Three important pieces of information implied in the semi-annual reports of banks about the bond market

Abstract

By the end of August 2024, after the banks released their semi-annual reports, integrating the data of listed and unlisted banks, we can identify three important pieces of information: Firstly, although the net interest margin of banks has slowed in its decline, it is still under pressure, especially for large banks, mainly due to the rapid decline in asset rates. By institution, in the second quarter, the net interest margin of large banks decreased by 0.01 percentage points compared to the first quarter; city commercial banks and rural commercial banks maintained the same net interest margin as the first quarter, while joint-stock banks saw a rebound in net interest margin. Looking at the net interest margin data of 42 A-share banks in the first half of the year, most banks experienced a decline compared to the same period in 2023. Among them, the net interest margin of the six major state-owned banks declined the most. The low net interest margin is mainly due to the overall insufficient credit demand, with asset rates trending downward faster than deposit rate cuts.

Secondly, banks are more reliant on financial market investments, which is more evident in their profit distribution. Overall, in the first half of 2024, the proportion of financial investments by state-owned banks and city commercial banks significantly increased, with bank SPV investments and financial investments on the rise. Rural commercial banks' investment income contributed the most to operating income, indicating an overall increased dependency of banks on financial investments.

Lastly, some banks are facing certain liquidity pressures, but generally have sufficient capital adequacy ratios, with some small and medium-sized banks shrinking their balance sheets. City and rural commercial banks have more abundant liquidity and are on an upward trend, while large banks and joint-stock banks have relatively weaker liquidity indicators, possibly influenced by the prohibition of "manual interest supplementation." Data from a total of 304 banks, including non-listed banks, in the first half of 2024 show that the average core Tier 1 capital adequacy ratios of state-owned banks/joint-stock banks/city commercial banks/rural commercial banks have increased compared to the end of 2023. This may indicate a slowdown in the growth of banks' risk capital occupation (such as loans, credit bonds) on one hand, and on the other hand, it may be the result of some banks proactively issuing capital replenishment tools.

We believe that the bond market may be influenced in the following ways: 1. Following the downward trend of asset rates, the speed of decline in liability-side rates may accelerate, potentially leading to another round of deposit rate cuts within the year, benefiting long-term rate bonds; 2. Asset rates for negotiable certificates of deposit in the third quarter may not decline rapidly, but the issuance rates of supplementary tools such as Tier 2 capital bonds may continue to decrease, possibly accompanied by ongoing fund tightness; 3. Banks' reliance on the financial market is mainly due to insufficient loan demand and other objective reasons, but regulatory concerns regarding issues such as SPV management and banks excessively speculating on bonds in the second half of the year will not diminish due to risk prevention and returning to the essence; 4. It is also necessary to pay attention to whether the balance sheet reduction of banks will expand to larger banks, which, combined with the third point, may weaken the "asset shortage" logic and become a major source of risk for a turning point in the bond market.

Main Content

By the end of August 2024, after the banks released their semi-annual reports, integrating the data of listed and unlisted banks, we can identify three important pieces of information: 1. Although the net interest margin of banks has slowed in its decline, it is still under pressure, especially for large banks, mainly due to the rapid decline in asset rates; 2. Banks are more reliant on financial market investments, which is more evident in their profit distribution; 3. Some banks are facing certain liquidity pressures, but generally have sufficient capital adequacy ratios, with some small and medium-sized banks shrinking their balance sheets, and the issuance of perpetual bonds may be more based on considerations of continued issuance In this scenario, we believe that the bond market may be influenced as follows: 1. Following the decline in asset rates, the speed of decline in liability rates may accelerate. In addition to the decline in policy rates, there may be another deposit rate cut within the year, which is beneficial for long-term rate bonds; 2. The asset rates of third-quarter certificates of deposit may be difficult to decline rapidly, but the rates of supplementary tools such as secondary capital bonds may continue to decrease, while also possibly accompanied by continued tight balance of funds; 3. Banks' dependence on the financial market is mainly due to insufficient loan demand and other objective reasons. However, regulatory concerns such as risk prevention and returning to the essence will not diminish in the second half of the year, including issues such as SPV management and banks excessively speculating on bonds, which may continue to disrupt the bond market in the future; 4. It is also necessary to pay attention to whether the balance sheet reduction of banks will expand to larger banks. Combined with the third point, this may weaken the "asset shortage" logic that the bond market has relied on for the whole year, becoming a major source of risk for the subsequent turning point in the bond market.

