Chinese Banks' Profit Decline to Worsen In 2H20

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Sunday, September 06, 2020 07:00 AM /by Fitch Ratings/ Header Image Credit:  PYMNTS


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The fall in Chinese banks' profits will accelerate in 2H20 as the authorities target to more than double the amount of non-performing loans (NPL) resolved compared with the first half of the year, Fitch Ratings says.


Chinese banks reported their aggregate net profit fell 9.4% yoy in 1H20 to CNY1 trillion. All Fitch-rated Chinese commercial banks reported net profit declines due to higher expected credit losses and lower net interest margins. In our rated portfolio, China Merchants Bank Co., Ltd. (CMB, BBB+/Stable/bb-) stood out with the smallest net profit decline of 1.5%.


Chinese banks' aggregate net profit in 2Q20 was also sharply lower quarter-on-quarter even though China's real GDP rose by 3.2% over the same period (from a 6.8% contraction in 1Q20), following government directives in June for banks to forgo returns to support the economy.


The China Banking and Insurance Regulatory Commission aims for full-year NPL resolution of CNY3.4 trillion in 2020, of which CNY1.1 trillion was completed in the first half. This compares with the CNY2.3 trillion of NPLs resolved in 2019.


Active NPL resolution has allowed the banks to maintain their reported allowance coverage ratios (182% for the sector at end-1H20) despite the impact from the coronavirus pandemic this year. However, this is at the expense of weaker reported profitability as banks saw varying levels of increases in provisioning. Most banks suggest the deterioration in consumer NPLs peaked in 2Q and has moderated since June.


These trends are consistent with China's official manufacturing Purchasing Manager's Index (PMI), which came in at 51.0 for August and has remained above 50 since March. That said, the banks have guided for higher NPLs (official sector NPL ratio was 1.94% at end-1H20) for the rest of the year as uncertainties remain amid the global pandemic and ongoing US-China tensions.

Core capital ratios generally fell during 1H20, as banks continued to grow their risk-weighted-assets. Loans were up 8% in 1H20 compared with the previous six months, in line with our expectation for full-year growth of 14% as loans typically increase faster in the first half for Chinese banks. It is still not yet clear when banks will be designated as domestic systemically important banks and would have to meet the regulatory minimum of 8.5% core capital ratio, although many mid-sized banks' ratios were approaching this level by end-1H20. Despite the challenging outlook on profitability, we believe the Chinese banks still aim to pay dividends for 2020, which could limit their pace of growth.


Chinese banks' top-line growth is also challenged by compression of their net interest margins. While most banks are nearing the completion of their transition to using the loan prime rate (LPR) as their benchmark, broader government directives to reduce borrowing costs will continue to suppress asset yields for banks, and fierce deposit competition will push up funding costs. Overall, we expect Fitch-rated banks to maintain similar risk appetites, but believe the pressures on their profitability and capitalisation will persist for the rest of 2020 and in 2021.

The outlook on Fitch's operating environment for Chinese banks is stable, reflecting our view that the 'bb+' mid-point adequately captures systemic risk for the rated banks. We expect regulators to remain committed to containing financial-sector risks, despite a one-off increase in system leverage to around 265% of GDP this year. Continued NPL recognition and resolution should help prevent a further build-up of credit risks in the system, and we view these factors as having a more lasting impact on our assessment of China's operating environment than near-term profitability pressures.


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