HSBC-China Banks and Real Estate-New risk assessment framework –...

Disclosures & Disclaimer This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it. Issuer of report: The Hongkong and Shanghai Banking Corporation Limited View HSBC Global Research at: https://www.research.hsbc.com The 10th edition of the EM Sentiment SurveyClick to viewReturn of the EM bull  The new risk assessment framework tightens recognition standards on non-loans and restructured assets  We see this as a move to prevent banks taking excessive risks linked to restructuring by distressed developers  Prefer CMB-A/H, CCB-H among mainland China banks, and CRL among developers, all Buy rated It’s a tightening measure: The PBOC and CBIRC have jointly announced a new financial asset risk assessment framework. The new rules tighten the recognition of restructured exposure and expand the five-category classification to finally cover non-loan financial assets, effective July 2023 with transition till end-2025. Key impacts: #1 Increased recognition of non-performing assets. Covering cross-default and mandated downgrades of restructured assets may lead to increased bad debt recognition. Credit costs, NPL ratios and SML ratios may increase, while the NPL coverage ratio may be reduced. #2 De-risking of investment book; de-risking of interbank exposure. Banks with higher-risk non-loan investment exposure may need to de-risk; the risk is higher for joint-stock banks and city commercial banks. The new rules may also weaken some smaller banks’ balance sheets, resulting in a rise in interbank counterparty risks. #3 Avoid excessive support to restructured developers. The new rule may act as a counter-balancing measure and further reduce banks’ appetite to extend credit to marginal developers with restructuring needs. The supply of credit could become more concentrated on top-tier borrowers and accelerate property sector consolidation (see China Real Estate and Property Management - 2023 outlook: The three big questions, 10 Jan 2023). #4 Reaffirm the need for capital. With a potential increase in asset impairment charges, capital generation will become more important to differentiate banks that can sustain organic growth vs those that need inorganic capital. For example, PSB and CITIC Bank are in the progress of completing their share placements. Investment implications – banks. We read the new rules as a tightening measure that could widen the differential between higher and lower quality banks. Longer term, the rules could enhance the credibility of the banking sector by discouraging the evergreening of loans, and avoid excessive risk-taking in relation to stressed developers. We prefer quality banks, including CMB-A/H and CCB-H. Investment implications – real estate. While the funding prospects of distressed developers appear to be diminished, we argue that banks have consistently had little appetite for extending credit to them. The positive news is th