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COMMENTS

China Banks After COVID-19: Big Get Bigger, Weak Get Weaker


China Banks After COVID-19: Big Get Bigger, Weak Get Weaker

As COVID-19 retreats in China, with the numbers of new daily cases stabilizing at double digits, the country's banking system is surveying the damage. The crisis will test lenders' resilience with more than a 50% increase in nonperforming assets likely in 2020 amid a halving in Chinese GDP growth. S&P Global Ratings expects the outbreak will exaggerate the pecking order of Chinese banks. Regional lenders with a high exposure to small enterprises will be hit hardest, while the biggest banks will likely come through the turmoil with enhanced market position.

To get a sense of how Chinese banks will fare in a post-COVID-19 world, we look at the industry along three dimensions: exposure to Hubei province, exposure to small enterprises, and exposure to industries hit hard by the outbreak.

About one-third of Chinese bank loans are in sectors significantly stressed by the pandemic. Regulators will likely give banks leeway to offer forbearance (debt rollovers, payment extensions, etc.) to borrowers hit by the outbreak. Banks are allowed to extend loan repayments from borrowers with sound credit standing to June 30, 2020. Some of these loans will see a payment extension of more than 90 days, which under normal circumstances, would have been classified as an NPL.

We expect such forbearance could keep reported Chinese bank NPLs at around 2.2% of gross loans, a moderate increase from an estimated 1.74% at end 2019 (see "China Banks And Coronavirus: Forbearance Today, Diminished Standards Tomorrow," Feb. 20, 2020).

However, the official NPL ratio alone does not give a full picture of the risks that Chinese banks are facing. We use 2017 industry numbers supplied by China Banking and Insurance Regulatory Commission (CBIRC) to estimate bank industry exposure to sectors worst affected by the outbreak. Referencing central bank stress tests, we believe NPL ratios (including forborne loans for these sectors) may climb to eight to nine times our 2019 estimated sector NPL ratios. Even the less-affected sectors may see a quadrupling of typical NPL levels.

Chart 1a

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Chart 1b

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Location, Location, Location

The velocity of banks' NPLs rise will partly depend on the degree to which they have lent to Hubei-based borrowers.

Hubei, which ranks seventh in GDP among Chinese provinces and was the center of the epidemic, will likely take the biggest economic hit. Wuhan city, Hubei's capital and the absolute ground zero for the outbreak, has borne most of this pain. The city endured a two-month lockdown. Moreover, it is a transport, logistics, and auto production hub, all sectors badly hurt by the epidemic.

Banks' aggregate loan exposure to Hubei was about 3.5% at end-September 2019, according to the Census and Economic Information Center. Some regional banks are much more heavily exposed. More than 90% of the loan books (as of end-2018) of the top three local banks in Hubei were to borrowers based in the province, according to their annual reports.

The lenders are among China's top 100 banks as of end-2019 according to the China Banking Association. They are: Wuhan Rural Commercial Bank Co. Ltd., (ranked 54), Hubei Bank Co. Ltd. (ranked 57), and Hankou Bank Co. Ltd (ranked 60).

Most of the large national banks have indicated in earnings calls that exposure to Hubei province is manageable, at below 5%. However, we are mindful of the potential for contagion in China's banking system should a Hubei lender fail.

The implosion, in May 2019, of Baoshang Bank Co. Ltd. showed how the failure of one regional lender can shock the national banking system. Regulators' takeover of Baoshang Bank shook confidence in China's interbank market, sharply raising other lenders' capital costs. The effects spread to corporations, which saw their borrowing costs rise as lenders pulled back (see "China Credit Outlook: Liquidity Crunch Just The Latest Headache For Corporate Issuers," July 8, 2019).

Worst Affected Sectors Make Up About One-Third Of Industry Loans

When assessing China banks' post-COVID pecking order, we also consider lenders' exposure to sectors upended by the outbreak.

This includes, in particular, consumer-driven industries reliant on household spending. The outbreak surged during the Lunar New Year, in January, a time when households spend heavily on travel, entertainment, and gifts. The timing was clearly bad for consumption. Risk aversion and tighter financial conditions will exacerbate the effects. This will amplify the credit pressure on banks.

We estimate wholesale and retail comprised 8% of Chinese banks' loan books. The logistics sector accounted for about 6% of lending. COVID-19 hit both industries hard. The manufacturing sector, which accounted for about 11% of bank loans, was also severely hampered by the outbreak. We estimate China's wholesale and retail sector was already weighted with a high NPL ratio of 4%-5% before COVID-19 landed, while the same ratio for the manufacturing sector was more than 4%.

Other severely disrupted industries include leasing and business services (about 5% of Chinese banks' aggregated loan book), and the hospitality and catering, and culture and entertainment industries (collectively accounting for about 1% of bank lending).

Forward-looking credit loss provisioning required by International Financial Reporting Standards could add to the strains felt by banks with high levels of special-mention loans.

Big banks well placed to withstand consumer setbacks.  The crisis has started to affect personal loan quality, in particular credit card loans (about 5% of sector exposure), with many people losing jobs. The NPLs--including forborne loans--from these hard-hit sectors will likely climb in 2020 between six and 10 times that of 2019 levels, with city commercial banks and rural commercial banks experiencing the most pain.

