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Banks' booming balance sheets could backfire
By Fitch Ratings |
September 6, 2012, Thursday
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Print Edition
Print Edition
THE rapid first-half expansion of Chinese banks' balance sheets amid a deteriorating operating environment is a concern, particularly following the massive post-crisis credit spree.
Results for the first half of 2012 at Chinese banks show that slowing economic growth and declining corporate profitability have begun to take a toll on asset quality and earnings.
Yet despite this deterioration, Chinese banks continue to expand their balance sheets at a brisk pace, with system assets rising an unannualized 11.9 percent in the first six months of the year, making it the second-fastest first-half on record. China's banking sector assets will shoot up above US$21 trillion if the second half continues at the same pace. To put the growth into perspective, assets were US$9 trillion at end-2008.
We have long held the view that such aggressive expansion at a time of weak global and domestic economic fundamentals has the potential to lead to large loan repayment problems, and could ultimately undermine solvency.
First-half data indicate that this process may now be underway, albeit in the very early stages. With economic growth yet to bottom, we expect balance sheets and earnings to weaken further into the second half of 2012 and the first half of 2013. This could result in downgrades of some banks' Viability Ratings.
Balance sheet expansion in the first half of 2012 was driven primarily by rapid growth of interbank exposures, which rose 29 percent, compared with corporate and retail credit growth of 9 percent (both unannualized).
Many interbank assets actually represent corporate credit disguised as interbank claims (which occurs through acceptances and letters of credit, or when credit transferred into wealth management products and trust products is brought back on-balance-sheet). Low capital charges for interbank exposures are a key driver of this activity.
Overdue loans rose 32 percent in aggregate for the 14 listed banks we rate, but still remain a low 1.3 percent of gross loans. Most of this deterioration occurred in the corporate portfolio, but retail delinquencies could begin to rise in coming quarters given the large amount of micro-enterprise lending booked as retail credit.
In contrast, annualized loan impairment charges fell 0.3 percent in the first half, suggesting that future credit costs could climb significantly for some banks. Problem loan figures are likely to be understated, and hence only serving as a signal of the direction of asset-quality trends rather than the magnitude of problem loans.
Comparatively robust
Earnings growth for most listed banks was slower in the first half of 2012 than a year before, but remained comparatively robust by international standards.
Key profitability ratios continued to hold up, with the net interest margin and return on average assets remaining in the region of 2.8 percent and 1.2 percent, respectively.
Profitability in the second half of 2012 and 2013 is expected to weaken, as rising delinquencies necessitate higher loan impairment charges, recent interest-rate changes squeeze net interest margin, and greater regulatory scrutiny slows the growth of fee income.
Over the medium term, credit costs are likely to be the most critical determinant of Chinese banks' profitability - given the potential for a considerable rise in impairment charges should asset quality deteriorate substantially.
Annualized pre-provision profit for listed banks ranged from 2 percent to 4 percent of gross credit exposure in the first half of 2012, underscoring how just a modest asset-quality shock could wipe out the sector's entire earnings.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.
Results for the first half of 2012 at Chinese banks show that slowing economic growth and declining corporate profitability have begun to take a toll on asset quality and earnings.
Yet despite this deterioration, Chinese banks continue to expand their balance sheets at a brisk pace, with system assets rising an unannualized 11.9 percent in the first six months of the year, making it the second-fastest first-half on record. China's banking sector assets will shoot up above US$21 trillion if the second half continues at the same pace. To put the growth into perspective, assets were US$9 trillion at end-2008.
We have long held the view that such aggressive expansion at a time of weak global and domestic economic fundamentals has the potential to lead to large loan repayment problems, and could ultimately undermine solvency.
First-half data indicate that this process may now be underway, albeit in the very early stages. With economic growth yet to bottom, we expect balance sheets and earnings to weaken further into the second half of 2012 and the first half of 2013. This could result in downgrades of some banks' Viability Ratings.
Balance sheet expansion in the first half of 2012 was driven primarily by rapid growth of interbank exposures, which rose 29 percent, compared with corporate and retail credit growth of 9 percent (both unannualized).
Many interbank assets actually represent corporate credit disguised as interbank claims (which occurs through acceptances and letters of credit, or when credit transferred into wealth management products and trust products is brought back on-balance-sheet). Low capital charges for interbank exposures are a key driver of this activity.
Overdue loans rose 32 percent in aggregate for the 14 listed banks we rate, but still remain a low 1.3 percent of gross loans. Most of this deterioration occurred in the corporate portfolio, but retail delinquencies could begin to rise in coming quarters given the large amount of micro-enterprise lending booked as retail credit.
In contrast, annualized loan impairment charges fell 0.3 percent in the first half, suggesting that future credit costs could climb significantly for some banks. Problem loan figures are likely to be understated, and hence only serving as a signal of the direction of asset-quality trends rather than the magnitude of problem loans.
Comparatively robust
Earnings growth for most listed banks was slower in the first half of 2012 than a year before, but remained comparatively robust by international standards.
Key profitability ratios continued to hold up, with the net interest margin and return on average assets remaining in the region of 2.8 percent and 1.2 percent, respectively.
Profitability in the second half of 2012 and 2013 is expected to weaken, as rising delinquencies necessitate higher loan impairment charges, recent interest-rate changes squeeze net interest margin, and greater regulatory scrutiny slows the growth of fee income.
Over the medium term, credit costs are likely to be the most critical determinant of Chinese banks' profitability - given the potential for a considerable rise in impairment charges should asset quality deteriorate substantially.
Annualized pre-provision profit for listed banks ranged from 2 percent to 4 percent of gross credit exposure in the first half of 2012, underscoring how just a modest asset-quality shock could wipe out the sector's entire earnings.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.
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