Photographer: Jerome Favre/Bloomberg

China's Banks Are Running Out of Ways to Keep Profits Growing

  • Biggest banks expected to post profit drop for full year
  • ICBC’s coverage ratio remains below regulatory threshold

China’s five largest banks are facing an increasingly daunting balancing act as they try to avoid snapping a streak of rising earnings.

The state-controlled lenders have managed to keep profits increasing every year since 2004, sending a message about the resilience of China’s financial system. Keeping that trend alive is becoming tougher because of rising bad loans and pressure on lending margins.

While analysts expect another quarter of profit growth when Bank of China Ltd., Industrial & Commercial Bank of China Ltd., Agricultural Bank of China Ltd., China Construction Bank Corp. and Bank of Communications Co. report earnings this week, it might just be a matter of postponing the inevitable. For the full year, the five are projected to post a 2 percent decline in net income, according to analysts surveyed by Bloomberg.

A politically-driven focus on keeping profits rising distracts the banks from addressing deeper issues such as how to rein in new bad loan formation, said Richard Cao, a Shenzhen-based analyst at Guotai Junan Securities Co.

"For a big state bank, reporting a profit decline means sending a bad signal to the market about the status of the Chinese economy. That’s not politically correct," said Cao. "For most investors, they look beyond the bottom line and are concerned more about the fundamentals."

Most attention will focus on ICBC, the world’s largest lender, which is due to report on Friday and faces the toughest challenge in maintaining profit growth. The bank has kept earnings rising this year by letting its bad-loan buffer sink below a regulatory minimum.

ICBC had 196.3 billion yuan ($29 billion) of nonperforming loans as of June 30, an increase of 20 percent from a year earlier. But it raised total allowances for bad debts by just 5 percent, allowing the coverage ratio to dip below the 150 percent minimum in the first two quarters.

ICBC would need to set aside another 13.7 billion yuan to bring its bad-loan coverage ratio back to 150 percent, which would cut the bank’s full-year profit by almost 5 percent, according to He Xuanlai, a Singapore-based analyst at Commerzbank AG. The Beijing-based lender might choose to keep profit rising even if it means another quarter of missing the required ratio, said Sanford C. Bernstein & Co. analyst Wei Hou.

"It’s about choosing which profit you want to sacrifice -- is it now or is it at some future time," Hou said.

ICBC declined to comment on its earnings or whether it will meet the bad-loan coverage threshold.

Recent signs that bad loans may be stabilizing could offer banks some respite. China’s official bad-loan ratio held at 1.75 percent in the second quarter after almost three years of increases, while ICBC reported the first decline in its bad-loan ratio since 2012. China’s cabinet this month released guidelines for allowing banks to swap corporate debt for equity on a market-oriented basis, opening another potential avenue for shedding bad debts.

Earlier this year, the large banks had lobbied the China Banking Regulatory Commission to lower the threshold, which would ease pressure on their profits. The regulator resisted and instead urged them to take steps to restore their buffers, people with knowledge of the matter said in July. ICBC’s breaches this year prompted the central bank to deduct points from its metrics under the so-called Macro Prudential Assessment framework, a measure of the health of Chinese banks, Caixin reported this month.

Bank of China also breached the threshold in the first quarter, but managed to add sufficient provisions in the following three months to move back above it.

The steady erosion of profit growth has also raised questions about future dividend payouts. The top four Chinese banks cut the dividend payout ratio to 30 percent in 2015 from 33 percent a year earlier as the sought to preserve capital. Hong Kong-traded shares in Chinese lenders have underperformed the benchmark Hang Seng Index in Hong Kong for five of the past six years, and are trading at average 0.8 times their forecast book value.

— With assistance by Jun Luo

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