China’s banks to weather credit woes

China’s bond market will experience rising defaults and more credit rating downgrades, but its banks will continue to perform well for investors.

China’s banks to weather credit woes
Christopher Lee, S&P

Many Chinese corporate bond issuers will experience worsening conditions, but this should not impact the financial performance of leading lenders, according to Qiang Liao, senior director for financial institution ratings at Standard & Poor’s.

Small city or regional banks, particularly those catering to small- and medium-sized enterprises (SMEs) may be adversely impacted, however.

Angus Hui, Asian fixed-income portfolio manager at Schroders, said banks will experience rising non-performing loan ratios and overdue loans as the downturn in China’s property sector worsens. But the top 10 developers continue to enjoy access to capital.

Small developers and those with heavy exposures to third- and fourth-tier cities, on the other hand, are at risk – but the big-five national banks have been cutting exposures to this segment. Moreover the central government has taken steps to ensure banks can ride out woes in the property sector, Hui said.

Qiang, Hui and S&P’s Christopher Lee, managing director of corporate ratings, discussed these issues in a webinar organised by FinanceAsia and broadcast yesterday. To register to view the recorded on-demand version and related materials, click here. Rupert Walker, contributing editor to FinanceAsia, moderated.

The registered audience of nearly 600 market participants voted the cleanup of local government debt as the most likely threat to banks’ financials in the next two years, accounting for 40% of the vote, versus only 25% citing property developers.

The panellists felt the concern on local government debt was overstated, probably out of too many unknowns regarding how the cleanup will proceed and which measures will do the most to mitigate refinancing risks. “We’re talking about large amounts of money and uncertainty over what is actually considered local government debt,” said Lee.

But recent measures such as a Rmb1 trillion debt swap to convert collateral in bilateral investment trusts into municipal bonds will help banks. Although they have to accept a lower yield on the bonds, they get a tradable instrument with much higher credit quality.

The real estate downturn, on the other hand, is likely to hurt banks, as will problems in related sectors such as construction as well as metals and mining (which is suffering partly from the property slowdown as well as from bearish trends in global commodity cycles).

Lee said property prices in Chinese cities continue to trend downward. So far this year, three rated issuers have defaulted on international bonds, more than in the past two years, and he expects more defaults in the coming months – including in the onshore market. S&P’s ratings actions have on balance turned negative since July 2014. Property developers and mining companies are the most at risk because they are the lowest-quality issuers, with a number of borrowers rated triple-C.

This will put pressure on banks’ net interest margins and NPL levels. Credit losses among banks have been doubling year on year for three years, reflecting deteriorating Ebitda coverage [earnings before interest, tax, depreciation and amortisation] of corporate borrowers. In 2014, credit loss ratios reached 40 basis points, and are on track to reach 80bps this year, Qiang said.

But banks are resilient. The provision ratios are stable, they are improving revenues from non-spread businesses, and their cost-to-income ratios are strong. Banks are raising new capital to provide a cushion against future problems, and their liquidity coverage ratio is a hearty 5x and improving.

Finally, the government has supported banks by liberalising interest rates, cutting reserve requirement ratios, introducing deposit insurance, and injecting capital into policy banks to guard against events that could be destabilising.

There are also some sectors that continue to perform well, which will support bank balance sheets, such as technology and consumer goods, whilst the booming A-share market is enabling some companies to improve their capital base.

 

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