1. Net Interest Margin Stabilizes, But May Still Face Pressure in the Second Half of the Year

In recent years, due to factors such as LPR cuts, loan repricing, adjustments to existing housing loan rates, and deposit maturity, the net interest margin of commercial banks has gradually declined. By the end of 2023, it fell below the 1.7% mark for the first time, dropping to a historical low of 1.69%, surpassing the critical value of 1.8% for the net interest margin agreed upon by the market interest rate self-discipline mechanism in the revised version of the "Implementation Measures for Qualified Prudent Assessment (2023)". Overall, the net interest margin decline narrowed in the second quarter of 2024, but it still remains at a relatively low level.

1.1. Overall Stability in Bank Net Interest Margin, While Listed Banks' Net Interest Margin Continues to Decline

According to data released by the China Banking and Insurance Regulatory Commission, the net interest margin of commercial banks in the second quarter was 1.54%, remaining stable on a month-on-month basis, showing an overall stabilization trend, with a significant narrowing of the decline in net interest margin, indicating signs of bottoming out. By institution, in the second quarter, the net interest margin of large banks was 1.46%, a decrease of 0.01 percentage points from the first quarter; city commercial banks and rural commercial banks maintained the same net interest margin as the first quarter, at 1.45% and 1.72% respectively; while the net interest margin of joint-stock banks has rebounded, rising slightly from 1.62% in the first quarter to 1.63%.

Looking at the net interest margin data of 42 A-share banks in the first half of the year, only one bank saw an increase of 8 basis points compared to the same period in 2023, while the net interest margin of the remaining banks declined compared to the same period in 2023. Among them, the net interest margin of the six major state-owned banks declined most significantly, with four of them having a net interest margin lower than the industry average. However, on a month-on-month basis, the net interest margin of some joint-stock banks and city rural commercial banks has improved compared to the first quarter.

1.2. Reasons for Weak Net Interest Margin: Decline in Liability Costs, But Greater Decline in Asset Returns So is the net interest margin weakening due to the asset side or the liability side dominating? On the one hand, the net interest margin remains low without significant improvement, mainly due to the overall insufficient credit demand, the overall downward trend of asset interest rates, dragging down the yield of interest-bearing assets; on the other hand, the temporary stabilization of the net interest margin is mainly due to the decline in deposit costs, reducing the pressure on the liability side. As fixed deposits gradually mature and renew, the effects of the past two years' downward adjustment of deposit benchmark interest rates are accelerating; coupled with the second-quarter regulatory rectification of manual interest supplementation for bank deposits, the cost of interest-bearing liabilities for most banks has improved, but the rate of decline in interest-bearing liabilities is far less than that of interest-bearing asset yields.

Asset side: The overall downward trend of interest rates is obvious, and the banking sector's loan income is under pressure. In order to benefit the real economy and stimulate financing demand, the yield on the asset side of commercial banks continues to decline, with loan rates hitting historical lows. In the first quarter of 2024, influenced by a significant 25 basis point cut in the 5-year LPR and insufficient willingness for household leverage, retail pricing has significantly decreased, with new individual housing loan rates in March at 3.69%, a year-on-year decrease of 45 basis points. In July, the 1-year and 5-year LPRs further decreased by 10 basis points.

According to the People's Bank of China's second-quarter monetary policy implementation report, the weighted average interest rate for new loans in June decreased by 31 basis points to 3.68% from March, with general loan rates dropping by 14 basis points to 4.13%; at the same time, mortgage rates rapidly declined after the "5.17" real estate policy, with prepayment of high-rate mortgage loans, resulting in a 24/10 basis point decrease in individual mortgage/business loan rates to 3.45%/3.63%. Therefore, the pressure on the banking sector's asset income side continues.

