Sneak peek on China bank earnings offers worrying credit cost picture

An economic slowdown in the fourth quarter of 2014 may have been tougher on mainland banks than many expected, with bad loans dragging down profits at three mid-sized commercial banks and sending a sector-wide warning signal on credit quality.

Preliminary earnings results from China Merchants Bank, China Minsheng Bank and Citic Bank showed soaring operating expenses in the last three months of the year, which slowed profit growth to record lows.

For Minsheng Bank, that meant recording just 5.4 per cent growth for 2014, the first time in its 19-year history that it has notched single-digit growth. Merchants Bank's profits grew by 8.1 per cent and Citic's by just 3.9 per cent.

The banks did not disclose total impairments in their earnings snapshots, which are an unofficial taste of what is to come when mainland banks start reporting in March. But most analysts believed the surge in operating costs was due to charges taken on bad loans.

Minsheng Bank's non-performing loan rate leaped to 1.17 per cent at the end of December from 1.04 per cent just three months earlier. Merchants Bank's rate edged up by just 0.01 percentage point, while Citic's even fell.

Those two banks hit the market with their bad debt, selling enough to investors to keep bad debt rates down, analysts said.

"The NPL rate increase at Merchants was low but the main reason for low profit growth was still the cost of credit," said Chen Shujin, an analyst at DBS Vickers in Hong Kong. "We have seen that they were very active in selling off distressed debt portfolios [in the fourth quarter]."

As was Citic, according to Barclays. More than 20 banks sold about 120 billion yuan (HK$151 billion) in bad debt in China during 2014, more than double the year before, the South China Morning Post reported last year.

Across the sector, banks have also ramped up write-offs from the 1.3 trillion yuan cache of provisions they have been building on the orders of the bank regulator since 2009. Hong Kong-listed mainland banks ratcheted up provisions by 76 per cent in the third quarter, BNP Paribas data showed. That trend probably continued in the fourth quarter, analysts said, masking the appearance of deteriorating assets.

The brief but limited glance into bank earnings for 2014 was yet another signal that more than a decade of rapid profit growth for Chinese banks was coming to an end.

"[It] again suggests that China banks' hyper-growth stage might be gone," said Erin Lee, an analyst at Yuanta Securities in Shanghai.

Perhaps more worrying, however, was the enduring deterioration of credit that accompanied in 2014 the slowest rate of gross domestic product growth China has experienced in 24 years.

After five years of declining or stable numbers of insolvency cases in China, Euler Hermes, the world's largest credit insurer, predicted a 5 per cent increase this year to 2,760 cases. The company also said the average number of days it takes companies to pay for goods and services bought on credit is set to climb to 90 from 69 in 2011, demonstrating an increasing squeeze in working capital for Chinese firms.