Investors have been anxiously watching for signs of a looming bad-loan crisis for China’s top banks, but the latest results from Bank of China (HKEx: 3988; Shanghai: 601398) indicate that Beijing may be looking to substitute slowing growth for a full-blow crisis. This kind of “compromise” could only happen in China, since Beijing’s position as both regulator and majority stakeholder of the major banks means it has the power to decide just how badly those lenders will suffer following a government-ordered lending binge in 2009 and 2010 that left most major players with billions of dollars in questionable loans.
Based on Bank of China’s latest results, it appears the government has decided to take a “middle road” by letting the banks defer collection of many of their more questionable loans. But at the same time, it is also forcing them to behave more commercially, meaning they could be facing slower profit growth over at least the next 2 years.
Let’s take a look at Bank of China’s latest results, which are the first of China’s big 4 lenders in the current reporting season. Bank of China reported its profit rose an anemic 5.1 percent in the second-quarter, marking its slowest growth since the financial crisis of 2008-2009. (earnings announcement; English article) But perhaps more interesting, the bank only increased the amount of money it sets aside for bad loans by a modest 5.8 percent in the first half of the year, as its non-performing loan (NPLs) ratio stayed roughly the same at an ultra-low 0.94 percent at the end of June from 0.97 percent 3 months earlier.That means the bank doesn’t expect to see its bad loans grow too quickly over the next year, which will clearly calm many market concerns.
The profit was roughly in line with market expectations, sending a signal that we probably won’t see too many downside surprises as the banks report their results in the current and future quarters. Any such surprises would obviously be counterproductive, immediately reigniting concerns of a bad loan crisis. Instead, the government probably wants to tell investors that the banks will remain a safe choice for the years ahead, but that investors also shouldn’t expect too much growth.
To recap quickly, China’s banks have been embroiled in controversy for most of the last 3 years, as many abandoned drives to behave more commercially and reverted to their traditional role as policy lenders during the global financial crisis. As a results, many banks are now thought to hold billions of dollars worth of loans that they may never be able to collect. Most of those were made to local governments for questionable infrastructure construction projects as part of Beijing’s economic stimulus plan during the global financial crisis.
Beijing previously indicated it would let the banks defer collection of many of the problematic loans while it looked for other solutions to avoid a crisis. (previous post) Such solutions could include letting local governments issue bonds to raise new funds, and in a worst-case scenario I could also see Beijing simply giving the necessary funds directly to local governments to help them repay their debts.
Such a strategy would help to relieve the banks of the heavy risk they now bear, which has weighed heavily on their share prices. Investors seem to slowly be understanding this new middle-road approach, with Bank of China shares up almost 10 percent over the last 3 months after falling sharply over the last 2 years. Of course, 1 quarter isn’t really enough to say if the banks are safe just yet, and we’ll need to look at more banking results this quarter and through the rest of the year before we can safely conclude a crisis has been averted. But at this point, the signs do look good that China’s banks may be set for a period of stability over the medium-term, perhaps providing modest but steady returns for investors.
Bottom line: Bank of China’s results show that Beijing will take measures to let its major banks avert a bad-loan crisis, while also forcing them to accept slow growth.
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