China’s banking sector appears to have lost its appeal to global investors but there are signs of a possible upturn.
The trading of listed commercial banks remains depressed as the valuation of their shares dropped to a price-to-book ratio of about 1 times 12-month 2014 P/B, from a 2007 peak of 4 times.
Bank of America, Goldman Sachs and HSBC have sold stakes in Chinese banks or insurance companies during 2013.
“Global banks [sold their shares in] Chinese financial companies mainly because of their own capital pressure. However, it also shows that Chinese banks are no longer their top pick for investment,” said Hu Bin, a senior analyst of the financial institutional group with Moody’s rating agency.
Meanwhile, mainland commercial banks have struggled to sell their own shares.
As of September, Hong Kong, the top choice for Chinese companies looking to list overseas, had not seen a single listing from the banking sector for three years.
Bank of Chongqing and Huishang Bank in September broke the drought. However, the deals were supported by local corporate and high-net-worth accounts and traded below or slightly above their IPO prices.
Similarly, China Everbright Bank managed to raise $3 billion from the Hong Kong listing last week, its third attempt.
More middle-and small-sized city lenders are waiting in line, including Harbin Bank, Jinzhou Bank, Longjiang Bank and Bank of Shanghai.
However, concerns about Chinese banks include issues such as interest rate liberalisation, intense competition and increase leverage.
“Among all the challenges, interest rate liberalisation stands out as the core concern,” said a vice-president in the financial institution group of a US investment bank.
Deregulation of deposit rates will increase competition among banks and put further pressure on their interest margins, the main source of banks’ profit, the banker explained. Investors may ditch bank shares as their return-on-equity (ROE) fall to a lower level.
The ROE ratio of the sector will decline from 20.7% in 2012 to 17.5% 2015, and profit growth will drop from 16% in 2012 to 6% in 2014 and 7% in 2015, according to a research from Credit Suisse.
Short-term pain
That said, the prognosis is not all bad.
Chinese banks will benefit from interest rate liberalisation over the long term because it will provide a solution to the hidden risk embedded in banks’ asset quality.
Following the Third Plenum, Beijing suggested market forces would play a much greater role in the country’s capital markets, and interest rate deregulation is a key part of its reform agenda.
Theoretically, banks under capital and growth pressure will seek higher risk assets for higher returns.
Chinese banks are already issuing or selling enormous volumes of wealth management products, most of which link to undisclosed underlying assets or local government debt.
The shadow banking industry – the majority of which is taken up by WMPs – has grown by 75% and 67% over the past two years respectively, according to a report by Moody’s.
And in the third quarter, China’s top four banks posted the biggest increase in non-performing loans since 2010. Their bad loans rose 3.5% to Rmb329.4 billion, ($54 billion) or a non-performing loan ratio of 1.02%.
Interest rate liberalisation will help build a more sound banking system given that banks will have much more freedom in managing their own lending.
“Once the deposit rate limits are removed and competition for deposits becomes furious, commercial banks may be willing to lend to middle or smaller-sized companies with more growth potential rather than [just] some big SOEs,” said Chen Xingyu, a Shanghai-based analyst with Phillip Securities.
After regulators removed the lending rate floor in July, analysts and investors expect that a move towards liberalisation of deposit rates will come in the next 12-18 months.
On December 8, China’s central bank allowed Chinese commercial banks to issue certificates of deposit on the interbank market, a further step towards the country liberalising its interest rate. As of now, 10 banks have issued CDs with different rates.
The final deregulation of interest rates will take several years to complete.
Policy boost
The China Securities Regulatory Commission on November 30 said it would start a trial permitting the issue of preferred shares, which offers listed companies a channel to raise more equity without immediately diluting existing investors.
Sources said that Agricultural Bank of China will be one of the first banks to issue preferred shares with a size of “hundreds of billions”. Smaller banks, such as Pudong Development Bank and Ping An bank, are also thought to be preparing preferred share offerings.
More policies are under discussion by the central bank and China Banking Regulatory Commission after the completion of the Third Plenum.
The policies will involve financial reforms such as allowing private companies to operate bank businesses, further curbing of shadow lending and boosting consumer financing.
“Chinese banks are now under pressure, but they also have much potential in capital markets,” said Liao Qun, chief economist and head of research with Citic Bank International.
Those long-term global institutional investors with sizable asset under management will like high-quality banking shares or bonds for their stable and consistent growth, said Liao.
Several banks and research agencies, including Credit Suisse, Goldman Sachs, Bank of America Merrill Lynch and Moody’s, have revaluated the sector and said the time could now be right to buy into China’s banks.
