Banks that issued a combined 7 trillion yuan in loans during the first half are now confronting earnings issues – and the future.
By Wen Xiu, Fang Huilei and Feng Zhe 04 September 2009
(Caijing Magazine) As sunlight beamed through a ceiling dome at the Beijing headquarters of China Construction Bank, Chairman Guo Shuqing couldn’t resist a comparison to CCB’s latest financial report.
“The sunshine is as splendid as our performance,” Guo told reporters who had gathered to review the bank’s interim, first-half 2009 report.
Indeed, CCB (SSE: 601939, HKEX: 00939) posted an impressive performance for the period, outshining other major banks in light of an enormous, nationwide surge in bank lending – an industry wide 7.37 trillion yuan in new loans between January and June.
CCB launched its loan campaign before other banks. It also turned more cautious toward lending in April. As a result, CCB issued fewer loans than other big, state-owned banks even while its loan-loss provision ratio rose above peers to as much as 150 percent, the standard set by banking regulators.
Although earnings fell 4.86 percent year-on-year in the first half, CCB said its lending position had laid a solid foundation for higher profits in 2009.
Nevertheless, the stock market’s response was less than upbeat for CCB and other banks after they issued first-half reports in late August.
Some investors apparently saw the unprecedented lending spree as a factor that could doom bank performance in the long run. They fear a downward trend could begin after some borrowers default, saddling banks with non-performing loans (NPLs).
In fact, as the market has been hinting lately, a golden age for Chinese banks may be ending.
NPL Fears
Quality control for loans issued during the recent borrowing binge will be a key factor for bank profitability for the foreseeable future.
First-half data from regulators shows the banking industry had offered an optimistic picture of decreasing balances and NPL ratios. But the picture seems suspicious. One reason is that the astronomical increase in lending helped decrease NPL ratios.
Meanwhile, many banks have been working hard to recover or write off old NPLs in hopes of covering for any new defaults. In other words, new lending was offset by settling dormant NPLs.
“What can really present the whole picture is the gross, non-performing loan balance,” said one analyst. “That is, the increase in non-performing loans plus the amount of existing NPLs recovered or written off in the same period.”
For example, CCB’s report said its NPLs in the first half decreased by 6.67 billion yuan. However, the bank also said it had recovered 19.6 billion yuan from older NPLs in the first half.
Bank of China’s interim first-half report said its NPL basket contracted by 10 billion yuan. BOC President Li Lihui said the bank recovered 12.6 billion yuan and wrote off 3.8 billion yuan worth of NPLs.
If other measures such as restructurings, acquisitions and mergers are taken into consideration, it could be said that BOC absorbed a total 22.6 billion yuan in NPLs.
Liao Qiang, a financial analyst at Standard & Poor’s, said the overall quality of loan clients worsened while client numbers increased during the loan campaign. Many loan applicants who failed bank criteria tests were approved anyway, Liao said.
A senior analyst from a commercial bank said: “The problems of new loans will not emerge until two years pass. Due to massive levels of capital on the market, many enterprises can still hang on and, therefore, a large outbreak of NPLs will be delayed.”
The analyst also said NPLs would have surfaced already if not for the Chinese government’s spending this year through a 4 trillion yuan economic stimulus package.
“Governments are playing an important role in supporting many projects,” a banking source said. “Without government support, many projects would not sustain themselves with their own capital.”
Liao argued that bad credit now poses a major risk for the domestic banking industry, adding operational risks tied to the loan surge will gradually unfold.
“Time will clarify the issue,” he said.
Profit Squeeze
Meanwhile, banks are being forced to face up to falling profits. One of the most popular among investors, China Merchants Bank (SSE: 600036, HKEX: 00036), reported a 37.4 percent drop in first half profit year-on-year -- the steepest earnings decline among China’s listed banks. The same day, China CITIC Bank (SSE: 601998, HKEX: 00998) posted a 16 percent decline in net profit.
CMB and CITIC blamed their poor performances on decreasing interest rate differentials. CMB’s differential fell 1.42 percent while CITIC’s declined 1 percent, although both were higher than the industry average.
The central bank cut benchmark interest rates five times in 2008. That was followed by a loosening of bank lending limits, lowering loan costs and narrowing the rate gaps between bank borrowing and lending.
Banks responded by issuing more loans -- 2.3 times more than during the first half 2008. However, the lending increase could not offset the narrowed interest rate gap and declines in per-loan earnings.
Uncertain Prospects
What banks tried to convey to the market while issuing their first-half reports in August was that interest rate differentials were expected to bottom out in the second half of the year. In turn, they said, financial performances would rise.
