Chinese banks’ profitability can weather record cut in mortgage lending rates, analysts say

The banks cut the five-year LPR by 15 basis points last Friday to 4.45 per cent
Banks have only cut the five-year LPR, as saving the property sector has become a new focus, Jefferies analyst says

Banking & finance

Georgina Lee

Published: 6:45pm, 23 May, 2022

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Chinese banks are likely to survive an unexpectedly large cut in their loan prime rate (LPR), the benchmark they use to price mortgages and long-term infrastructure loans, thanks to lower funding costs that have given them more headroom to heed Beijing’s call to support the ailing property sector, analysts said.

The banks decide the five-year LPR, which is calculated from the quotes provided by a panel of 18 banks on the 20th of each month. They cut the rate by 15 basis points last Friday to 4.45 per cent. The five-year rate is the basis on which banks price their mortgage loans. The tenor of the one-year LPR remains unchanged at 3.7 per cent.

The cut on Friday was the largest on record and the second this year after a 5 basis point cut to 4.6 per cent in January. While banks’ LPRs are guided by the central bank’s one-year medium-term lending facility, a policy rate at which the People’s Bank of China (PBOC) lends to commercial banks, last week’s LPR cut has come without a corresponding cut in the policy rate.

The impact on banks’ operating income was likely to be minimal, said Chen Shujin, an analyst at Jefferies. With mortgage loans accounting for about a fifth of banks’ yuan loan books, banks are likely to see a total reduction of 0.8 per cent to 1.2 per cent in their operating incomes, she said.

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“Banks have cut only the five-year LPR, as saving the property sector has become the new focus for them,” Chen said. The cut, effective since last Friday, will affect newly-issued mortgages immediately. Existing loans are expected to be repriced lower starting January 1, when Chinese banks reset the pricing of their existing mortgage loans.

The banks will be able to withstand the impact due to more cushy funding conditions. The PBOC guided banks to lower the cap on time deposit rates by 10 basis points in April, while banks’ cost of funding in the interbank market also dropped this month by 40 basis points from March, she said.

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“Mortgages have been one of the best risk-reward asset classes for banks,” Chen said. The average mortgage rate for the purchase of first and second homes across 103 major cities in China this month stood at 4.91 per cent and 5.32 per cent, respectively, according to Beke Research, a real estate broker in China.

The mortgage rate for first-time homebuyers could fall further to 4.25 per cent, after the PBOC announced this month that the mortgage rate floor for these buyers would be lowered by 20 basis points below the five-year LPR, Bank of America (BofA) analysts including Helen Qiao and Benson Wu said in a recent research note. The unprecedented cut “signals a strong policy intention to boost credit expansion in the property market”, according to BofA.

Banks also share a common interest with the government in supporting the sector, wherein developers saddled with liquidity issues such as Sunac, China Evergrande and Zhenro have defaulted on bond payments. With state-backed entities as shareholders, Chinese banks often act as the state’s conduit for achieving national policy goals.

The five-year LPR reduction will not directly benefit property developers, but it could increase the sales of residential property, which will in turn help developers increase their cash flows from sales and allow them to repay debt, said Iris Pang, ING’s chief economist for Greater China.

The leverage ratio of indebted property developers should go down. As “long-term loans are also usually linked to the five-year LPR, infrastructure financing should benefit from this rate cut, too”, she said.

Banks’ net interest rate margin, a key gauge of their profitability, will decline by 2.5 basis points, according to Jefferies. The average margin for Chinese banks last year stood at 2.16 per cent, higher than the average of 1.48 per cent calculated for six international banks, including HSBC, JPMorgan and MUFG Bank, according to Deloitte.

Both ING and Jefferies said they believe more LPR cuts were likely, and ING said it expected such cuts to continue into the third quarter.

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