Liability side: The cost of deposit benchmark rates is decreasing, but the trend towards fixed-term deposits is evident. Since the market-oriented adjustment of interest rates, commercial banks have lowered deposit benchmark rates five times in a row, mainly following the lead of large banks with smaller banks following suit. On July 25th, state-owned banks and some joint-stock banks lowered deposit benchmark rates (current deposit benchmark rate by 5 basis points to 0.15%, 3-month, 6-month, and 1-year deposit benchmark rates by 10 basis points to 1.05%, 1.25%, 1.35%, and 2-year, 3-year, and 5-year deposit benchmark rates by 20 basis points to 1.45%, 1.75%, 1.80%), with subsequent adjustments by medium and small banks. In addition, in April 2024, regulatory authorities rectified cases of improper manual interest supplementation, leading to improvements in the cost of liabilities for banks, with significant achievements in controlling the cost of commercial bank liabilities Under the almost synchronous reduction of interest rates on both the deposit and loan sides, the reason why most banks still maintain a low net interest margin is as follows: First, the repricing cycle for bank deposits is longer than that for loans. Unlike the situation where LPR adjustments are effective for both existing and new loans, adjustments to the listed interest rates for time deposits only affect new time deposits. Second, there is a clear trend towards the regularization and long-term nature of bank deposits, leading to rigid deposit costs, which to some extent offset the downward pressure on interest margins caused by deposit rate reductions.

1.3. Pressure on net interest margin in the second half of the year may ease, but fluctuations are likely

Regarding the trend of interest margins in the second half of the year, it is expected that the downward pressure will gradually ease throughout the year. The repricing pressure on the asset side in 2024 is expected to improve quarter by quarter, the contribution of the liability side to the interest margin is gradually becoming apparent, the efficiency of deposit rate reductions is being released, combined with the active decline in liability costs, driving the support of the liability side for the interest margins of listed banks. Moreover, the prohibition of "manual interest supplementation" is expected to further regulate the competition in the bank deposit market, thereby reducing the industry's deposit costs.

However, there is still a distance to go before the net interest margin completely stabilizes and rebounds, and fluctuations are not ruled out. On one hand, it will take time for the deposit market to return to normal, as the proportion of time deposits remains relatively high; on the other hand, under the pressure of economic downturn, banks still need to further support the real economy, which may exert certain pressure on the banks' net interest margin, leading to fluctuations and oscillations.

2. Banks' financial investment ratio increases, enhancing dependence on the financial market

As of September 1, 2024, a total of 251 banks have disclosed their semi-annual reports for 2024, including 49 listed companies and 202 non-listed companies, of which 230 companies have disclosed the total scale of their financial investments, and 24 companies have disclosed the specific investment content of their financial investments.

Overall, in the first half of 2024, the proportion of financial investments in state-owned banks and city commercial banks has significantly increased, with bank SPV investments and financial investments showing an upward trend, and rural commercial banks' investment income contributing the most to operating income, leading to an overall increase in banks' dependence on financial investments.

2.1. Significant increase in the proportion of financial investments in state-owned banks and city commercial banks

In the first half of 2024, the average balance of bank financial investments has increased. Data from the early warning system, including 230 banks including non-listed banks, shows that in the first half of 2024, the average balance of financial investments for each bank was 405.3 billion yuan, an increase of 4.77% from the end of 2023.

By classification, financial investments in state-owned banks, rural commercial banks, and city commercial banks have significantly increased, while financial investments in joint-stock commercial banks and foreign-funded banks have decreased. As of the first half of 2024, the average total amount of financial investments in state-owned banks was 8,810 billion yuan, an increase of 7.11% from the end of 2023, with the highest growth rate reaching 14.62%; the average total amount of financial investments in joint-stock commercial banks was 2,246 billion yuan, a decrease of 0.53% from the end of 2023, with an average decrease of 2.71%; The average total financial investment of urban commercial banks is 249.4 billion, an increase of 5.48% from the end of 2023. Among them, Jiangsu Bank, Ningbo Bank, Nanjing Bank, and Hangzhou Bank increased by 12.85%, 7.57%, 8.99%, and 8.37% respectively. The average total financial investment of rural commercial banks is 35.4 billion, an increase of 1.09% from the end of 2023. Foreign banks, namely Dahua Bank, saw a decrease of 18.91% in total financial investment.

