Concerns about a slowdown in Chinese growth and a rise in U.S. Treasury yields have put pressure on emerging market equities this year. One segment in particular receives much attention: the Chinese banks. Chinese banks trade at some of the lowest price-to-earnings multiples and the highest dividend yields in the emerging markets. There is skepticism about the asset quality of Chinese banks and whether their non-performing loans (NPLs) are as low as they officially report.
A Chinese Property Bubble?
Some analysts argue that excessive loan growth in China has resulted in a surplus of properties with artificially inflated values. These analysts have also accused the Chinese government and banks of not accurately reporting these potential bad loans. Certainly slower growth or a “hard landing” in China could put pressure on non-performing loans, but below I will discuss why I believe accusations of outright accounting manipulation have been exaggerated.
Non-performing Loans
The China Banking Regulatory Commission recently announced that by the end of June, the non-performing loan balance of commercial banks was 539.5 billion yuan, with an NPL ratio of 0.96%. The commission also reported that loan loss provisions stood at 1.57 trillion yuan, up 18.97% year-over-year, and the provision coverage ratio was 291.3%1. This means that commercial banks have set aside enough reserves to cover approximately three times the amount of current non-performing loans. In the below chart I highlight the individual NPL ratios and the respective allowances for a few of the largest Chinese banks as of their most recent 2013 interim financial reports.