Chinese banks, set to post record profits, are trading at their cheapest level in two years and may stay depressed in 2011 as investors bet faster inflation and slower economic growth will erode earnings.
Shares lost allure over the last three months, even as banks are forecast to have boosted earnings by more than 25 percent in 2010 and have slashed non-performing loan ratios. The nation’s five biggest lenders, with a combined $777 billion market value, trade at an average of 8.6 times forecast profits, compared with 10.4 times at the world’s 20 largest banks, according to data compiled by Bloomberg. India’s five largest banks trade at an average of 19 times.
The combination of rising profits and cheap valuations has failed to lure investors concerned that China’s government will be forced to step up measures to combat inflation, creating a drag on the economic growth that has fueled demand for loans. Expansion may cool to 9 percent this year, the slowest pace in a decade, according to Fitch Ratings.
“Banks as a barometer of the macro economy are more sensitive to inflation and tightening policies,” said Li Ming, a portfolio manager at Dacheng Fund Management Co., which oversees more than $15 billion in Shenzhen. “Lack of conviction in banking shares is ultimately a reflection of no confidence in the economy.”
Global institutional investors, including BlackRock Inc. and Prudential Financial Inc., have reduced their holdings in Industrial & Commercial Bank of China Ltd. by 66 million Hong Kong-listed shares since October and in China Construction Bank Corp. by 1.27 billion shares, Bloomberg data show.
The banks, both based in Beijing, are the world’s two largest by market value. ICBC, also the most profitable, has gained 3.3 percent in Hong Kong trading this year after falling 8.4 percent in 2010. Construction Bank, the second-most profitable, has dropped 2.3 percent.
“Obviously the big challenge facing China right now is inflation,” said Russ Koesterich, the San Francisco-based head of investment strategy for scientific active equities at BlackRock, which oversees $3.56 trillion as the world’s largest asset manager. “Most of what investors focus on when they think about investment in China over the short term is the success the central bank has been having in bringing down inflation. We have a position that during the first half of the year we prefer to be overweight in developed markets rather than emerging markets, precisely because of the inflation reason.”
Theresa Miller, a spokeswoman for Prudential in Newark, New Jersey, declined to comment, as did spokesmen for ICBC and Construction Bank.
Five of the nine Hong Kong-listed Chinese banks underperformed the benchmark Hang Seng Index, which has gained 1.3 percent this year. The banking sector is the second-cheapest among 18 industry groups in the index, higher only than airlines, Bloomberg data show. Based on price to book value and return on equity, Chinese banks are the cheapest industry in Asia, according Sheng Nan, a Shanghai-based analyst at brokerage firm UOB Kayhian Investment Co.
“Chinese banks are cheap, very cheap considering that these are probably the most successful banks in the world, but the problem is the stock market may not care so much about it,” said Jim Antos, a Hong Kong-based analyst at Mizuho Securities Asia Ltd. “Some of the macro issues have to be resolved, but that doesn’t seem to be happening. Inflation is the biggest risk concerning investors.”
China’s January inflation rate of 4.9 percent exceeded the government’s 2011 target of 4 percent for a fourth month as prices, excluding food, jumped the most in at least six years. Jun Ma, a Hong Kong-based economist at Deutsche Bank AG, said he expects inflation to peak at 5.8 percent in June and the annual rate to stay at 5 percent.
The People’s Bank of China, the nation’s central bank, has raised its benchmark one-year lending rate three times since mid-October to 6.06 percent and increased the amount of deposits banks must set aside as reserves to curb lending to the highest level in at least two decades.
Economists at Nomura International Ltd. predict an additional 75 basis points of interest-rate increases and a 150 basis-point rise in the reserve-requirement ratio in 2011. A basis point is one-hundredth of a percent. The State Information Center, a government think tank in Beijing, said on Feb. 15 that the reserve ratio for the biggest banks may be raised to as much as 23 percent from the current 19.5 percent.
