The astronomic bank loans inevitably stressed the banks’ balance sheets. In their mid-year reports, 14 banks listed in Shanghai and Shenzhen Exchanges posted a YoY 6.9% drop on pretax pre-provision profit and a YOY 3.1% decline on net profits. Minsheng Bank and Shanghai Pudong Development had the best YOY net profit growth, 7.82% and 6.37% respectively. On the other hands, China CITIC Bank (CHBJF.PK) and China Merchants Banks were the worst, -16.3% and –37.6% respectively. The surges in lending eroded the net interest margin by 88bp and the total interest incomes fell 9.9%. China CITIC Bank achieved the second highest growth on the new loans and notes (44.8%) while suffered 100bp drop on its net interest margin.
The aggressive lending practices foreshadowed a potential credit crisis. 8 of the 14 banks indicted a decline in capital adequacy ratio, 3 below 8% and another 3 below 10%. The tie 1 capital ratios of Pudong, Minsheng, Shenzhen Development were at 4.68%, 5.9% and 5.08%, respectively. China Banking Regulatory Commission issued the warnings on those banks with ratio below 9% and required all banks to maintain the capital adequacy ratio above 10% by the end of 2009 and 12% in 2010. Since the banks are still required to issue new loans to support the economics growth, several banks had to file the capital raising requests or issued more debts to replenish their capital reserves. Minsheng plans IPO on Hansheng exchange to raise additional capitals.
The data from China International Capital Corporation, the tier 1 capitals in the current banking system stood at CNY 2.35 trillion by the end of August. To replenish the plunging capital reserves as the results of the massive lending, the banks issue 3 times more subordinated debts so far in 2009 than in 2008. At least 51% of these debts were subscribed within the banking system. The inter-bank subordinated debt was estimated at CNY 300billion. The upper limit on the inter-bank subordinated debts was CNY 470 billion.
The Analyst Yonggang Wu at Guotai Junan pointed out that as a supplemental capital, subordinate debts would not alleviate the pressures on the tier 1 capitals. The inter-bank cross holding didn’t bring any new capitals into the banking systems. The banks didn’t mitigate the systemic risk within the entire system. CBRC proposed to limit the amount of the debt issuing by the commercial banks no more than 25% of the tier 1 capitals and deduct the subordinate debts from the supplemental capitals.
In its research report released on August 24, Shenyin WanGuo, one of the largest local brokerage houses, concluded that in the best scenario (10% capital adequacy and no subordinate debts deductions), the banks need to raise additional CNY 21.6billion capital in the 4th quarter, apart from the already-planned capital raises by Pudong, Shenzhen, Minsheng, and China merchants Bank. The amount of the capital needed will reach CNY 264.5billion in 2009 and CNY 116.4billion in 2010 in the worst scenario (12% capital adequacy and full subordinate debt deduction).
The separate report done by China International Capital Corporation showed that with the total amount of new bank loans not exceed CNY 10trillion in 2009 and CNY 8trillion in 2010, and 10% capital adequacy ratio, Pudong, Shenzhen, Minsheng, and China Merchants have to raise capital worth of CNY 22.2billion, 3billion, 7.1billion and 3.5billion respectively.
The semi-annual report showed a continuous improvement on the bad debts. 6 banks achieved drops on both the bad-loan ratio and the balance of bad loans in the book. 7 had a drop on the bad-loan ratio only. Shenzhen Development had increases on both. The total balance of the bad loans was at CNY 518.13 billion. The recent scandal on Shenzhen Development CNY 18 million bad loans shed some lights on how the Chinese bank could reduce the bad loans so quickly. When a company failed and incurred a non-performing loan, it is a common practice for its bank to transfer this non-performing loan to the entities related to the failed company. The bank will issue 4-5 times amount of the loan to the entities under the condition that those entities will pay the non-performing loans back first.
The improved picture on non-performing loans in the semi-annual report didn’t stop the analysts’ worries. Many analysts had trouble relying on the old models to adequately predict the future non-performing loans since the unprecedented amount of loans were issued in a relatively short time period in this round. Many predicted a possible explode on non-performing loans in the mid of 2010. Besides the commercial sectors, the risks on the retail sectors started to emerge. The defaults on personal loans, residual and commercial mortgage increased slightly from the beginning of 2009. The credit card default and delinquency rate were also up. Considering the CNY 30trillion mortgage nationwide, a small increase on mortgage faults rate can have a large impact.
To proactively protect the banks from unforeseen risks, CBRC imposed a 150% provision coverage ratio on bad loans. That is, for every CNY 100 loan loss, the bank needs to set aside CNY 150 in profit to offset it. Among the big 4 SOE banks, China Construction Banks (OTCPK:CICHF) exceeded 150% coverage. Industrial and Commercial Bank, Bank of China and China Communications Bank (CCCGF.PK) were below 150%, 138.2%, 136.17% and 123% respectively. Under the requirement, the banking sector has to put away at least CNY 81.35billion into reserves by the year end. However, many analysts didn’t think that the increase on provision coverage ratio would have any substantial impacts on the banks. “If you just write off the bad loans, it will not impact the bank performance” commented by one of the analysts at China International Capital Corporation.
The local governments also posted potential systemic risks. The majority of the bank loans flowed into the local government-sponsored financing platform supported by the fixed asset investment projects. The local governments had incurred the total liability of CNY 5.26trillion since the beginning of 2009. According to the state budget law, it is unlawful to have an implicit guarantee by the local governments on such projects. Technically, the commercial banks are not allowed to directly invest into the local government revenue sources. To secure the finance, the local governments usually set up several platforms and apply loans through various channels, which made it difficult to accurately access the overall risks. It is difficult for the banks to monitor the capital flow through the platform. Mr. ShiYu Liu, deputy governor of Bank of China, warned the potential credit risks on those bank loans and suggested to create a municipal bond market.
Bank loans are a double-edged sword. It brings the economics growth and yet posts a potential systemic risk. The figures on the bank loans, and the quarterly reports from the banks will give us some clues on how this risk will manifest itself.