Should We Worry About The Chinese Banks

Thanks to the current financial combustion, many of the usual top banks have been cut at their knees. Many China banks have been elevated up the biggest bank ladder. The strong equity run up over the past 6 months in China has pushed their valuations even further ahead of the rest. But just how solid are the Chinese banks. We all know that many of these banks still have tons of "unsettled loans to state owned companies". Their recent aggressive bank lending, exhorted by Beijing, meant that their loan portfolio cannot be too pretty.

China's banks posted relatively flat profit growth in H1 2009 as new lending more than doubled. The surge in liquidity meant that non-performing loans decreased as a percentage of assets (mostly due to an increase in the denominator). Regulators have indicated that lending standards will tighten in H2, which along with the need to meet new capital adequacy requirements could eat into profits. However, a shift toward longer-term loans and and shift of savers into demand deposits may increase the net-interest margin for banks, which fell in H1 2009 due to lower interest rates.

• ICBC, the world's largest lender by market value, posted a 2.9% rise in profit for H1 2009 on a 17% jump in total assets, dramatically slower than the 57% profit growth posted in H1 2008. H1 profit rose to RMB66.42 billion (US$9.72 billion) as the bank issued RMB865 billion in new loans (up 19% y/y). Non-performing loans fell to 1.81% of assets from 2.29% at the end of 2008. The bank's net interest margin fell 70 basis points to 2.25% on lower interest rates.
• John Foley, BreakingViews: "For now, ICBC's balance sheet is iron-clad. Tangible common equity is a healthy 5% of total assets. Loans are 58% of deposits." But a tide of liquidity may just be refinancing risky commercial loans, pushing off problems for later.
• FT's Lex notes that the increase in equity prices encourages a shift from term to demand deposits which cost the banks less and could improve interest margins in Q3. Moreover the effects of higher capital adequacy ratios will not come until late in 2009 or more likely early in 2010.
• China's second largest bank by market value, China Construction Bank (CCB), profit fell 4.9% from H1 2008 to RMB55.8 billion in H1 2009. CCB reported RMB29.55 billion (US$4.33 billion) in net income for Q2. Net fees and income increased as the bank set aside 7.8% less in provisions for bad loans. Net interest margin narrowed to 2.46% from 3.29% on lower interest rates.
• Much of the decline in NPLs of ICBC and CCB was due to write-offs and a higher recovery rate. CCB’s coverage ratio grew to 150% in Q2 2009, meaning it is the first big bank to meet the new capital restrictions which will be implemented in 2010, a step that should reduce its costs in H2 2009.
• Bank of China (BoC), the third largest lender, reported a 2.5% drop in profits for H1 2009, though Q2 saw a 21.5% increase over Q1. Its net-interest margin was 2.04%, down 68 basis points from H1 2008, and its net interest income fell 8.3% to RMB74.7 billion (US$10.9 billion). BoC had the highest exposure to the U.S. housing market at the start of the crisis. The bank still held US$2.2 billion in U.S. subprime investments at the end of H1 and its impairment losses on subprime-related investments stood at US$4.67 billion (down from US$4.84 billion at end of Q1).
• China's banking regulator noted that 12 small and midsize commercial banks saw net profit fall an average 19% in H1 2009.

How Much will Non Performing Loans Increase?

• The increase in NPLs may come in mid to late 2010 given that they tend to peak 12-18 months after a credit boom. However, the revival in property markets and increase in mid to longer-term loans may limit the deterioration of assets.
• Fitch: Loan growth is driven by monetary policy that encourages banks to expand loan portfolios. Banks make up for lower loan margins with expanded loan volumes and an assumption that stimulus-related credit losses will be covered by the central and/or local government. The increase in corporate loan portfolios and credit expansion may threaten the medium-term outlook for Chinese banks.
• Higher NPLs/credit costs will be driven by lower collateral values, declining recoveries and higher NPL formation levels. The sector’s 2009 NPL ratio may rise 74bps to 3.0%.
• Net interest margin expansion, a lower tax rate and fee income helped boost earnings in H1 2008
• China plans to make it easier for banks to participate in M&A, as part of encouraging consolidation and taking steps to liberalize China’s financial system by allowing banks to be less affected by the government’s interest-rate policy.

p/s photos: Kelly Lin