In the second quarter of 2024, the banking sector's credit allocation aligns with expected timelines, maintaining the annual goals set at the beginning of the yearHowever, signs of differentiation are becoming apparent in asset structuresWhile interest margins continue to face downward pressure, the overall asset quality remains stable as banks opt for time to manage space, keeping the non-performing loan (NPL) ratio steady.

Recent surveys involving several banks indicate that since the second quarter commenced, credit issuance aligns well with expectations, bolstered by geographic advantagesThe surveys primarily involve urban commercial banks and rural commercial banks located in prosperous regions such as Jiangsu, Zhejiang, Shandong, and Guangdong, where credit demand benefits from favorable local economic conditions

As a result, banks have conservatively set the credit growth target for 2024, aligning it approximately with the elevated credit allocations seen in 2023.

From the perspective of social financing data, the credit growth for the first five months accounted for 49% of the projected total for the entirety of 2023, illustrating alignment with quarterly expectationsHowever, the growth of credit in joint-stock banks may still confront pressure as their traditional favorable sectors, such as real estate and retail, still require recoveryConcurrently, in response to the evolving economic landscape, several joint-stock banks are adjusting their asset structures proactively.

In terms of corporate business, credit allocation primarily targets external demand, emerging industries, and inclusivityBanks display robust corporate credit issuance, particularly within manufacturing sectors and microfinance

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On one hand, external demand remains relatively strong, supporting export-oriented manufacturing companies; on the other hand, the introduction of initiatives like “Five Major Areas” and “New Quality Productivity” injects fresh vitality into emerging industriesMany banks have reported that loans supporting technological innovation and environmentally sustainable projects have continued to grow faster than average loan growth rates across their portfolios.

However, credit for real estate and platform financing remains under pressure for growthOn the demand side, the recovery remains sluggish; from the transaction volumes of commercial properties as of June 27th, key metropolitan areas showed listings that were disappointing when compared to previous yearsFor instance, the transaction area of residential properties in the ten largest cities fell to approximately 22.89 million square meters, significantly short of prior annual averages, while the national price indices for new and existing homes reflected declines of 4.3% and 7.5%, respectively, indicating a continued trend of weakening prices.

On the supply side, post-implementation of the “517 Policy” for hoarding and refinancing, strategies have shifted toward “in-kind acquisition” rather than mere construction, further constraining the potential for loans dedicated to real estate development

In the domain of platform financing, debt management pressures have introduced restrictions—certain regional platforms face tight funding, impacting infrastructure loan growth, while some banks have internally enforced limits on the volume of platform loans they authorize.

On the retail side, credit growth continues to be challengedMany banks report that retail loan issuance is lagging its expected timeline, prompting alterations in future retail loan strategies, consequently filling the gaps with corporate loansWhen analyzing consumer loans, household consumption has yet to show robust recovery, as evidenced by a mere 4.1% year-on-year increase in retail sales over the first five monthsFurthermore, mortgage loans remain low amidst lackluster real estate sales, alongside a persistent trend of early loan repayments that have contributed to negative growth in most banks’ mortgage lending portfolios; operating loans are similarly subdued, with small business owners demonstrating heightened caution in withdrawing and utilizing funds due to the prevailing economic environment.

Within the investment landscape, as average lending rates continue to drop, the economic value added (EVA) from state bonds and policy bank bonds has exceeded that of common loans

It appears that certain banks are potentially inclined to shift their resources towards the financial markets based on their internal fund transfer pricing (FTP) strategies.

Evaluating the trading environment, the sustained drop in interest rates positively influences commercial banks' investment returns, with government bond yields declining further in the second quarter, consequently boosting the bond marketNotably, the ten-year government bond futures saw a 1.6% increase in Q2, surpassing the 1.3% rise in the preceding quarter.

Other non-interest revenue for listed banks witnessed impressive growth, recording a 22.7% rise in the first quarter, and amidst the continued strength in the bond market, expectations for moderate non-interest income growth in the second quarter remain highThough profit-taking tendencies may arise in certain banks, others are sustaining a strategic focus on maintaining a consistent duration level.

Additionally, examining the liabilities side reveals ongoing pressures for capital acquisition against the backdrop of banned manual interest supplementation, suggesting potential shifts in the sector's competitive landscape

From the start of 2024, as the wealth management sector gradually recuperates, occurrences of deposit migration have resurfaced, signifying an intensified competition among banks for capital inflowIn comparison to the deposits from 2023 characterized by less competition, 2024 banks are poised to encounter greater retention challenges primarily due to the following factors:

Firstly, the base effect: In the wake of large fluctuations in debt markets at the end of 2022, combined with significant capital market volatilities during the first half of 2023, there has been a substantial increase in bank depositsThis significant rise has created high baseline pressures for deposit growth expectations in the first half of 2024. Secondly, the diversion of capital: As deposit rates continually decrease and bond rates rise, capital originally flowing from wealth management into deposits is now reversing courses back towards those wealth products.

Moreover, the prohibition on manual interest supplementation disproportionately impacts large state-owned banks and joint-stock banks more than municipal and rural commercial banks, a trend reflected in the newly added deposit figures across different bank categories

In the three months prior to the ban, major state banks, central state-owned large banks, and national small-to-medium banks saw their deposit growth significantly decline relative to the same period in 2023, with the latter group experiencing more severe downturns.