2.2. SPV Investments and Financial Investments are on the Rise

As only 24 banks disclosed the specific investment content of their financial investments in this semi-annual report, the analysis of the proportion of bank SPV investments and financial investments also referred to the data from the 2023 annual report.

In 2023, the proportion of financial investments to total assets of each bank was 28.6%, with urban commercial banks having the highest proportion. In 2023, the total financial investment of banks reached 104 trillion, accounting for 28.6% of total assets, with the proportions for state-owned banks/joint-stock banks/urban commercial banks/rural commercial banks being 26.66%/30.50%/36.07%/32.02% respectively.

In 2023, banks' financial investments were still mainly in bonds, with a total investment in SPVs (funds + asset management plans + trust plans + wealth management) of 11.1 trillion, accounting for 3.09% of total assets. SPVs (Special Purpose Vehicles) not only cover various forms of bank wealth management products, trust plans, funds, securities asset management schemes, fund management companies and their subsidiaries' asset management plans, and insurance companies' asset management products, but also, according to Document No. 127, public funds are also considered SPVs. In 2023, the scale of bank SPV investments was approximately 11.1 trillion, accounting for about 3.09% of total assets, with the proportions for state-owned banks/joint-stock banks/urban commercial banks/rural commercial banks being 0.84%/5.99%/8.72%/2.28% respectively; the proportion of SPV investments to total financial investments was 10.8%, with the proportions for state-owned banks/joint-stock banks/urban commercial banks/rural commercial banks being 3.15%/19.65%/24.16%/7.11% respectively.

In the first half of 2024, based on the financial reports of listed banks, the proportion of bank SPV investments to total assets was 7.32%, accounting for 20.21% of financial investments, also showing an upward trend. In the 2024 semi-annual report, 8 joint-stock banks, 7 urban commercial banks, and 6 rural commercial banks (all listed companies) disclosed their specific financial investment situations In the first half of 2024, the proportion of bank financial investments to total assets was 31.49%, and the proportion of bank SPV investments to total assets was 7.32%, with the proportions of joint-stock banks/city commercial banks/rural commercial banks being 6.88%/10.43%/2.68% respectively. The proportion of financial investments was 20.21%, with joint-stock banks/city commercial banks/rural commercial banks accounting for 23.01%/26.98%/8.13% respectively. From the data of these 21 banks, there is also an upward trend in bank SPV investments.

2.3. The proportion of financial investments to revenue has increased, and banks' dependence on financial investments has strengthened.

In the first half of 2024, the contribution of bank investment income to operating income was 9.91%. The total investment income of various banks in the first half of 2024 reached 314 billion yuan, contributing 9.91% to operating income, with joint-stock banks/city commercial banks/rural commercial banks contributing 5.02%/14.43%/18.73%/19.32% respectively. City commercial banks and rural commercial banks had the highest contribution of investment income to operating income, consistent with their highest proportion of financial investments to total assets.

In the first half of 2024, the contribution of bank loan income to operating income was 71.92%. The total net loan income of various banks in the first half of 2024 reached 23 trillion yuan, contributing 71.92% to operating income, with joint-stock banks/city commercial banks/rural commercial banks contributing 75.28%/65.69%/69.25%/71.52% respectively. State-owned banks and rural commercial banks had the highest contribution of loan income to operating income.

Compared to the first half of 2023, the contribution of trading business performance in the first half of 2024 has significantly increased, and banks, especially rural commercial banks, have strengthened their dependence on financial investments. With interest rates declining in the first half of the year, the contribution of various bank investment incomes to revenue has increased. The proportions of investment income to operating income for state-owned banks/joint-stock banks/city commercial banks/rural commercial banks increased by 0.59%/4.37%/5.03%/6.54% respectively. In the current market environment, large state-owned banks, due to their higher asset allocation ratios, have shown a certain stability in the contribution of their trading business income. At the same time, the contribution rate of rural commercial banks' trading business has significantly increased. This phenomenon once again highlights the high competitiveness of the market and the increased risk exposure faced by small and medium-sized banks, which may lead to a deterioration in the asset quality of these banks. Therefore, it is expected that in the future, small and medium-sized banks may adopt a profit-locking strategy to ensure the safety cushion of their capital

