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April 7, 2016

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Banks face bitter medicine as bad debts rise

WHEN Zhang Jianguo, former president of China Construction Bank joked at the National People’s Congress last year that “banks are a disadvantaged group,” everyone in the room burst out laughing, including Premier Li Keqiang and central bank Governor Zhou Xiaochuan.

One year on, it doesn’t seem very funny.

China’s banks now find themselves at a great disadvantage. Amid a slowing economy and a shaky stock market, banks’ profit growth has diminished and bad loans last year alone surged 51 percent to 1.27 trillion yuan (US$196 billion).

Among the suggested remedies being floated is another round of debt-for-equity swaps that bankers are loathe to embrace because of liquidity and management risks.

“Some banks may post zero-growth or even negative growth in 2016,” said Jimmy Leung, banking and capital markets leader at Pricewaterhouse Coopers China.

Last week, Industrial and Commercial Bank of China (ICBC), the world’s biggest lender by assets, said in a filing to the Hong Kong Stock Exchange, where it is listed, that its net profit in 2015 rose by just 0.5 percent to 277.1 billion yuan. That followed a 5 percent gain a year earlier.

The filing also revealed about 179.5 billion yuan in bad loans, mainly made in the manufacturing, wholesale and retail sectors. The bank’s bad-loan ratio rose to 1.5 percent from 1.13 percent a year earlier.

The bad loan ratio was even worse at Agricultural Bank of China. It stood at a six-year high of 2.39 percent, compared with 1.54 percent a year earlier and with an average 1.67 percent among all lenders nationwide.

“Some industries and enterprises faced persistent challenges, and some suffered from capital chain tension, which led to worsening solvency under economic structural adjustment and industrial transformation,” a report from China’s banking regulator said.

Bank of China, China Construction Bank, AgBank and other lenders reported less than 1 percent growth in net earnings last year. Even smaller joint-stock banks that boasted double-digit growth in 2014 failed to expand. China Merchants Bank, the sixth-biggest lender, slowed to 3.19 percent growth from 8.06 percent, and China Everbright Bank sank to 2.23 percent from 8.12 percent.

Smaller regional lenders that benefited aggressively from fee-generated business in the fourth quarter in 2014 ran out of luck when the stock market collapsed last June.

The hardship facing banks was reflected in lower salaries. Average annual pay for bankers fell by almost half last year to 159,500 yuan, according to the annual reports from 16 listed lenders. That’s a departure from many Western banks, where remuneration levels frequently look uncoupled from earnings performance.

Staff at Agriculture Bank of China fared the worst. The annual wage package there shrank to about 98,800 yuan, which was a pretax figure that included various subsidies like house accumulation funds and social security fees.

The cutbacks affected those at the top as well as those at the bottom of the banking ladder. Jiang Jianqing, chairman of ICBC, had his salary slashed by 51 percent to 546,800 yuan in 2015.

Halved salaries

The chairmen of the other “Big Four” lenders all suffered at least a third cut in salary, dragging the average annual salary of the bank bosses to 571,220 yuan from over a million yuan in 2014.

“With market sentiment remaining gloomy,” said Pricewaterhouse Cooper’s Leung, “banks must explore new channels to increase income and cut expenditures to survive.”

Among the options on the table is a proposal to convert bad debt into equity. That was proposed by Premier Li during the National People’s Congress in March as a way to reduce corporate leverage and clear away some of the non-performing loans.

The idea is not new. In 1999, China bailed out its four biggest banks by transferring US$230 billion of soured loans to unprofitable state-owned companies from the lenders’ balance sheets and converting it into equity held by four specially created asset management companies. Those companies subsequently made profits from swaps, with support from the government.

In the latest variation on the same theme, government said it would focus only on the debt of state-owned companies that have some hope of restructuring themselves into profitable operations. So-called “zombie companies” with little or no hope of survival would be excluded.

The first batch of debt-to-equity swaps will involve one trillion yuan and will be completed in three years, Caixin magazine reported over the weekend.

But who will ultimately foot the bill is uncertain, the magazine said.

Conversions of the magnitude now being contemplated could lift the annual net profit of banks by an average 4 percent, analyst Luo Yi at Huatai Securities Co wrote in a note.

But other industry insiders, including bank bosses themselves, remain lukewarm to the idea. They say such swaps could harm the interests of lenders’ shareholders. As such, if banks are required to take equity in ailing companies in exchange for non-performing loans, those swaps should be capped, they warn.

Among the pessimists is Yang Kaisheng, who led China Huarong Asset Management Co in conducting China’s first swaps of bad debt to equity in the late 1990s.

“The debt-to-equity swap is a painful process to both creditors and to debtors,” Yang wrote in an opinion piece published in the 21st Century Business Herald on Wednesday. “Creditors and debtors need to be aware that this is done only when there’s no alternative.”

Jiang Chao, chief analyst at Haitong Securities Co, agreed that the swaps do entail risk.

“If the government is going to back up the move by cash injections or easier capital rules, the financial system would have to face the risk of money over-issuance,” said Jiang. “If not, then banks would have to bear the results of turning bad loans into bad equities, and thus face a liquidity crisis in order to offset the risks by raising their core capital adequacy ratios.”

Many observers said an economic rebound is the only way to avoid swaps. But if that doesn’t occur and the plan is pursued, it’s just another headache facing banking during the sector’s toughest time in a decade.


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