Improving margins and asset quality of China's banking sector amid the nation's economic recovery have set the stage for the lenders' earnings to rebound further this year, analysts say.
Analysts are becoming more optimistic about Chinese banks, some of which posted steep profit declines during the first half of 2020, after the world's second-largest economy managed to expand 2.3% at the end of last year.
The stronger-than-expected recovery helped the aggregate net interest margin of all Chinese commercial banks to edge higher in the fourth quarter of 2020, the first increase in three quarters, according to the latest data from the China Banking and Insurance Regulatory Commission. The sector's aggregate nonperforming loan ratio slid for the first time in two years.
"Chinese banks could see profit rebound on the back of broader economic recovery, a gradual exit of relending programs as well as less high-cost deposit products amid regulatory moves, all of which will support revenue growth with a more stabilizing net interest margin," said Bruce Pang, head of macro and strategy research at China Renaissance.
As Beijing pushes banks to lend more to power the economic recovery, the regulators have been trying to keep a lid on their funding costs in order to facilitate lending, which also relieved some pressure on their net interest margins. For instance, the People's Bank of China reportedly curbed interest rates on high-yield structured deposits, a growing funding source for banks in addition to deposits, in January.
Pang added that China's central bank is unlikely to further lower the benchmark lending rates, or known as the loan prime rates, which also eases pressure on bank margins as recovery gathers steam. The one-year and five-year LPRs have been unchanged for nine consecutive months.
Green shoots of recovery
Net profit of all Chinese commercial banks totaled 1.939 trillion yuan in 2020, down 2.7% from 1.993 trillion yuan in 2019, according to the CBIRC. Green shoots of recovery started showing in the second half of 2020, after the sector's total net profit in the six months ended June 2020 fell 9.4% to 1.027 trillion yuan from 1.133 trillion yuan a year earlier.
A Feb. 10 Nomura note also predicted a "strong rebound in profit," and that the Chinese banks, especially the large state-owned lenders, are likely to maintain their dividend policies. The dividend payout ratios of major Chinese banks have been hovering around 30% in recent years.
Individual Chinese banks are scheduled to release their full-year earnings for 2020 toward the end of March.
Key improving metrics
Despite a spate of high-profile bond defaults by state-linked companies in China in the fourth quarter of 2020, the banking sector's aggregate NPL ratio slid to 1.84%, the lowest since 1.81% in the second quarter of 2019, according to the CBIRC. It was also down from 1.96% in the previous quarter, which was the highest level in at least six years.
The ratio for special mention loans, which are deemed at risk of becoming nonperforming, also decreased to 2.57% from 2.66%. The drop in these ratios might be linked to the clean-up of nonperforming loans in 2020, as banks disposed of 3 trillion yuan of bad loans during the year, writing off as much as 1.2 trillion yuan off their balance sheets, a Feb. 1 S&P Global Ratings note said.
A Feb. 8 note from CGS-CIMB Securities said that the disposal of bad loans "curiously falls short of the initial target of 3.4 trillion yuan" announced in August 2020.
"We think it is because NPL formation rate have been much better than policymakers expected," the note read. "This is given the strong rebound of industrial profitability, and the monthly stats that indicate an improvement in consumer credit quality."
Banks' capital positions have also improved, giving them more buffer and firepower to grow their loan book as well as other businesses. Chinese commercial banks' aggregate liquidity coverage ratio is at 146.7% in the December quarter, up from 138.67% three months prior.
Loan growth may slow further
Credit growth in China's banks may slow further in 2021 as the government scales back its support for the economy, China Renaissance's Pang said.
Total outstanding yuan loans at Chinese financial institutions reached a fresh record of 172.75 trillion yuan as of Dec. 31, 2020, up 12.82% from 153.11 trillion yuan a year ago, according to data from the People's Bank of China. However, on a monthly basis, the loan growth in December 2020 fell for the seventh straight month, which was still up 12.82% year over year.
"We think credit growth in general will continue to drop back further in 2021, as the [People's Bank of China] will scale back support for the economy but focus more on reining in financial risks and capping leverage," Pang said.
In the fourth quarter of 2020, the outstanding amount of so-called inclusive loans targeting small businesses and individuals rose to 15.267 trillion yuan from 14.762 trillion yuan in the previous quarter. While all bank types increased lending to this segment, rural financial institutions remained the biggest contributor, with such loan balance totaling 5.178 trillion yuan, up from 5.065 trillion yuan in the previous quarter.
"We think investors will watch closely on whether the continuously decelerating credit growth would derail China's macro recovery and risk more debt defaults," he said. "Moreover, concerns over tightening credit and draining funds may cause market jitters if there are small steps to cool inflation, limit asset bubbles or curb speculation."
As of Feb. 17, US$1 was equivalent to 6.46 Chinese yuan.