3. Bank Capital Adequacy Ratio Rebounds in the Second Quarter, Financing Demand Increases

3.1. Overall Bank Liquidity Abundant, with Relatively Weak Liquidity in Major Banks

Overall bank liquidity remains stable and abundant. By the end of the second quarter of 2024, the overall liquidity coverage ratio of commercial banks was 150.7%, a decrease of 0.14 percentage points from the end of the first quarter; the liquidity ratio was 72.38%, an increase of 3.72 percentage points from the end of the previous quarter; both far exceeded regulatory standards and were at a high level. In terms of types, the liquidity of city commercial banks is more abundant and on an upward trend, while the liquidity indicators of major banks and joint-stock banks are relatively weaker, possibly affected by the prohibition of "manual interest rate adjustments."

Excess reserve ratio of banks gradually declines. With policies such as reserve requirement ratio cuts and interest rate reductions being implemented, the reserve requirement ratios of various financial institutions have been continuously reduced. As of February 5, 2024, the weighted average reserve requirement ratio has dropped to 7%, but the excess reserve ratio reached 1.5%, a decrease from the previous period. Even considering its clear quarterly cyclical trend, it has decreased by 0.1 percentage points compared to the same period in 2023. Banks are facing certain pressure on overall liquidity.

Increase in interbank certificate of deposit issuance, boosting bank liquidity supplementation demand. Despite the overall increase in bank liquidity, looking at the issuance of interbank certificates of deposit, the total issuance in the second quarter of 2024 was 8.97 trillion yuan, with a maturity amount of 7.57 trillion yuan and a net financing amount of 1.39 trillion yuan. This represents a significant increase compared to the same period in the past two years, with the net financing amount returning to positive. As of the end of August, the total outstanding interbank certificates of deposit amounted to 17.14 trillion yuan, with the interbank certificate of deposit yield declining. State-owned banks, joint-stock banks, and city commercial banks are the main issuers, and the issuance volume from April to August 2024 has increased compared to the same period in 2023.

This indicates that there is a certain degree of liquidity gap on the liability side of banks, especially for major banks. In a situation where loans have not changed significantly relative to historical averages, deposits have shown a significant non-seasonal decline. Furthermore, the regulatory measures on manual interest rate adjustments since April have further exacerbated the outflow of deposits, with the impact being most severe on state-owned major banks, making them the main force in interbank certificate financing since the second quarter 3.2. Capital Adequacy Ratios Generally Rebound, Some Banks Experience Balance Sheet Contraction

In the first half of 2024, the capital adequacy ratios of various banks have all increased. Data from a total of 316 banks, including non-listed banks, shows that the average capital adequacy ratios of state-owned banks/joint-stock banks/city commercial banks/rural commercial banks are 17.71/13.44/13.13/13.74 respectively; data from a total of 285 banks, including non-listed banks, shows that the average Tier 1 capital adequacy ratios of state-owned banks/joint-stock banks/city commercial banks/rural commercial banks are 13.63/11.25/11.02/11.61 respectively; data from a total of 304 banks, including non-listed banks, shows that the average core Tier 1 capital adequacy ratios of state-owned banks/joint-stock banks/city commercial banks/rural commercial banks are 11.77/9.51/9.49/11.51 respectively. All three indicators have increased compared to the end of 2023, which may indicate a slowdown in the growth of bank risk capital occupation (such as loans, credit bonds) on one hand, and the result of some banks proactively issuing capital replenishment tools on the other.

Some small and medium-sized banks are facing pressure to replenish capital. Although the core Tier 1 capital adequacy ratios of the entire sector remain at a high level, some banks, such as East Ocean Bank, Wenzhou Bank, Hubei Bank, among others, have core Tier 1 capital adequacy ratios close to the regulatory minimum requirements, facing pressure to replenish capital.

