Summary of Key Points
Nanjing Bank achieved a 40.19% increase in net interest income for the first half of the year, which is at the top level in the industry. However, behind this impressive figure lies both a real expansion in bond investment and an accounting adjustment that has a “bookkeeping effect”: by moving bonds from the “trading for profit” account to the “holding for interest” account, the interest income has been reclassified from non-interest income to interest income. This move not only helps to mitigate the risks associated with bond market fluctuations but also improves the bank’s financial statements. Overall, Nanjing Bank remains a leading and high-quality city commercial bank, but it also faces challenges such as a narrowing interest margin and a weaker non-interest business.
The Two Main Drivers of the Surging Net Interest Income
Nanjing Bank’s 40% increase in net interest income can be attributed to two main factors:
1. A significant expansion in bond investment: The average balance of bond investments increased from 0.69 trillion yuan to 1 trillion yuan, a 47% increase, which is the core driver of the growth in interest-generating assets (which overall increased by 24%). As a “bond king,” the bank is already adept at bond investment and has further increased its allocation.
2. Substantial accounting adjustments: Bonds purchased before were classified as “trading financial assets (FVTPL),” where the interest income was considered non-interest income. Now, newly acquired bonds are classified as “other debt investments (FVOCI),” where the interest income is directly recognized as profit. This reclassification effectively moves the interest income from the “non-interest” category to the “interest” category, thereby increasing the reported net interest income. For example, while bond interest income increased by 32% in the first half of the year, the investment returns on trading assets decreased by 47% due to this adjustment.
The Accounting Adjustment: FVOCI vs FVTPL
These two terms may sound complex, but they are actually quite simple:
- FVTPL (Trading Account): This category is similar to trading stocks, where profits are made from price fluctuations. If bond prices rise, profits increase; if they fall, profits decrease, resulting in significant volatility.
- FVOCI (Holding Account): This category is similar to holding bonds as a fixed deposit, where profits come from the fixed interest payments. Bond price fluctuations do not affect current profits; only when bonds are sold are any gains or losses recognized.
Nanjing Bank has moved its newly acquired bonds to the FVOCI category to stabilize its financial statements and protect them from the impacts of bond market fluctuations.
Why Make This Adjustment?
There are two main reasons for this adjustment:
1. Risk Mitigation: Bond market interest rates are currently very low, leaving little room for profit from price fluctuations (FVTPL). If interest rates rise and bond prices fall, it could lead to significant losses. By moving bonds to FVOCI, the bank can shield its profits from these risks.
2. Improve Financial Statements: With many banks experiencing a narrowing interest margin, Nanjing Bank wants to present a stronger image by showing higher net interest income. Net interest income is often seen as a sign of a bank’s ability to manage risks. This adjustment also helps the bank move away from its image as a “bond king” and convey a focus on its core business of lending.
Real Performance: Excellent but with Weaknesses
Excluding the accounting adjustments, Nanjing Bank remains a high-quality city commercial bank:
- Good Asset Quality: It has a low non-performing loan ratio of 0.82% and a high provision coverage ratio of 306%, indicating strong financial resilience. Its regional business in Jiangsu and Zhejiang is stable.
- Advantageous Interest Margin: Its net interest margin of 1.79% is slightly higher than that of Jiangsu Bank (1.64%) and Ningbo Bank (1.7%).
However, there are also shortcomings:
- Weaker Non-Interest Business: Revenue from fees and other intermediary services decreased by 18.5% year-on-year, and its wealth management and sales activities are not as strong as those of Ningbo Bank.
- Pressure on Interest Margin: The net interest margin is continuing to decline, and there is limited room for reducing liability costs in the future. Therefore, the bank will need to rely on further expansion to maintain growth.
Potential Risks
1. Hidden Losses: The potential losses from bonds held in the FVOCI account are not yet reflected in the financial statements. If these bonds are sold in the future, the losses will reduce the bank’s profits.
2. Sustainability of Growth: The growth in net interest income depends on expansion and accounting adjustments. If the expansion slows down, the bank’s performance may struggle to maintain its growth momentum.
In Conclusion
Nanjing Bank’s approach is a “smart move” within accounting standards, as it helps to maintain financial stability and improve the appearance of its financial statements. However, investors should be aware of the underlying reasons for these adjustments. While Nanjing Bank is an excellent bank, it is not without its weaknesses.