China's largest banks are best placed to absorb such losses. They are well capitalized with an excellent ability to get financing, and can withstand a substantial volume of bad loans.

China's largest banks have a high exposure to transport and logistics, another hard-hit sector. At end-2019, the industry accounted for 13.8% of the loan book of Industrial and Commercial Bank of China Ltd., China's biggest bank by assets. Note, however, that the bigger banks tend to lend to large national or provincial operators with good backing and funding access, and better ability to withstand a downturn than smaller operators.

Exposure to the wholesale and retail sector is low at China's "mega" banks (a label we give to Industrial and Commercial Bank of China, China Construction Bank Corp., Agricultural Bank of China Ltd., Bank of China Ltd., Bank of Communications Co. Ltd., and Postal Savings Bank of China Co. Ltd.) at around 5% or less of their total loan books (see chart 2).

Chart 2

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Credit card loans account for about 10% of lending or above at most joint-stock commercial banks. Ping An Bank Co. Ltd. and China Guangfa Bank Co. Ltd. stand out with credit card loans comprising about one-quarter to one-third of their lending.

Both banks eased growth in their credit card portfolio in 2019 to address the heightened risk in the sector. The lenders boosted their capital in the past two years, which will provide some cushion in the case of asset deterioration (see chart 3).

Chart 3

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Manufacturing sector shocks linger for small firms.  The Chinese National Bureau of Statistics' manufacturing purchasing managers' index (PMI) hit a multiyear low of 35.7 in February 2020, before rebounding to 52 in March. A reading of below 50 indicates contraction. Above 50 signals expansion.

The March number is a relative number, reflecting what may be just a temporary rebound from a very depressed February. The full effect of COVID-19 on the manufacturing sector (10.8% of system-wide loans based on 2017 CBIRC data) is not fully measurable at this stage.

The pace of the manufacturing recovery depends on how quickly China's factories return production to normal levels, how severely the epidemic has disrupted supply chains, and how far global consumption drops. Based on the National Bureau of Statistics data, more than 95% of China's large and midsize factories had resumed operations as of March 25, 2019.

Smaller entities have been much slower to reopen factories as they sort through cash shortages. The sector may yet emerge as a significant source of bad loans given banks' large exposure to manufacturing and a high NPL ratio (4.2%) leading into the outbreak.

S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak about midyear, and we are using this assumption in assessing the economic and credit implications. We believe the measures adopted to contain COVID-19 have pushed the global economy into recession (see our macroeconomic and credit updates here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

Bad loans loom from the developers.   The release of most Chinese developers' 2019 results show many firms were facing margin compression well before the COVID-19 outbreak hit. The business disruptions triggered by the COVID-19 pandemic have exposed vulnerabilities in weaker Chinese developers that didn't use the good years to bolster their financial strength. Companies with a larger project exposure to Wuhan city and Hubei province will likely be hit the most. (see "China Developers' 2019 Results Expose Strains Before COVID-19 Crisis Hit," April 8, 2020, and "China's Illiquid Developers Ask, How Long Will The Coronavirus Crisis Last?", February 2, 2020).

Real estate accounted for 5.3% of system loans as of end-2017, according to CBIRC. Usually only the better quality developers get bank financing, and typically real estate loans are collateralized. While we note a 136% rebound (on month) in contract sales in March 2020, from a 44% drop the previous month, this recovery is fragile. The unfolding global recession may yet indirectly depress demand for property in China.

Joint-stock banks more exposed to downturn in wholesale and retail sector.  We believe joint-stock commercial banks are prone to weakness in wholesale and retail sector. Hua Xia Bank Co. Ltd.'s lending to the sector took up 8.9% of its loan book in the first half of 2019. The comparable figure for China Zheshang Bank Co. Ltd. was 8.1%, while Industrial Bank Co. Ltd.'s sector loans stood at 7.3% in the same period.

China Zheshang Bank's bank acceptance business also involves pooling and cross-guarantees, instruments that are susceptible to misuse, for instance as a tool for regulatory arbitrage. (see "China Banks May Not Be As Resilient As Numbers Suggest," Jan. 30, 2020).

Except for China Merchants Bank Co. Ltd., where exposure to the transportation and logistics sector accounted for 7.5% of its loan book as end of 2019, the exposure of other joint-stock commercial bank to the sector compared to the mega banks, at around 4% or less.

Small Enterprise, Big Problem

The Chinese government's drastic measures to contain the outbreak have hit small and midsize enterprises (SMEs) particularly hard. A February survey led by Tsinghua University's professor Zhu Wuxiang showed that, of the 995 SMEs reviewed, almost one-third expect revenue to fall by half this year because of the virus. Eighty-five percent said they were unable to maintain operations for more than three months with cash on hand.

This will hurt banks that have been increasing their exposure to SMEs, which took Chinese renmnibi (RMB) 36.9 trillion (28.5% of system loans) as of end-2019, according to CBIRC, up 10.1% year on year.