However, the industry rate differential is not likely to bounce back to the original – and now enviable -- 3.5 percent. According to an analysis by China International Capital Corp. Ltd., listed banks’ interest rate differentials, if the benchmark interest rate keeps steady, are expected to increase 8 basis points to 2.43 percent in 2010 and 2 basis points to 2.45 percent in 2011.
And any upward trend would depend on a stable increase in interest revenue from borrowers – a situation that appears difficult considering the change in China’s loan climate since June.
The loan pace slowed as the first half wound down in June. That month, lending rose by only about 300 billion yuan, compared with a peak of 1.6 trillion yuan per month earlier in the year.
How the loan business will fare in the second half has yet to be determined. BOC officials argue that prospects for the second half would not completely depend on the government’s macroeconomic policy decisions. Rather, Li told Caijing the stock market would influence bank lending, explaining that if the market continues to attract investors, bank deposits would greatly fluctuate.
Meanwhile, the disposal of BOC’s derivative products related to the collapsed market for U.S. subprime mortgages will also depend on the market. This issue was described August 27 by Zhu Ming, BOC vice president, who said the bank sold some of its subprime mortgage-related bonds in the first half.
By the end of June, Zhu said, the face value of subprime mortgage-related bonds held by BOC had decreased by US$ 6 billion. Zhu said the bank may get a chance to sell more bonds in the future, although risks tied to these bonds are considered low.
Loan-loss Dilemma
Bank loan-loss provisions are also affecting bank profits, according to the latest financial statements. Raising loan-loss provisions equips a bank for future risk and stability, but squeezes short-term profits.
Since early this year, bank regulators have required commercial banks to raise loan-loss provision ratios to at least 130 percent to protect against possible future losses. That requirement was raised to 150 percent in June.
The average provision ratio among listed banks at the end of July had reached more than 169.5 percent. At the high end was CMB, with a ratio of more than 241 percent, while the industry’s lowest ratio was 133 percent at Shenzhen Development Bank.
“In the first quarter, the increase of loan-loss provision exerted a negative impact on bank net profits,” said an expert working in the risk management department of a major bank. He added that “profitability will be under more pressure” as a result of the decision to raise the required ratio to 150 percent.
A regulatory source told Caijing some banks have failed to properly assess loan risks and need relatively high loan-loss provision ratios for their own protection.
“Many banks have not established systematic and precise measurements for assessing risks,” the source said. “The categorization of many loans is casual, so raising provision coverage ratios in advance is necessary.”
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Post-Lending Boom Blues for China’s Banks
Banks that issued a combined 7 trillion yuan in loans during the first half are now confronting earnings issues – and the future.
By Wen Xiu, Fang Huilei and Feng Zhe
04 September 2009
(Caijing Magazine) As sunlight beamed through a ceiling dome at the Beijing headquarters of China Construction Bank, Chairman Guo Shuqing couldn’t resist a comparison to CCB’s latest financial report.
“The sunshine is as splendid as our performance,” Guo told reporters who had gathered to review the bank’s interim, first-half 2009 report.
Indeed, CCB (SSE: 601939, HKEX: 00939) posted an impressive performance for the period, outshining other major banks in light of an enormous, nationwide surge in bank lending – an industry wide 7.37 trillion yuan in new loans between January and June.
CCB launched its loan campaign before other banks. It also turned more cautious toward lending in April. As a result, CCB issued fewer loans than other big, state-owned banks even while its loan-loss provision ratio rose above peers to as much as 150 percent, the standard set by banking regulators.
Although earnings fell 4.86 percent year-on-year in the first half, CCB said its lending position had laid a solid foundation for higher profits in 2009.
Nevertheless, the stock market’s response was less than upbeat for CCB and other banks after they issued first-half reports in late August.
Some investors apparently saw the unprecedented lending spree as a factor that could doom bank performance in the long run. They fear a downward trend could begin after some borrowers default, saddling banks with non-performing loans (NPLs).
In fact, as the market has been hinting lately, a golden age for Chinese banks may be ending.
NPL Fears
Quality control for loans issued during the recent borrowing binge will be a key factor for bank profitability for the foreseeable future.
First-half data from regulators shows the banking industry had offered an optimistic picture of decreasing balances and NPL ratios. But the picture seems suspicious. One reason is that the astronomical increase in lending helped decrease NPL ratios.
Meanwhile, many banks have been working hard to recover or write off old NPLs in hopes of covering for any new defaults. In other words, new lending was offset by settling dormant NPLs.
“What can really present the whole picture is the gross, non-performing loan balance,” said one analyst. “That is, the increase in non-performing loans plus the amount of existing NPLs recovered or written off in the same period.”
For example, CCB’s report said its NPLs in the first half decreased by 6.67 billion yuan. However, the bank also said it had recovered 19.6 billion yuan from older NPLs in the first half.
