3 billion) by December, the slowest quarterly increase in two years, data from the China Banking Regulatory Commission showed on Monday (Feb 15). Including "special-mention" loans, where future repayment is at risk but yet to become non-performing, the industry's total troubled loans swelled to 4.2 trillion yuan, representing 5.46 per cent of total advances.

Concern over borrowers' ability to service debt has weighed on Chinese lenders, with shares of the nation's four largest banks trading at valuations at least 35 per cent below a gauge of their emerging-nation peers. China's economy grew last year at its slowest pace since 1990.

"The slower quarterly increase in NPLs are likely to be results of stepped-up efforts by banks to recollect loans, more aggressive write-offs, and some relaxation in their bad-loan recognition standards," said Chen Shujin, a Hong Kong-based analyst at DBS Vickers Hong Kong. "We don't expect to see any turnaround of asset quality until the end of this year."

Separately, the People's Bank of China reported on Tuesday (Feb 16) that new credit surged in January to a record 3.42 trillion yuan, almost double the amount in December and exceeding the median forecast of 2.2 trillion yuan in a Bloomberg survey of analysts. The increase was linked to a seasonal binge as banks front-loaded lending and Chinese borrowers refinancing foreign-denominated debt.

The CBRC data comes amid speculation that soured loans could be much larger than indicated by official data. Kyle Bass, a hedge fund manager who successfully bet against mortgages during the subprime collapse, said earlier this month that the Chinese banking system may see losses of more than four times those suffered by US lenders during the 2008 credit crisis.

That claim has been disputed by DBS' Chen and analysts at China International Capital Corp and Macquarie Securities.

Should the Chinese banking system lose 10 per cent of its assets because of nonperforming loans, the nation's banks will see about US$3.5 trillion in their equity vanish, Mr Bass, the founder of Dallas-based Hayman Capital Management, wrote this month in a letter to investors obtained by Bloomberg. Larry Hu, a China economist at Macquarie in Hong Kong, said in a research note on Monday that Mr Bass's estimate could be too large as it implied a true bad-loan ratio for China banks at 28 per cent to 30 per cent.

The industry's bad-loan coverage ratio, a measure of its ability to absorb potential losses from soured credit, weakened to 181 per cent in December from more than 200 per cent a year earlier, signaling a drag on future profits from the need to set aside additional reserves. The minimum required level is 150 per cent.

Shang Fulin, chairman of the banking regulator, told an internal meeting last month that banks would be forced to restructure, inject new capital or change their senior management if key risk indicators, such as bad-loan coverage and capital adequacy ratios, fall outside "reasonable ranges," according to people familiar with the situation.

The Hong Kong-listed shares of Industrial & Commercial Bank of China currently trade at 4.2 times their projected 12-month earnings, the highest valuation among China's four largest lenders by assets. That compares with a multiple of 6.5 times for the MSCI Emerging Markets Banks Index, according to data compiled by Bloomberg.

DBS's Chen said China banks are trading at trough value and it is the time for investors to start accumulating.

ICBC shares rose 2.8 per cent to HK$4.02 in Hong Kong as of 11.40am, and Bank of China rose 2.7 per cent to HK$3.

Chinese lenders' combined net profit expanded 2.43 per cent from 2014 to 1.59 trillion yuan last year, marking the weakest increase since at least 2011 when the banking regulator started releasing the profit numbers, the CBRC data showed. Banks' core Tier-1 capital ratio improved to 10.91 per cent as of Dec 31 from 10.66 per cent three months earlier.