Squeezing a highly profitable segment
- A 25bp cut to China’s 5-year LPR sees the net interest margins of mortgages, one of the most profitable loan segments of banks, continue to be squeezed.
- Nevertheless, we still think China mortgage margins remain higher than most other regions globally and also higher than average margins on all loans.
- We see the LPR cut impact on banks’ EPS as very manageable. We maintain our view of bank profitability buffers only eroding back to 2020-21 levels.
Squeezing one of China banks’ most profitable segments
? The 25bp cut of China’s 5-year loan prime rate (LPR) to 3.95% by the People’s Bank of China today (20 Feb) was greater than Bloomberg consensus expectations (of a 10bp cut) and was the largest cut to the 5-year LPR since the introduction of the LPR system in 2019. Banks typically price mortgages based on the 5-year LPR rate. Assuming an unchanged basis point spread relative to the LPR, we think mortgage rates for primary mortgages could fall to 3.59% in Mar 2024F. For outstanding mortgage loans, while they do depend on individual mortgage contracts, we estimate at least half the outstanding mortgages will only enjoy the benefit of the 25bp 5-year LPR cuts on 1 Jan 2025.
? We had previously estimated that mortgage ROEs of the large China banks were in excess of 50% in China banks in 2020, dated 9 Jan 2018. Even with the sizable cuts in mortgage rates of over 170bp since 2018 (Fig 1), we still think that mortgage margins in mainland China remain higher than most other regions in the world and are also higher than the average margins of China banks’ lending portfolio.
? We continue to believe that the already record-low banking NIM will continue to trend down in both FY24F and FY25F. The pace of the fall of banking NIM over the 1Q22 – 3Q23 has been relatively rapid, and should such a pace continue, banking sector NIM could fall to 1.16% in FY25F (Fig 4), in our view.
Net profit impact of the 5-year LPR cut is very manageable
? We expect the further release of both provisioning and non-performing-loan (NPL) recognition buffers to help offset the adverse impact on net interest margins, with the consequent impact being a negligible impact on banking EPS in both FY24F and FY25F. We still expect bank profitability buffers, which had been built up since 2016, to only erode back to 2020-21’s levels (see How much are buffers worth, dated 25 Oct 2022 and Significant buffers to absorb LPR cuts, dated 15 Aug 2023).
? If these profitability buffers were not used to offset the impact of the LPR cut, we estimate the 25bp cut in 5-year LPR would lower FY24F net profits by 1.7% on average, on an annualised basis, with CCB the most adversely impacted at a -2.5% impact (Fig 6). We expect an average 3.1bp annualised adverse impact to FY24F NIM for the banks under our coverage.
? We still maintain our view of a mid-single-digit mortgage growth for the China banks in FY24F, rising to mid-high-single-digit mortgage growth in FY25F.
Retain sector Neutral rating; top picks are BOC, CCB, CMB & CITIC
? We value the China banks using a stress-test-adjusted GGM. Upside/downside risks: an improving/worsening Chinese economy, and better/worse NIM trends.
