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Fitch: China Banks’ Profitability, Capital Pressures to Persist

September 08, 2015, 07:31 AM
Filed Under: Banking News
Related: China, Fitch Ratings

Chinese banks, especially mid-tier lenders, are likely to continue facing profitability and capitalisation pressures in the near term, says Fitch Ratings. Fitch expects that the macroeconomic slowdown will continue to result in weakening asset quality and suppressed revenue growth, while net interest margins will remain constrained by earlier interest-rate cuts.

Fitch-rated Chinese banks reported subdued 1H15 results, in line with Fitch's expectations that the earnings outlook would not improve this year (see "Chinese Banks' Earnings Unlikely to Improve in 2015", 13 April 2015). Net profit rose by 2.4% year-over-year on a weighted-average basis on revenue growth of 9.6% compared with full-year profit and revenue growth of 7.6% and 13.5% in 2014.

Ongoing NIM pressures were a key factor suppressing profit growth, and this should persist into 2016. The effects on lending rates of the five rounds of interest-rate cuts since November 2014 are expected to continue to filter through over the coming months. Furthermore, the slowing economy, which is contributing to greater bank scrutiny in credit decisions, regulatory restrictions on lending to certain sectors, and the local government debt swap programme, will continue to contribute to an absence of strong broad-based loan demand that will limit banks' ability to widen NIMs.

Continued deterioration in asset quality will also squeeze potential profit growth. Reported NPLs, "special mention" loans and overdue loans for rated banks rose by 27%, 23% and 42% versus end-2014. As a result, the reported system NPL ratio and special mention loan ratio rose to 1.50% and 3.64% respectively. Annualised NPL formation for rated banks nearly doubled to 1.21% from 0.65% in 1H14. The full-year NPL formation rate is likely to be higher, as Chinese banks often provision more aggressively in the second half of the year. Provision coverage is dropping sharply, given the higher NPL formation rates with weighted-average NPL provision coverage having dropped by 33pp to 189% as of end-1H15 for rated banks - the regulatory minimum is 150%.

Weakening asset quality could result in some profit decline in the near term, as banks cannot rely on lowering their provision coverage to generate positive profit growth. That said, government intervention through more aggressive disposals to asset management companies, debt migration and/or policy banks stepping into finance unfavourable projects, could mitigate the effects.

Rated mid-tier banks saw fee income surge to 39% yoy on average, driven by increases in wealth management and agency fees, as well as financial advisory/investment banking fees. The volatility seen in China's equity markets since July 2015 may slow the fee growth momentum, as the market turmoil and concerns over China's economic slowdown may reduce investor demand for such products and services.

As expected, reported capitalisation for state-owned banks has improved from slower asset expansion, except for Bank of Communications. We expect the state banks will focus more on their overseas expansions to mitigate the impact from the domestic economic slowdown. Capital adequacy ratios continue to decline for some mid-tier lenders, where loan and non-loan credit growth has remained aggressive, highlighting the broadly divergent financial trends between the larger state banks and others. This is reflected in their Viability Ratings, with China's large state banks at 'bb' while the mid-tier lenders are mostly in the 'b' range.

The authorities have cut rates, reduced reserve requirement ratios (RRRs), and removed the 75% statutory limit on loan/deposit ratios in part to help boost economic growth. The reserve ratio requirement (RRR) cuts in particular could help limit NIM contraction, and there is room for further cuts with the RRR only 3.5pp from the peak. These should help to ease some pressure on the banks, but unlikely to reverse the subdued earnings trends in the short term.

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