China has set an annual economic growth target of 7 percent for the five years through 2015, Premier Wen Jiabao said yesterday. The target was 7.5 percent for the period from 2006 through last year -- actual growth averaged 11.2 percent.
The government has also told Chinese banks to recalculate capital levels by March 31 to account for higher risk weightings on at least $1.2 trillion in loans to local governments. The move may increase pressure on China’s five largest lenders to raise money or reduce lending, two people with knowledge of the matter said, declining to be identified as the deadline hasn’t been publicly announced.
Some tightening measures, such as lending curbs, have started to take effect. Domestic banks lent 1.04 trillion yuan ($160 billion) of new loans in January, 13 percent below economists’ estimates and 25 percent less than the same period a year earlier.
Tighter liquidity and slower loan growth raises corporate borrowing costs and leads to higher interest payments, which will increase default risks. China’s biggest lenders derive almost 80 percent of their revenue from interest income.
“Concerns on Chinese banks for 2011, as in the past, always dwell on top-down macro views related to a China growth slowdown, which would impact banks’ asset quality,” said Lei Wang, who helps oversee more than $56 billion at Santa Fe, New Mexico-based Thornburg Investment Management Inc., which owns shares of ICBC.
BlackRock Fund Advisors sold 75.5 million shares in ICBC and 60.2 million shares in Construction Bank last month, according to filings on Jan. 31. Prudential Financial sold 20.7 million ICBC shares and 394,170 Construction Bank shares in December, filings showed.
‘Matter of Time’
ICBC may report next month that 2010 net income climbed 26 percent to 162 billion yuan, according to the average estimate of 19 analysts surveyed by Bloomberg. Construction Bank is expected to boost full-year profit by 30 percent to 139 billion yuan, a survey of 17 analysts showed.
Analysts expect ICBC’s return on equity, a measure of profitability, to have risen about two percentage points to 22 percent in 2010, according to the survey. That would be more than double returns for London-based HSBC Holdings Plc and New York-based JPMorgan Chase & Co., the two largest non-Chinese banks by market value, data compiled by Bloomberg show.
“People may be surprised by the good earnings numbers and be relieved,” said Claude Tiramani, who manages $50 million of emerging-market stocks at Lutetia Capital in Paris. “The value is there, it’s just a matter of time before the market reassesses that.”
Tiramani said he invested in ICBC, Construction Bank and Bank of China Ltd., China’s third-largest bank by market value, “over the past few months” and plans to add to his holdings if share prices drop. He said he expects inflation to peak in June.
Chinese bank shares may jump as much as 30 percent this year from their lows as investors seize on depressed valuations and as concerns about worsening asset quality and tougher regulations dissipate, said May Yan, an analyst at Barclays Plc in Hong Kong.
Still, people familiar with China’s banking regulator have said the watchdog agency will enforce stricter rules governing lending and asset quality.
The China Banking Regulatory Commission may order the country’s biggest lenders to boost capital adequacy ratios as high as 14 percent when credit growth is judged excessive, a person with knowledge of the matter said on Jan. 28. The minimum ratio, used to gauge banks’ ability to withstand financial stress, stands at 11.5 percent.
Banks may also be told to draw up contingency plans for how to deal with a possible crisis, according to a person familiar with the CBRC’s plans. The regulator may also enforce stricter standards governing liquidity for the biggest lenders, the person said.
The CBRC’s January order requiring banks to transfer 1.66 trillion yuan of off-balance-sheet assets often packaged as wealth-management products back onto their books may also force lenders to raise more capital, Xiang Junbo, chairman of Agricultural Bank of China Ltd., the country’s fourth-largest bank by market value, told China Finance magazine this month.
China’s five biggest lenders have raised $56 billion by selling shares and convertible bonds in the past year.
“This is a market that’s still dominated by negative sentiment toward China’s banks because of regulatory and macro uncertainties,” said Sheng, the UOB Kayhian analyst. “Banks will be range-bound in the first half unless all the dust settles.”