TEXT-Fitch: Chinese Banks' Balance Sheet Growth A Concern

Wed Sep 5, 2012 8:43am IST

(The following was released by the rating agency)

Sept 5 (Fitch) The rapid first-half expansion of Chinese banks' balance sheets amidst a deteriorating operating environment is a concern, particularly following the massive post-crisis credit spree, Fitch Ratings says.

First-half 2012 results for 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 11.9% (un-annualised) 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 USD21trn if the second half continues at the same pace. To put the growth into perspective, assets were USD9trn 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.

H112 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 deteriorate further into H212 and H113. This could result in downgrades of some banks' Viability Ratings. As Chinese banks' Long-Term Issuer Default Ratings are based entirely on state support, they will only be revised in the event of a shift in the ability and/or willingness of the state to support the banks. Balance sheet expansion in H112 was driven primarily by rapid growth of interbank exposures, which rose 29%, compared with corporate and retail credit growth of 9% (both un-annualised).

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% in aggregate for the 14 listed banks we rate, but still remain a low 1.3% 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 microenterprise lending booked as retail credit.

In contrast, annualised loan impairment charges fell 0.3% in H112, suggesting that future credit costs could climb significantly for some banks. Problem loan figures in China are likely to be understated, and hence only reliable as a signal of the direction of asset-quality trends rather than the magnitude of problem loans. Earnings growth for most listed banks was slower in H112 than H111, but remained comparatively robust by international standards.

Key profitability ratios continued to hold up, with the net interest margin (NIM) and return on average assets remaining in the region of 2.8% and 1.2%, respectively. Profitability in H212 and 2013 is expected to weaken, as rising delinquencies necessitate higher loan impairment charges, recent interest-rate changes squeeze NIM, 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.

Annualised pre-provision profit for listed banks ranged from 2% to 4% of gross credit exposure in H112, underscoring how just a modest asset-quality shock could wipe out the sector's entire earnings.

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