China banks face escalating operating pressure up to two years

As the country's economic growth reduces speed.

Moody's Investors Service has said that listed Chinese banks will face rising operating pressure over the next 1-2 years, as China's economic growth slows, and as the banks' interest margins narrow further on the government's monetary easing policies and deregulation of interest rates.

According to a release from Moody's Investors Service , Moody's conclusion was based on the banks' results for the half-year ended 30 June 2015 (1H 2015).

"While most of the banks recorded a modest growth in profit in 1H 2015, their asset quality and margins are coming under increasing pressure," says Christine Kuo, a Moody's Senior Vice President.

"Pressure on asset quality in particular, is reflected not only in the rise in headline non-performing loan ratios, but also in the less stringent recognition of such loans," adds Kuo. "We note that an increasing amount of loans overdue for at least 90 days are not classified as non-performing loans."

Kuo explained that this non-recognition of loans overdue for at least 90 days (90+ day delinquencies) prompted Moody's to focus its asset quality analysis on 90+ day delinquencies. Specifically, in analyzing the banks' results in 1H 2015, Moody's focused on the new formation of 90+ day delinquencies before write-offs and the sale of problem loans.

Here's more from Moody's Investors Service:

Kuo was speaking on the release of a new Moody's report titled "Chinese Banks' 1H 2015 Results Show Rising Pressure on Operations," and which is authored by Kuo. At 30 June 2015, the Chinese commercial banking sector reported a non-performing loan (NPL) ratio of 1.50%, which represented a moderate 25 basis point deterioration from the result seen at end-2014.

For the 11 listed banks that Moody's rates, the NPL ratios for the banks rose by 24 basis points in 1H 2015; a similar degree of deterioration as seen by the sector as a whole. By contrast, Moody's analysis shows a much larger deterioration by new formation of 90+ day delinquencies.

Moody's says that new formations of 90+ day delinquencies averaged 1.54% of average loans on an annualized base for the first half of 2015, and ranged for the individual banks between 1.24% and 3.57%. The 1.54% represented a 77 basis point deterioration from the 0.77% of 90+ day delinquency formation seen in 2014.

Increasingly higher 90+ day delinquencies have led to lower loss reserve coverage ratios for most banks, although such ratios are still at good levels. At end-June 2015, the 11 Moody's-rated banks demonstrated loan loss reserves for 90+ day delinquencies of 68%-261%, which represented a fall in the ratio of 4-122 percentage points versus the result seen at end-2014.

The banks' profits also show signs of increasing strain from rising asset quality pressure and narrowing margins. The return on average assets for China's commercial banking sector was at 1.23% in 1H 2015, down from 1.37% a year ago.

A key driver of this deterioration was rising impairment charges, which for the 11 banks, jumped by 53% between 1H 2015 and 1H 2014. Another factor contributing to weak profitability is the banks' narrowing net interest margins (NIMs), due to the central bank's rate cuts and interest rate deregulation.

The sector's NIM was at 2.51% in the first half of 2015, down 19 basis points from the level seen at end-2014. Moody's expects the banks' profits to deteriorate further in 2H 2015. In addition to higher credit costs, their NIMs are likely to come under pressure due to: (1) asset and liability re-pricing; following the recent central bank moves, (2) a possible reduction in low-cost current deposits, as a result of recent poor stock market performance, and (3) possible further central bank rate cuts.

The sharp falls seen in China's stock markets since June 2015 will also sharply lower the banks' stock market- related fee and commission income for the remainder of 2015. Liquidity conditions remain broadly stable.

The 11 listed Chinese banks that Moody's rates are:
1) Industrial Commercial Bank of China Ltd. (ICBC, A1 stable, baa2),
2) China Construction Bank Corporation (CCB, A1 stable, baa2)
3) Agricultural Bank of China Ltd. (ABC, A1 stable, baa3),
4) Bank of China Ltd. (BOC, A1 stable, baa2),
5) Bank of Communications Co. Ltd. (BoCom, A2 stable, baa3),
6) China Merchants Bank Co. Ltd. (CMB, Baa1 review for upgrade, baa3),
7) Shanghai Pudong Development Bank Co., Ltd. (SPDB, Baa1 stable, ba1),
8) China CITIC Bank Corp. (CITICB, Baa1 stable, ba1),
9) China Everbright Bank Co., Ltd. (CEB, Baa2 stable, ba2),
10) Ping An Bank Co., Ltd. (PAB, Baa2 stable, ba2), and
11) Bank of Ningbo (NB, Baa2 stable, ba1)