Fitch: Off-Balance Sheet, Property, Still China Banks' Key Risks

Wed Jun 11, 2014 1:17am EDT

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(The following statement was released by the rating agency) HONG KONG/SINGAPORE, June 11 (Fitch) The decision by the People's Bank of China (PBOC) for a targeted cut in the reserve requirement ratio (RRR), announced on 9 June, does not fundamentally alter the medium-term outlook for Chinese banks, says Fitch Ratings. The cut is a selective easing, reducing the RRR of qualified banks by 50bp to facilitate new agricultural loans and lending to small and micro enterprises. It does not apply to major banks. The decision highlights the ongoing challenges Chinese policymakers face as they look to slow growth of total credit, yet channel funding to priority sectors, while also maintaining sufficient liquidity to avoid a sharp economic slowdown. We last affirmed the stable outlook and 'A' Issuer Default Ratings of China's five largest state banks in December, when we identified rising leverage and the rapid growth of off-balance sheet lending as the key risk focus for the system as a whole. While noting that any upgrades of the state banks' Viability Ratings (VRs) was unlikely in the immediate future, we highlighted that ratings would be supported if : 1) there was a more manageable/sustainable pace of credit growth (i.e. a convergence of credit growth with nominal GDP growth), 2) reduced off-balance sheet activities (or greater transparency surrounding them), 3) improved loss-absorption capacity, and 4) stronger deposit funding and liquidity. Beyond the large state banks, these risks were the principal factors contributing to our VR downgrades for five Chinese banks over the course of 2013. Data through 1Q14, including earnings results from the country's largest banks, confirm that these risks continue to raise significant uncertainties. Loan growth, at an average of just over 13% yoy for major banks in the first quarter, continued to outstrip that of nominal GDP, confirming our expectation that deleveraging was unlikely in 2014 and that the credit/GDP ratio will continue to grow through the forecast period. Furthermore, 1Q data on trust assets continued to show double-digit growth, indicating ongoing accumulation of off-balance sheet lending. Non-loan credit (including trust and wealth management products) is particularly substantial among mid-tier lenders, accounting for between 30%-40% of total assets. This is partly reflected in their relatively lower VRs of 'b+' versus the less-directly exposed large banks which are rated in the 'bb' category. Chinese banks' exposures to the property sector, while not excessive by international standards, are still substantial and a principle source of risk in an environment of tightening liquidity. Property development and mortgages reportedly account for over 20% of the loans of the banks covered by Fitch. But total exposure could be higher, considering the risk of mis-classification of loans and exposures that may reside off-balance sheet. Indeed, the "shadow banking" sector has been an important source of funding for smaller or weaker property development companies. The property market has already shown signs of weakness amid liquidity tightening by the PBOC in 2013. A collapse in prices is not a core scenario, while the scale of exposure amid a slowdown is a significant macro risk. Notably, equity markets continue to heavily discount the sustainability of both Chinese banks' growth rates and their underlying book values - despite the banks reporting what appear to be solid earnings in 1Q14. Current valuations are making it difficult for banks to raise common equity to support growth and absorb higher credit costs. This, in turn, may encourage banks to tap alternative forms of capital, such as preferred stock and subordinated debt, over the remainder of 2014. Contacts: Jonathan Cornish Managing Director Financial Institutions +852 2263 9901 Fitch (Hong Kong) Limited 2801 Tower Two, Lippo Centre 89 Queensway, Hong Kong Justin Patrie Senior Director Fitch Wire +65 6796 7232 Media Relations: Leslie Tan, Singapore, Tel: +65 67 96 7234, Email: leslie.tan@fitchratings.com; Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings. ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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