Preview of China banking sector H1 2010 earnings and LGFV risk in the medium term
In the upcoming interim results reporting, we expect the Chinese banking sector to report strong growth on the back of decent loan growth, in line with 19% YoY system loan growth, net interest margin (NIM) expansion, continued strong fee-based income and a benign asset quality outlook keeping credit costs low. We have highlighted previously that the overhang in the Chinese banking sector is mainly due to concerns about capital-raising pressure, a property sector credit tightening and the risk of LGFV (local government funding vehicle) default. We believe capital-raising pressure has come to an end. Of the known CNY 450 bn capital-raising plans of China's top six banks, we estimate that approximately 54% has been completed. With respect to the remaining 46%, given Huijin's commitment to support the rights issue and maintain its stake in major Chinese banks, we estimate that the additional cash call pressure is only around CNY 80 bn (or USD 12 bn).
Given the healthier balance sheets and developers' willingness to cut prices to clear inventories, we expect the impact of property tightening policies on developers to be manageable. Mortgage quality should remain in a safe zone, giventhe stringent enforcement of loan-to-value lending. On the other hand, we expect the LGFV risk to linger. However, as there is limited information on hand, we are unable to make an educated guess about the quantity of the earnings impact. We expect the upcoming results announcement will bring us more clarity.
As we understand, all Chinese banks have completed a self-investigation of their LGFV-related loans exposure and asset quality and have reported their findings to the China Banking Regulator Commission (CBRC). Based on the preliminary survey, CBRC reported that the outstanding LGFV loans was CNY 7.66 trillion,for which 27% are commercially viable, 50% would require secondary source of debt servicing payment and the remaining 23% (or CNY 1.8 trillion) are faced with high risk of default. According to the number 19 memo issued by the State Council, local governments will be reporting their self-investigations by December. There is talk that key government and regulatory bodies, including the CBRC, People's Bank of China, Ministry of Finance and the National Development and Reform Commission, are drafting new regulations to address and clean up the debt problem. In our Investment Idea "China still has time to act on LGFV problems", we indicate that China has a healthy fiscal position and has not run out of policy options, such as issuing local government bonds to finance loan obligations. Nevertheless, we anticipate a risk of default for non-commercially viable projects. Chinese banks would need to make additional provision charges, but we believe earnings power is strong enough while leaving shareholders' equity largely intact. We continue to prefer large-cap banks, such as ICBC (1398 HK, BUY) and CCB (939 HK, BUY), given their lower exposure to higher-risk rural and municipal-level LGFV lending.
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