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China's banks expect biggest profit drop in over 10 years

Faster provisions against pandemic loan losses seen cleaning up balance sheets

The China Banking and Insurance Regulatory Commission last month urged the country's banks to boost bad-loan recognition and provisions.   © Reuters

HONG KONG -- First-half profits at Chinese banks are expected to take their biggest tumble in a decade, as bad loans surged and the government ordered lenders to forgo gains to support a domestic economy that is experiencing its slowest growth in nearly half a century as a result of the coronavirus pandemic.

Thirteen of the country's 18 largest banks, including Industrial & Commercial Bank of China and Bank of China, will report earnings on Friday, with more following on Saturday. Most of these lenders have done away with their usual pre-announcements and pushed the release of earnings as late as they can, which analysts are taking as a warning sign for poor results.

Reuters has reported that some leading brokers in China have canceled their forecasts for first-half bank earnings, citing uncertainties over the hit each institution may take to support the economy.

Regulators have ordered banks to accelerate provisions for loan losses, and "we expect the kitchen-sinking process to start in [the] second quarter and last until the end of 2020," Citigroup analysts, led by Judy Zhang, wrote in a report, referring to the cleanup process. "The potential negative earnings growth will overhang the China banks' near-term share performance."

The China Banking and Insurance Regulatory Commission, the industry's regulator, has already given a preview of the results. The commission on Aug. 10 said that the nation's more than 1,000 commercial banks had accumulated a net profit of 1 trillion yuan ($145 billion) in the first half, down 9.4% from a year earlier, with the decline in the second quarter even sharper at 24%.

The six largest banks posted a 12% profit decline from a year ago, the commission said. Sour loans climbed for the sixth straight quarter, to 2.7 trillion yuan, the highest level in more than a decade.

Declining profitability among lenders comes amid mounting tensions between Washington and Beijing, including U.S. sanctions on Chinese officials over alleged human rights abuses against the Uighur Muslim minority and the crackdown in Hong Kong. The banks could be slapped with fines for dealing with certain officials, and there also is speculation that Washington will deny dollar funding access to Chinese banks.

The commission last month urged the banks to boost bad-loan recognition and provisions, and analysts expect banks to undertake the exercise for the rest of the year, collectively slashing earnings by more than 10%. The Chinese government in June said that authorities would push financial institutions to sacrifice 1.5 trillion yuan in profit this year to support companies of all kinds by lowering lending rates and fees, and deferring loan payments.

However, the aggressive provisioning should help clean up the books and eventually assure investors, according to analysts and investors.

Chinese banks' "valuation is near a historical low, and mutual funds' allocation to the banking sector is at the lowest since 2015," said Mark Dong, the Hong Kong-based co-founder of Minority Asset Management, which manages $1.6 billion in the mainland, including large holdings in Chinese bank stocks.

"Banks' profitability and asset quality are the main concerns among investors," he said. "We are expecting the profit reduction this year will help banks to clear most nonperforming loans and have an even more robust balance sheet to [face] economic uncertainties."

The Chinese flag flies at half-staff outside a bank in Beijing on April 4, as China holds a national mourning for those who died of COVID-19.   © Reuters

The largest banks are trading at 0.7 times the value of their net assets, compared with the 10-year average of 1.1 times, which indicates values are lagging the long-term mean.

At the end of June, bad loans stood at 1.94% of total lending, according to the banking regulator, up from 1.86% six months earlier. However, ratings agency S&P Global has estimated that nonperforming assets, which include rolled-over debt, could double this year to 10% from pre-pandemic levels.

Banks are selling bad debts aggressively, largely to state-run managers of distressed debt, to keep the ratio of nonperforming loans in check.

Chinese lenders are expected to offload 3.4 trillion yuan worth of bad loans in 2020, compared with 2.3 trillion yuan last year, to contain financial risks in an economy weakened by the COVID-19 pandemic, the official Xinhua News Agency reported this month.

The rise in bad loans also has been capped by moves to let banks roll over troubled debt under a program that is open until March 2021. These measures, along with moves to lower interest rates, are aimed at stimulating the economy.

The world's second-largest economy grew 3.2% in the three months to June from a year earlier, reversing a 6.8% decline in the first quarter, but the recovery remains fragile. A poll by Nikkei last month showed that the economy is expected to expand by 1.6% in 2020, down from 3.3% in the previous survey in March.

"The pressure on asset quality and profitability will remain high as consumer sentiment stays weak amid a slow recovery from the pandemic and credit costs stay elevated despite multiple government relief measures," analysts at Moody's Investors Service, led by Sophia Lee, said in a note.

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