The central government has in particular encouraged lending to so-called inclusive SMEs, or small lenders borrowing less than RMB10 million. Inclusive SME loans stood at RMB11.7 trillion as end of 2019, up by one-quarter year on year, comprising about 9% of China's total bank loans.

The NPL ratio for inclusive SMEs at the end of 2019, at 3.22%, were almost double that of the system-wide ratio. As the COVID-19 crisis disproportionately hits smaller borrowers, we believe a large portion of these entities will seek temporary relief from loan repayment strains.

Chinese policymakers have encouraged banks to continue to provide low-cost funding to these SMEs. Measures include encouraging banks to increase their SME lending in 2020, cutting SMEs' funding cost as much as 50 basis points, giving banks leeway to rack up higher NPLs on SME loans.

CBIRC has also allowed banks to roll over principal and interest for inclusive SME loans till the end of June 2020. In our view, the banking sector will inevitably bear some of the cost of policies supporting SMEs. The near-term effect will likely be seen in a lower net interest margin and more overdue loans.

While inclusive SME loans do not pose significant risk on an industry level, individual banks' inclusive SME exposures vary notably. Postal Savings Bank of China, China Minsheng Banking Corp. Ltd., Ping An Bank, and China Zheshang Bank have a high ratio of inclusive SME loan exposure. For example, inclusive SME loans accounted for about 13% of Postal Savings Bank of China's loan book as of end-2019, compared with 9% for the wider Chinese banking sector.

Postal Savings Bank of China has a low loan-to-asset ratio of 48.7%, meaning it has a small loan book relative to the industry. This gives it more ability to absorb losses. The bank also has a long history in inclusive finance, with experienced staff in villages and counties where these loans are originated. Postal Savings Bank of China's NPL ratio is lower than industry peers at 0.86% for 2019, with good overall NPL provision coverage at 389%.

China Minsheng Banking shrunk its SME business between 2013 and 2017, and tightened its underwriting standards after a significant spike in its small and micro loan delinquency in 2013. The bank has, for example, increased the proportion of collateralized and pledged loans from 46.8% as of end-2013 to 59.1% as of end-2019, at the high end among major listed banks. China Minsheng Banking has turned its focus to higher quality clients while seeking increased collateral against loans.

Nonetheless, heightened competition for high quality SME borrowers and the outbreak will challenge the bank's ability to maintain the quality of this portfolio.

Chart 4

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Chart 5

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Banks Will Have To Bear Some Of The Pain

The regulatory response has so far used the banking system to cushion the economic effect of the epidemic. Authorities in particular want to support entities crucial to coronavirus containment and medical support.

On Feb. 1, 2020, five central government bodies, including the central bank, CBIRC and the Ministry of Finance, asked banks to provide support to the people and entities most affected by the outbreak. Another cross-agency notice was issued on March 1, 2020, instructing banks to consider offering a moratorium on principal and interest payments to inclusive SMEs till June 2020 to eligible borrowers.

We expect the biggest banks will likely have to provide the most relief given their size and close ties with the government. But we believe that when COVID-19 fully recedes, the pecking order among Chinese banks will be more entrenched, with the largest lenders more dominant than ever.

Related Articles

  • Credit Costs for China's Banks Could Rise by US$224 Billion in 2020, April 8, 2020
  • For Asia-Pacific Banks, COVID-19 Crisis Could Add US$300 Billion To Credit Costs, April 6, 2020
  • Asia-Pacific Credit Conditions Will Be As Bad As In 1997, March 30, 2020
  • COVID-19 Will Stretch CCB's Performance But Fundamentals Are Resilient, March 30, 2020
  • Agricultural Bank of China's Past Provisions To Soften COVID-19 Blow, March 30, 2020
  • Industrial and Commercial Bank of China To Stay Resilient Despite COVID-19 Blow, March 27, 2020
  • Bank of China Has Adequate Buffers To Withstand COVID-19, March 27, 2020
  • Asia-Pacific Recession Guaranteed, March 17, 2020
  • Coronavirus Impact: Key Takeaways From Our Articles, Feb. 24, 2020
  • China Banks And Coronavirus: Forbearance Today, Diminished Standards Tomorrow, Feb. 20, 2020
  • COVID-19 Will Hit Asia-Pacific Economies Hard, Feb. 19, 2020
  • E-Commerce Provides Some Support As Coronavirus Knocks China Retail Sales, Feb. 10, 2020
  • Coronavirus To Inflict A Large, Temporary Blow To China's Economy, Feb. 7, 2020
  • China's Illiquid Developers Ask, How Long Will The Coronavirus Crisis Last? Feb. 3, 2020
  • Coronavirus In China: Domestic Banks To Face Stress Test, Feb. 3, 2020

This report does not constitute a rating action.

Primary Credit Analysts:Fern Wang, CFA, Hong Kong (852) 2533-3536;
fern.wang@spglobal.com
Patrick Chan, Hong Kong (852) 2533-3528;
patrick.chan@spglobal.com
Secondary Contact:Ryan Tsang, CFA, Hong Kong (852) 2533-3532;
ryan.tsang@spglobal.com
Research Assistant:Ronald Huang, Hong Kong

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