Mainland banks are likely to post decent first-half profits this year but an increase in overdue loans is a cause for concern.
The nine Hong Kong-listed mainland banks are expected to report about 10 per cent growth in net earnings when they start releasing results this month, according to analysts.
Their profits are unlikely to boost their stock prices with impairment losses from rising bad loans set to dent sentiment.
"Chinese authorities' tough stance on industrial overcapacity will initially mean rising overdue loans, and, over time, rising non-performing loans," analysts at Nomura Securities said in a research note. "This will be a gradual process since NPL recognition and before-tax provisioning of bad debts is a somewhat more cumbersome procedure in China compared to developed markets."
Regulators have asked lenders not to extend new loans to sectors hit by overcapacity, such as steel and cement. That means companies will struggle in the case of a prolonged economic slowdown and have problems repaying existing loans.
Analysts at Barclays Capital estimate non-performing loans at the end of June rose on average nearly 13 per cent among the Hong Kong-listed mainland banks from six months ago.
They forecast the non-performing loan ratio of those banks to have climbed two basis points to 0.93 per cent.
"Investor concern will be focused on asset quality and the interbank business during the interim report season," said Barclays analyst May Yan.
Yan estimates a "moderate increase" in non-performing loans of 6.3 per cent in the second quarter from the preceding period.
"Due to recent regulatory tightening in the interbank market and the interbank rate spike in late June, we estimate banks' interbank business could be shrinking, with most of the impact seen in the second half of this year," she said.
Interbank rates on the mainland hit historic highs in June as regulators decided to rein in shadow banking and crack down on the bond market. Small and medium-sized banks were affected severely because they are the major borrowers in the interbank market.
Banks' profits will be underpinned by a stable net interest margin (NIM), a key measure of lending profitability, and a recovery in fee income growth driven by credit card and wealth management fees, analysts say.
"The slow move towards deposit interest rate liberalisation will benefit the outlook of NIM," an analyst with a major mainland investment bank in Beijing said.
The central bank announced the abolition of the floor on loan rates last month, in a small step towards interest rate deregulation. Market participants are now waiting for the move that will allow the market to determine the interest rate to be paid to depositors.
Because of an increase in bad loans and further moves towards interest rate deregulation, mainland banks were likely to report declines in profit over the coming three years, said JP Morgan's Josh Klaczek.
Additional reporting by Kanis Li
This article appeared in the South China Morning Post print edition as Bad loans to weigh on mainland bank profits