Some small and medium-sized banks are experiencing balance sheet contraction. In the first half of 2024, one bank in the joint-stock bank category saw a decrease in assets by -1.62% and liabilities by -1.36%; among city commercial banks, 4 banks experienced asset reduction, with an average asset decrease of -0.57% and liability decrease of -0.89%; according to data from a total of 204 rural commercial banks in the early warning system, 16 rural commercial banks have to some extent reduced their balance sheets, with 8 of them reducing their balance sheets by more than 5%. Once again, this reflects the pressure faced by small and medium-sized banks to replenish capital and adjust asset quality.

3.3. Second Perpetual Bonds Increase by 56.8% YoY, Small and Medium-sized Banks Periodically Replenish Capital

In the first half of 2024, the issuance of bank second perpetual bonds has significantly increased. According to data from Enterprise Early Warning, in the first half of 2024, the issuance volume of bank second perpetual bonds far exceeded the same period in 2023, with a year-on-year growth of 106.02%, and the net financing amount of second perpetual bonds reached 376.5 billion, a year-on-year increase of 29.66%. Considering that most banks have relatively high capital adequacy ratios as mentioned earlier, this is partly due to the peak period of maturity for second perpetual bonds for small and medium-sized banks in 2024-2025, requiring them to issue new bonds to replenish capital, and partly due to some banks aiming to proactively replenish capital in a low-interest rate environment for long-term operational considerations

Classified data can verify the above point, after 2024, state-owned banks will be the main force in the perpetual bond issuance, but joint-stock banks and city commercial banks are growing rapidly. In the first half of 2024, the issuance volume of perpetual bonds by state-owned major banks accounted for 58.23% of the total issuance volume of the four types of banks. Perpetual bonds of all types of banks are showing a net financing trend. The issuance volumes of state-owned banks/joint-stock banks/city commercial banks/rural commercial banks increased by 78.82%/540%/144.21%/24.05% respectively compared to the same period in 2023, and the net financing amounts increased by 9.77%/270%/361%/235% respectively compared to the same period in 2023. Joint-stock banks and city commercial banks are growing rapidly. Refer to our previous report "2024 Perpetual Bond Issuance Pace: Peak May Be in the Second Quarter" 20240308. This is related to the upcoming maturity of many perpetual bonds for small and medium-sized banks in 2024-2025, which require renewal. It is still premature to assume that the capital adequacy ratio of small and medium-sized banks is expected to weaken.

Analyzing the major changes in banks, we believe that the bond market may be influenced as follows in the future: 1. Following the decline in asset rates, the speed of decline in liability rates may accelerate. In addition to the decline in policy rates, there may be another interest rate cut for bank deposits within the year; 2. The asset rates of third-quarter certificates of deposit may be difficult to decline rapidly, but the rates of supplementary tools such as Tier 2 capital bonds may continue to decrease. At the same time, it may also be accompanied by a continuous tight balance of funds; 3. Banks' dependence on the financial market is mainly due to insufficient loan demand and other objective reasons. However, regulatory concerns such as risk prevention and returning to the essence will not diminish in the second half of the year. Issues such as SPV management and banks excessively speculating on bonds may continue to disrupt the bond market in the future; 4. It is also necessary to pay attention to whether the balance sheet reduction of banks will expand to larger banks. Combined with the third point, this may weaken the "asset shortage" logic that the bond market has relied on for the year, becoming a major source of risk for the subsequent turning point in the bond market.

In this scenario, we believe that the bond market may still be more suitable for long-term interest rate bond investments in the future. This is mainly due to the environment of tight liability, where banks still seek high-yield assets and prefer relatively long-term high-yield bonds. However, credit bond investments may be disrupted by the tightening of SPV investments, and long-term interest rate bonds may benefit from further interest rate cuts. In addition, considering that banks' independent bond investments (rather than through fund channels) may become the main trend in the second half of the year, local government bonds will also become a more stable variety.

Author: Tang Yuanmao S0880524040002, Article Source: Guotai Junan Securities, Original Title: "Three Important Information Implied in the Bank Semi-Annual Report on the Bond Market - Net Interest Margin, Financial Investment Dependency, and Capital Adequacy Ratio"