China banks face tough times

By Kennix Chim and Tony Munroe

HONG KONG (Reuters) - China's huge state banks are poised to report strong profit growth for the first half in 2008, thanks to wider margins and strong fee income, but funding costs are expected to rise in the second half, eroding growth.

Chinese lenders are likely to face a harder time for the rest of the year and beyond as customers lock up funds in time deposits and move away from more profitable demand deposits, and as a weak stock market dents enthusiasm for investing in shares.

Asset quality is expected to deteriorate as property firms are hit by Beijing's clampdown on borrowing and exporters are squeezed by a weakening U.S. economy and higher costs. Banks will also be without the incremental benefit of a lower tax rate that kicked-in last year.

Robust loan growth, meanwhile, is slowing as Beijing has taken steps to stave off economic overheating.

"We think this year's high earnings growth will not be sustainable into next year," said Y.K. Lee, analyst at Core Pacific-Yamaichi, who expects earnings growth next year to be in line with that of China's nominal economic growth and has a neutral rating on the sector.

"Next year the banks may face higher credit costs and that may lower earnings growth," he added.

Even though profit growth at Chinese banks are seen to have peaked during the first quarter, western banks such as Bank of America (BAC.N) and Royal Bank of Scotland (RBS.L) are expected to hang on to their holdings in the country's big lenders given the strategic importance of China and high barriers to entry.

TOUGHER ROAD AHEAD

Some big Chinese banks have already pre-announced robust first-half earnings, expecting bottom-line growth of over 50 percent due to net interest margin expansion, a lower tax rate and strong fee income in an economy that grew by 10.4 percent from January through June.

But such bumper outlooks may be scarce in the near future.

"The positive earnings revision cycle over the past 12 months looks to be ending as NIMs (net interest margins) are reaching a plateau and credit risks are rising as China's economy faces potentially greater-than-expected slowdown risks," Citigroup analyst Simon Ho wrote in an August 14 note.

Industrial & Commercial Bank of China (1398.HK) (601398.SS), the world's biggest bank by market value, is forecast to see a 44.7 percent rise in its second-quarter net profit to 32.3 billion yuan, while first-half profit could rise 59 percent to 65.4 billion yuan, according to analysts forecasts.

No.2 lender China Construction Bank (0939.HK) (601939.SS) is expected to say first-half profit rose 70 percent to 58 billion yuan after it earned 32.1 billion yuan in the first quarter.

Bank of China's (3988.HK) (601988.SS) profit growth is expected to be the weakest among China's three biggest listed banks because of its exposure to U.S. subprime-related holdings, slower fee growth, higher loan impairment losses and large presence in slower-growing Hong Kong.

China's top foreign exchange lender is expected to post a 38 percent increase in first-half profit and a 7 percent year-on-year increase in second quarter profit, based on the forecasts of six analysts polled by Reuters.