RETAIL BANKING | Staff Reporter, China

Chinese banking sector's net profits down 24.6% YoY in Q2

Improvement in sight for H2, but lenders may face capital shortfall.

Net profits for China’s banking sector shrunk 24.6% YoY in Q2, pushing down overall net profits to a 9.9% YoY contraction in the first half of the year, reports UOB Kay Hian. Performance across various bank types was mixed on the back of repercussions from the “national service” play out.

Lower profits were mainly caused by higher provisions taken, which surged 34.4% YoY as at end-1H20.

City banks performed the best as net profit only edged down 3.1% YoY in Q2.

On the other hand, SOEs and rural commercial banks fared the worst with declines of 27.9% YoY and 28% YoY respectively, which were likely attributable to a series of “national service” obligations.

Sector non-performing loans (NPL) ratio inched up to 1.94% in Q2 against 1.91% in Q1. Provision coverage also fell slightly to 182.4% as of end-Q2 vs 183.2% in the previous quarter. 

Asset quality performance varied across different bank types, with SOEs and rural commercial banks continuing to suffer asset quality impairment in Q2. The NPL ratio of SOEs rose 6 basis points (bp) QoQ to 1.45%, whilst provision coverage ratio fell 3 percentage points (ppt) QoQ to 228% compared to Q1.

However, UOB Kay Hian analysts Eric Zhen and Jayson Kong are not overly-concerned as provision coverage remains comfortably above the minimum regulatory requirement of 150%.

The asset quality of rural commercial banks saw a much steeper deterioration as NPL ratio spiked 13bp QoQ to 4.22% in Q2. Provision coverage ratio is also only at 118.1%. Year-to-date, the NPL ratio of rural commercial banks have surged 32bp.

Positively, the PBOC has signalled greater clarity on that front. Key uncertainties weighing on banks’ valuations continue to be asset quality and the subsequent capital inadequacy arising from NPL disposal.

In contrast, Joint-stock banks (JSBs) and city banks registered lower NPL ratios at -1bp QoQ and -15bp QoQ, respectively, on the back of more robust provision coverage. This were impressive given the challenging economic conditions induced by the COVID-19 pandemic, says Zhen and Kong.

The analysts expect net interest margins (NIMs) to remain suppressed in the second half of the year as banks work towards fulfilling their “profit transfer” target in 2020. NIMs remained largely unchanged in Q2 compared to Q1.

On the upside, as there is little room for mortgage rate to fall, the ordinary loan rate—which fell below the mortgage low rate for the first time since 2008—is expected to rebound alongside an economic recovery starting H1 2021. This should drive NIM recovery for banks early next year.

The People’s Bank of China (PBOC) has also indicated that they have no plans to expand on credit support policies as “the economy has returned to normal”. This signifies clarity for banks regarding its “social obligations” in H2, according to Zheng and Kong.

“With gradual easing of national service duties, we expect banks to report single-digit YoY net profit declines in H2, an improvement from Q2,” the analysts said.

Meanwhile, growth in provisions should further accelerate in H2 as asset quality woes remain.

Another point of concern is capital adequacy, as Zheng and Kong expect some banks to encounter capital shortfall. Lenders have traditionally replenished capital from profit growth, but this looks increasingly unlikely in 2020.

“That said, capital concerns would be unwarranted for large banks in our view, because most large banks are currently riding on strong capital buffers; and large banks have greater access to capital markets should the need for capital-raising arise,” they added.

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