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Chinese big banks expect high loan-loss provisions, but margin pressure may ease

The largest banks in China said their buffer against expected loan losses may stay at elevated levels in the second half of 2020, although pressure on net interest margins may ease, after they reported the sharpest year-over-year decline in their first-half net profit in recent years.

Among the nation's five biggest lenders by assets, Bank of China Ltd. reported the steepest drop in net profit for the six months ended June 30, down 11.51% from a year earlier to 100.92 billion yuan. Impairment losses on loans, also called loan-loss provisions in other markets, rose 70% to 60.73 billion yuan from 35.72 billion yuan a year earlier, also the largest increase among major lenders. Its nonperforming loan ratio increased to 1.42% as of June 30, from 1.37% as of end-2019.

"We will continue to increase our provisions to hedge against [loan loss] risk … But the overall risk is still reasonable and manageable," Liu Jiandong, chief risk officer of Bank of China, said in an earnings teleconference Aug. 31. "In the second half, we will need to strengthen our risk management, speed up the sale of bad debts and the use of debt-to-equity swap to handle nonperforming loans."

In a bid to revive the world's second-largest economy that was first hit by global trade tensions and then by the coronavirus pandemic, Beijing has been pushing banks to lend more aggressively and cheaply, especially to projects and small businesses that have weaker credit profiles. The government also allowed banks to postpone the recognition of some of the troubled loans, extended loan moratoriums to March 2021, and launched state-sponsored credit guarantees for small and medium enterprises to share lending risks with financial institutions.

Other major lenders also set aside greater provisions in the first half as more loans were deemed risky. Impairment losses on loans at China Construction Bank Corp. rose 49% to 111.38 billion yuan from a year earlier. It was followed by a year-over-year increase of loan impairment losses of 35% at Agricultural Bank of China Ltd., 26% at Industrial & Commercial Bank of China Ltd. and 21% at Postal Savings Bank of China Co. Ltd.

Loan losses remain major concern

During the first half of 2020, ICBC's net profit fell 11.4% from a year earlier. It was followed by a 10.74% fall at China Construction Bank, a 10.4% drop at Agricultural Bank and a 9.96% decline at Postal Savings Bank.

"In the second half, we will need to focus on our monitoring of the risk of borrowers who delay their repayment of principals and interests," Liao Lin, chief risk officer at ICBC, said at the bank's earnings teleconference Aug. 31. "But we are confident that we can manage it as the Chinese economy is recovering."

While pressure from bad loans is expected to drag on earnings, China Construction Bank's chief risk officer Jin Yanmin said Aug. 31 that the lender's nonperforming loan situation "won't be as bad as before," citing the nation's efforts to contain the pandemic.

Bruce Pang, head of Macro and Strategy Research at China Renaissance, said Chinese banks' nonperforming loan ratios could be "steady or even improved" when the loan moratorium expires next year. "If the inclusive [small and medium enterprise] lending and support to manufacturers with cheaper and easier credit can successfully lead to a V-shape economy recovery from [the second half of 2020], [that could] prevent widespread bankruptcies and worker layoffs while bolstering the manufacturing industry."

For large-scale commercial banks, the average nonperforming loan ratio rose to 1.45% in the second quarter from 1.39% in the first quarter, according to the Chinese Banking and Insurance Regulatory Commission.

Recent bank loan data suggested default risk might have moderated in the second quarter. Analysts said previously that China's economic recovery appears to be on a firmer footing, as credit demand is driven more by the manufacturing, infrastructure and private sectors, instead of real estate and investments in stocks and bonds as in previous economic cycles.

Margin pressure may ease

All five major banks lent more in the first half, but reported lower or flat net interest margins. ICBC posted the biggest year-over-year drop of 16 basis points to 2.13%, followed by 13-bp decline each at China Construction Bank and Postal Savings Bank. The NIMs at Agricultural Bank and Bank of China were largely flat.

"Net interest margin will continue to narrow in the second half, but the pressure will likely be less than in the first half," Zhang Jinliang, chairman of Postal Savings Bank, told an earnings teleconference Aug. 31.

Since early 2018, the Chinese central bank has cut the banks' required reserve ratios multiple times, and has gradually lowered the benchmark interest rates in order to bring down funding costs. The government also explicitly asked the banks to "forgo" profits for now, and offer loans at more affordable rates to borrowers facing liquidity stress.

For example, ICBC said the average interest rate on its new loans fell 40 bps to 4.53% in the first half from the previous year. The average interest rate on so-called inclusive loans, which are no more than 10 million yuan per credit line, fell 87 bps as the bank also waived some of the transaction fees.

As the Chinese economy started recovering in the second quarter, the People's Bank of China has not lowered the loan prime rates since April. The central bank had earlier cut the LPRs five times, or 40 bps in total, since the new benchmarks were introduced in August 2019.

The other benchmark, the Shanghai Interbank Offered Rates, started rising in April. As of Aug. 28, the one-year Shibor stood at 2.922%, after hitting this year's lowest level of 1.674% in mid-April.

Although the LPRs may fall more slowly from now, Postal Savings Bank's Zhang said since banks are required to gradually increase the proportion of new loans that are priced against the LPRs, the full impact of the new benchmark rates on net interest margins "could become more obvious" in the second half of this year as well as 2021.

Zhang did not disclose the proportion of the bank's loans pricing against the LPRs. Bank of China said as of end-June, 45% of its loan portfolio is priced against the LPRs, in which 76% of its outstanding corporate loans have migrated to the new benchmark.

"Net interest margins [are] definitely likely to be under less pressure in [the second half of 2020], as the economy is improving, and the cuts to the loan prime rates are likely to be much less," said Michael Chang, director, HK and China Financials, Equity Research at CGS-CIMB Securities.

"In addition, short term and long term rates such as repo rate, interbank rates, and bond yields have risen, which will help increase the yields on the bank investment, thus helping the banks' NIM," Chang added.

As of Aug. 28, US$1 was equivalent to 6.87 Chinese yuan.