Steady economy lifts China's banks

China’s major banks are looking at the first earnings upgrade cycle since 2014 as margins jump on the back of rising interest rates.

China’s central bank stunned markets earlier this month by raising short-term interest rates as the economy showed signs of steadying.

Since the end of 2014, the China banks' earnings forecasts have been constantly chopped on slower economic growth concerns, asset quality and falling net interest margins. But, last month, consensus earnings showed a slight pick-up.

According to Morgan Stanley’s, Richard Xu, net interest margins could increase by 9 basis points on average - if the impact from rising market rates is fully priced in.

The analyst is raising his 2017 and 2018 earnings forecasts for state-controlled lenders by 1 per cent and 3 per cent on average, and these could go higher if there are hikes in the one- year benchmark rate.

Xu has raised his net profit forecasts for by 4.1 per cent and 7.4 per cent for 2017 and 2018. And, Agriculture Bank of China got its profit estimates bumped up by 2.4 per cent and 4.6 per cent respectively.

Net interest margin changes to forecasts are driven mostly by higher bond investment yields and interbank rates.

Already peaked

But Xu could see upside to loan yields in the 2017 second-half if policy makers further tighten regulation on shadow banking channels. And that's even if the central bank doesn't move the one-year benchmark rate, as banks could start to re-price new loans above benchmark.

Real interest rates are still falling, Xu added, despite the likely continued modest pace of interbank market rate increases. This is why he sees limited negative impact on credit quality from higher nominal interest rates.

In his view, further tightening by the regulators would not only support bank margins, but quash irrational lending growth.  Xu admits to being worried that further tightening measures might be delayed.

"We believe further tightening by the central bank could help the economy avoid overheating due to over-investment in the industrial sector as a result of low real interest rates."

In his opinion, China banks' bad loans have already peaked, which leads to stable, if not lower, credit costs in 2017 and 2018.

In his view, ABC, PSBC, China Merchant Bank, Bank of China, Agricultural Bank of China, China Construction Bank and Chongqing Rural Commercial Bank are tipped to be the winners from rising rates since they have great funding franchises.

"Those banks that rely heavily on wholesale funding will benefit notably less."

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