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Bank of China (HKEx: 3988; Shanghai: 601398) made news earlier this week when it became China’s first member at the prestigious London Metals Exchange (English article), but its latest headlines are far less positive as it reported lackluster growth in the first quarter that was below market expectations. (earnings announcement; English article) The 10 percent profit growth for the quarter was less than half the 28 percent growth rate from a year earlier, when Bank of China and its peers were reaping big new profits after a lending binge ordered by Beijing to stimulate the domestic economy during the global economic crisis. With the economy now showing signs of slowing sharply as the government tries to cool the real estate market and tame inflation, many fear that Chinese banks could start to see many of the loans they made during that binge start to sour. Recent weakness in the stock market, following a rally early in the year, could add to the problems, as many recent bank loans have gone to fund stock buying. From a purely numerical perspective, Bank of China’s 10 percent profit rise doesn’t look too bad, since that kind of growth rate is certainly respectable. But more worrisome is growth rate’s slowing, which is likely to accelerate in the next 2 quarters and could even turn negative by the end of the year. Bank of China is one of the nation’s top 4 lenders, and first-quarter results will come out later today from the other 3, ICBC (HKEx: 1398; Shanghai: 601398), China Construction Bank (HKEx: 939; Shanghai: 601939) and Agricultural Bank of China (HKEx: 1288; Shanghai: 601288). I would expect all 3 of the other big lenders to report slowing profit growth as well, signalling a recent rally for their stocks could soon be finished. Most of China’s major bank stocks performed poorly for most of last year on concerns that they would soon face a flood of bad loans after the lending binge of 2009 and 2010. But most have bounced back since then as Beijing took steps to address the problem, including allowing many lenders to raise billions of dollars in new capital to strengthen their balance sheets. Bank of China’s own shares have risen nearly 50 percent since hitting a low early last October. Perhaps sensing that the rally may soon be over, Goldman Sachs (NYSE: GS) became the latest major shareholder in a Chinese bank to sell down its stake earlier this month, dumping more of its stock in ICBC. (previous post) Goldman joined Bank of America (NYSE: BAC) and Citigroup (NYSE: C), which last year also sold off large stakes in China Construction Bank and Pudong Development Bank (Shanghai: 600000), respectively, partly due to concerns about a looming Chinese banking crisis. Following this lackluster Bank of China earnings report, investors will be watching closely to see if the other 3 banks also report weak earnings, and also if any are showing signs of growing bad loans. If the reports are weak, which seems likely, look for a sell-off in Chinese banking shares next week, which could mark the beginning of a long downturn for the sector.

Bottom line: Bank of China’s lackluster first-quarter report could mark the beginning of a long downturn for Chinese lenders and their stocks.

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