Bank of China’s interim first-half report said its NPL basket contracted by 10 billion yuan. BOC President Li Lihui said the bank recovered 12.6 billion yuan and wrote off 3.8 billion yuan worth of NPLs.
If other measures such as restructurings, acquisitions and mergers are taken into consideration, it could be said that BOC absorbed a total 22.6 billion yuan in NPLs.
Liao Qiang, a financial analyst at Standard & Poor’s, said the overall quality of loan clients worsened while client numbers increased during the loan campaign. Many loan applicants who failed bank criteria tests were approved anyway, Liao said.
A senior analyst from a commercial bank said: “The problems of new loans will not emerge until two years pass. Due to massive levels of capital on the market, many enterprises can still hang on and, therefore, a large outbreak of NPLs will be delayed.”
The analyst also said NPLs would have surfaced already if not for the Chinese government’s spending this year through a 4 trillion yuan economic stimulus package.
“Governments are playing an important role in supporting many projects,” a banking source said. “Without government support, many projects would not sustain themselves with their own capital.”
Liao argued that bad credit now poses a major risk for the domestic banking industry, adding operational risks tied to the loan surge will gradually unfold.
“Time will clarify the issue,” he said.
Profit Squeeze
Meanwhile, banks are being forced to face up to falling profits. One of the most popular among investors, China Merchants Bank (SSE: 600036, HKEX: 00036), reported a 37.4 percent drop in first half profit year-on-year -- the steepest earnings decline among China’s listed banks. The same day, China CITIC Bank (SSE: 601998, HKEX: 00998) posted a 16 percent decline in net profit.
CMB and CITIC blamed their poor performances on decreasing interest rate differentials. CMB’s differential fell 1.42 percent while CITIC’s declined 1 percent, although both were higher than the industry average.
The central bank cut benchmark interest rates five times in 2008. That was followed by a loosening of bank lending limits, lowering loan costs and narrowing the rate gaps between bank borrowing and lending.
Banks responded by issuing more loans -- 2.3 times more than during the first half 2008. However, the lending increase could not offset the narrowed interest rate gap and declines in per-loan earnings.
Uncertain Prospects
What banks tried to convey to the market while issuing their first-half reports in August was that interest rate differentials were expected to bottom out in the second half of the year. In turn, they said, financial performances would rise.
However, the industry rate differential is not likely to bounce back to the original – and now enviable -- 3.5 percent. According to an analysis by China International Capital Corp. Ltd., listed banks’ interest rate differentials, if the benchmark interest rate keeps steady, are expected to increase 8 basis points to 2.43 percent in 2010 and 2 basis points to 2.45 percent in 2011.
And any upward trend would depend on a stable increase in interest revenue from borrowers – a situation that appears difficult considering the change in China’s loan climate since June.
The loan pace slowed as the first half wound down in June. That month, lending rose by only about 300 billion yuan, compared with a peak of 1.6 trillion yuan per month earlier in the year.
Looking Ahead
How the loan business will fare in the second half has yet to be determined. BOC officials argue that prospects for the second half would not completely depend on the government’s macroeconomic policy decisions. Rather, Li told Caijing the stock market would influence bank lending, explaining that if the market continues to attract investors, bank deposits would greatly fluctuate.
Meanwhile, the disposal of BOC’s derivative products related to the collapsed market for U.S. subprime mortgages will also depend on the market. This issue was described August 27 by Zhu Ming, BOC vice president, who said the bank sold some of its subprime mortgage-related bonds in the first half.
By the end of June, Zhu said, the face value of subprime mortgage-related bonds held by BOC had decreased by US$ 6 billion. Zhu said the bank may get a chance to sell more bonds in the future, although risks tied to these bonds are considered low.
Loan-loss Dilemma
Bank loan-loss provisions are also affecting bank profits, according to the latest financial statements. Raising loan-loss provisions equips a bank for future risk and stability, but squeezes short-term profits.
Since early this year, bank regulators have required commercial banks to raise loan-loss provision ratios to at least 130 percent to protect against possible future losses. That requirement was raised to 150 percent in June.
The average provision ratio among listed banks at the end of July had reached more than 169.5 percent. At the high end was CMB, with a ratio of more than 241 percent, while the industry’s lowest ratio was 133 percent at Shenzhen Development Bank.
“In the first quarter, the increase of loan-loss provision exerted a negative impact on bank net profits,” said an expert working in the risk management department of a major bank. He added that “profitability will be under more pressure” as a result of the decision to raise the required ratio to 150 percent.
A regulatory source told Caijing some banks have failed to properly assess loan risks and need relatively high loan-loss provision ratios for their own protection.
“Many banks have not established systematic and precise measurements for assessing risks,” the source said. “The categorization of many loans is casual, so raising provision coverage ratios in advance is necessary.”
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