As for the asset side, interest rates are on a general downward trendSome banks have noted seasonal improvements; however, the pressure on interest margins is significant throughout the yearThe dropping interest rates across the board create more competition for banks to maintain desirable lending margins, with a tendency for newly issued loan rates in Q2 to show a modest seasonal increase compared to Q1 due to the strong promotional efforts at the start of the year.

Looking ahead into the second half of the year, banks foresee ongoing downward pressure on asset yield

With the benchmark loan prime rate (LPR) redefinition nearing completion, the downward pressure on rates appears limited, stemming mainly from the reduction in new loans and the push for municipal debt repaymentsThe overall view for the year predicts an ongoing narrowing of interest margins, albeit at a reduced rate compared to 2023.

Between September 2022 and June 2024, as many medium and small banks lower deposit rates, the industry has experienced four rounds of interest rate cuts that are progressively alleviating the cost of liabilities for banksGiven the continued narrowing of interest margins in the banking industry, further reductions remain possible in the latter half of the yearSimultaneously, the trend towards longer-term deposits persists, which cushions some of the downward pressures stemming from deposit rate cutsRural and commercial banks, which already have a substantial base of fixed deposits, stand to benefit significantly, as their lower deposit rates will positively influence their interest margins while the potential for further elongation of deposit terms remains relatively limited.

Assessing the combined impact of both sides of the balance sheet, interest margins are expected to trend downward slightly but steadily

Feedback from various banks indicates that lending rates in the asset sector face downward pressures, which will likely be managed through structural adjustments, such as increasing the share of retail lending or targeting smaller clientele to mitigate pressures on asset deploymentMoreover, banks are cautious as declining deposit rates contribute to both the improvement of margins and the effects of ongoing trends towards more term-deposit arrangements.

As far as asset quality is concerned, an overall stable outlook is projectedFrom the results of investigations, banks express confidence in maintaining asset quality through 2024, with existing non-performing loans and provisions having ample maneuvering spaceRetail assets are still under pressure from marginal increases in bad debts; however, infrastructure loans and loans for manufacturing sectors—all significant components of overall lending—remain relatively stable

Additionally, industry provisions for loan loss reserves continue to sit at historically high levels, ensuring that credit costs remain well covered, and excess reserves facilitate risk management, suggesting stability for non-performing loans across the board.

In terms of corporate finance, after several years of cleansing from accumulated defaults, the outlook for real loans is improving, bolstered by favorable metrics in industrial indices and debt repayment capacityOver the short to medium term, substantial exposure to defaults within real loans is unlikelyInfrastructure loans, particularly those associated with local governments' capital projects, remain robust under current consolidation conditions, and pressure across the year is mitigated as time is traded for more favorable positions.

Within the real estate sector, large and impactful property developers have already revealed much of their risk exposure, now transferring focus to banks on balance sheet management

Currently, banks hold sufficient provisions to maintain stability in NPL ratiosHowever, banks report a slight uptick in consumer loan risks—particularly in mortgagesThe increasing trend of early loan repayments has resulted in a noticeable depletion of high-quality clientsConcurrently, declining property values contribute to rising pressure on mortgages, emphasizing a sharper burden on banks with difficult local conditionsConversely, banks with favorable locations, favorable loan-to-value (LTV) ratios, and sufficient collateral values report steady but cautiously monitored asset quality.

As for credit cards, an examination of the “Jiancheng 2022-1” issued by China Construction Bank reveals a consistent upward trend in overdue rates since June 2023, indicating a steady rise in credit card defaultsFurthermore, data from May 2024 show that the overdue rates have begun to decrease, suggesting some moderating pressure on generating new delinquencies.

In consumer lending, when evaluating the “Anshun 2022-1” from Ping An Bank, there were evident spikes in overdue rates seen at the turn of 2022 into early 2023 due to the impact from the pandemic

Entering into 2024, the rates have shifted markedly higher, revealing a concerning trend in defaults related to consumer lending.

In the mortgage sector, the “Jianyuan 2021-10” is observed revealing stable conditions for mortgage lending quality, as indicated by channels showing low overdue ratiosHowever, several upticks occurred between 2022 to present, notably in 2024, associated directly with housing market downturns that reflect increased pressures on mortgage yieldsMeanwhile, for operational loans, data from Changshu Bank’s “Changxing Financial 2022-2” show a distinct escalation in overdue ratios since mid-2023, signifying pressures on generating bad debts largely stem from the softened economic landscape and lower home values impacting cash flow within small enterprises.

As policies regarding the housing sector continue to materialize, particularly with policies around supportive housing financing being refined, the expectations for banking assets tied to real estate loans look promising

The “517 Supportive Housing Refinancing” initiative is in its initial phase, with anticipation of loan distributions commencing in July following groundwork laid in JunePrevious trials hinted at subpar effectiveness, as revealed in January 2023 with policies surrounding rental housing financing, indicating lack of enthusiasm across participating entities.

Amidst these conditions, platform corporations are currently under heavy debt obligations, discouraging engagement in alternative tasks due to limited funding sourcesLocal governments are equally constrained, facing challenges in identifying properties meeting requisite standards—these criteria include the capability for handover, ensuring levels of rent yields, and space limitations.

For financial institutions, future audits will impose stringent scrutiny on the use of refinancing funds; the loan rates acceptable to the government must remain below rental yield levels, disincentivizing banks outside of the four state-owned corporate giants and policy banks from participating actively