Third quarter profit results for China's banks will show a spurt in earnings growth thanks to higher margins and steady loan growth.
UBS China analyst May Yan is expecting the big four banks to report strong net interest income growth of 14 per cent year-on-year on the back of steady loan growth and average net interest margin growth of 9 basis points.
The Hong Kong-based analyst predicts continued sector-wide weakness in fee income and estimates net fee income to drop by 3 per cent.
Importantly, in her view, net margin trends will likely to diverge quarter-on-quarter depending on the size of the lender.
“Large banks will likely continue to outperform mid-size and small banks in net interest margin both on the quarter and on the year," she wrote clients.
“Also, we expect this divergence in net interest margin trends between large banks and joint-stock banks to continue as monetary policy remains relatively tight and deposit competition intensifies."
Bad loans improving
With the macro environment steadily improving in the September quarter, Yan figures that the banks will report declines in both their non-performing loans ratio and balance, except for a few joint stock banks with relatively weak asset quality.
However, the analyst sees limited room for banks to lower provisioning owing to the 2.5 per cent minimum required provision-to-loan ratio.
In addition, she added, management may remain cautious on the SOE reform outlook and its implications for their bad loans.
“In terms of capital adequacy, we believe China Construction Bank and ICBC are unlikely to raise capital, while other banks with lower capital ratios may have funding needs.”
In her view, China Construction Bank will lead earnings growth among the big four banks - posting a rise of 5.6 per cent on greater net interest margin growth and better performance in fee income than peers.
In terms of bad debts, the analyst argues that the private sector bad debt cycle peaked in 2015 and 2016 and the SOE-sector bad loan cycle will go at a manageable pace in the next three to five years.
China in transition
In the long term, asset quality improvement is likely to be driven by China’s economic transition to a more sustainable growth model; driven by the rise of new-economy industries, industrial and consumption upgrades, and SOE reforms.
“We believe such a transition has already started.”
From where Yan sits, recent monetary and regulatory tightening is unlikely to be a major risk to China banks, especially in the short term.
“We believe the regulators’ tightening bias is a response to the Chinese government's long-term objective of debt deleveraging and reducing financial systemic risks, but the overall policy may be toned down if it poses potential risks to economic stability.
“We also believe the central bank and the bank regulator have gained further tools and experience in supervising financial institutions when dealing with liquidity events.
“The risk of liquidity crises, such as those related to private lending in Wenzhou in 2011 and interbank liquidity in 2013, is low, in our view.”
All up, the analyst believes China banks' decade-long de-rating has reached a bottom.
Based on UBS top-down and bottom-up analyses, she estimates estimate average medium-term return-on-equity of between 12 per cent and 13 per cent. Of course, this assumes that banks need to retain a 10 per cent core tier one capital ratio, interest rates will not be cut significantly, and the SOE bad loan cycle is gradual.
The evidence for this she added is that the gross non-performing loan formation for the big listed Chinese lenders stabilised in 2016, with a few witnessing significant improvement.
“Their margins appear to be recovering with loan rates going up, while the impact of benchmark rate cuts has worn off.
“Some macro data show signs of softening but in general continue to hold up.