Chinese banks' earnings to stabilise over the coming quarters

The banks' net profit rose 7.9% in Q2.

Analysts have been bearish on Chinese commercial banks for many years, but they now believe that the fundamentals are starting to improve. Specifically, BMI Research analysts expect earnings growth of Chinese banks to stabilise over the coming quarters due to an improvement in asset quality and a stabilisation of their net interest margins (NIM), which is in contrast to our previous view for profitability to suffer.

Here's more from BMI Research:

According to data released by the China Banking Regulatory Commission (CBRC), net profit growth of Chinese commercial banks rose to 7.9% y-o-y in Q217, compared to 3.5% y-o-y in Q416.

We include special-mention loans, which are loans that could potentially turn sour, together with non-performing loans (NPLs) in order to estimate asset quality in a more prudent way.

Based on our calculations, the adjusted NPLs ratio (including special-mention loans) reached a high of 5.8% in Q316, before dropping to 5.4% in Q217, indicating an improvement in asset quality. The slower formation of NPLs will ease pressure on banks to set aside provisions, which should be supportive of earnings.

The improvement in asset quality was mainly driven by recovering corporate earnings, especially in the industrial sector. According to the National Bureau of Statistics , total industrial profits expanded by 16.5% y-o-y in July, compared to only 5.1% y-o-y in the previous year as they were supported by rising producer price inflation (PPI) due to the rallies seen in major base metals such as iron ore, copper, and aluminium.

While we expect PPI to lose steam at the end of the year and going into 2018, growth of industrial profits will still be higher than that of last year, which will be positive for the asset quality of banks.

Additionally, the ongoing debt-to-equity swap programme has helped to reduce the formation of bad debt on banks' books. According to the National Development and Reform Commission, Chinese banks have agreed to convert more than CNY1trn of debt into stock holdings in more than 70 state-owned enterprises by August 8.