China’s biggest banks, already poised for the weakest profit growth in more than a decade, risk a further erosion in earnings from record share sales intended to boost their capital after a credit binge.
Industrial & Commercial Bank of China Ltd., the nation’s largest lender, and its listed peers this year proposed selling $63 billion of preferred and common stock, exceeding U.S. and European banks’ combined $56 billion, according to data compiled by Bloomberg. The five biggest Chinese banks report second-quarter earnings beginning tomorrow.
Selling preferred stock will saddle the banks with expensive dividend payments, an extra drag on retained profits. Shares of China’s lenders, trading at the cheapest price-to-earnings valuations among global banks, are already constrained by rising bad loans, a faltering economy and prospects of more equity sales.
“It’s a vicious cycle,” Chen Xingyu, a Shanghai-based analyst at Phillip Securities Research, said by telephone. “Unlike the biggest banks in U.S. and Europe, Chinese banks are still run on a very primitive and capital-intensive business model of taking deposits and offering loans: that means they are always in need of capital replenishment.”
China’s five biggest banks -- ICBC, Bank of China Ltd., Agricultural Bank of China Ltd., China Construction Bank Corp. and Bank of Communications Co. -- may report a 7 percent increase in combined net income to 924 billion yuan ($150 billion) this year, according to analysts’ estimates compiled by Bloomberg. That compares with about $70 billion for the top five U.S. banks, led by Wells Fargo & Co., and $47 billion for the five biggest in Europe.
Second-quarter profit growth for China’s big five may range from a high of 12 percent for Agricultural Bank to a low of 5 percent for Bocom, according to the average estimates in a Bloomberg survey.
ICBC, the bank with the world’s biggest profit, will probably report a 7.4 percent gain to $12.2 billion when it releases second-quarter earnings on Aug. 28. Shares of the lender, based in Beijing, dropped 0.4 percent in Hong Kong today. The stock has fallen 2 percent this year in Shanghai and is little changed in Hong Kong, weighing further on the bank’s valuations as its share price fails to match the profit growth.
Shares of Chongqing Rural Commercial Bank Co. fell by the most in more than two months in Hong Kong today, sliding 6 percent, after the lender reported a jump in nonperforming loans in its first-half results.
The five largest banks trade in Hong Kong at an average of about five times their estimated earnings on a per-share basis for 2014, the lowest globally, according to data compiled by Bloomberg on global banks with a market valuation of more than $10 billion. That’s less than half the valuation of the benchmark Hang Seng Index. HSBC Holdings Plc trades in London at about 12 times, JPMorgan Chase & Co. at about 10 times in New York.
Rising nonperforming loans, which climbed to 1.08 percent of outstanding credit at the end of June, or the highest level since the first quarter of 2011, have curbed investors’ appetite for the stocks. In May, Guotai Junan Securities Co. said lenders’ share prices implied a perceived bad-loan ratio as high as 7.8 percent.
$77 Billion Shortfall
The big five may face a combined capital shortfall of as much as $77 billion by the end of 2018, taking into account the fundraising already announced and assuming the Chinese government pushes banks to exceed minimum capital-adequacy standards, according to Jim Antos, a Hong Kong-based analyst at Mizuho Securities Asia.
Listed Chinese banks have already raised at least 207 billion yuan from so-called Basel-compliant bond sales this year to boost their Tier-2 capital. Bank of Communications sold 28 billion yuan of the securities today.
ICBC and Agricultural Bank each plan to sell 80 billion yuan of preferred stock, while Bank of China says it will raise 100 billion yuan. The companies haven’t said when the securities will be sold. The regulator allowed preferred-share sales this year for the first time because most banks’ market valuations were less than their net assets, which prohibits them from selling common shares under Chinese rules.
“Preferred shares are a new way to raise funds, but it’s an expensive way and won’t change the pessimism many investors have toward China banking stocks,” Chen of Phillip Securities said. “The deterioration of earnings and asset quality will continue for at least the next three years.”
The yields for the preferred shares will probably be set at 8 percent to 9 percent, which will make them “very attractive” to institutional investors such as insurance firms, according to Tang Yayun, a Shanghai-based analyst at Northeast Securities Co. That compares with the 5.8 percent coupon rate for 10-year bonds sold by ICBC this month.
The banks rely more on credit growth than their global rivals partly because Chinese rules, now in the process of being changed, guarantee a margin of about 3 percent between one-year deposit and lending rates. The government-controlled lenders also were the main channel for the unprecedented wave of economic stimulus that drove the nation’s recovery from the global financial crisis.
“Chinese banks are addicted to loan growth and that makes them more likely to tap equity markets again in the future,” said Xue Huiru, a bank analyst in Shanghai for SWS Research Co., a unit of Shenyin & Wanguo Securities Co. “Asset-quality deterioration is the biggest overhang for China banks and bad loans will keep rising at least for the rest of this year, so I don’t expect their valuations to recover any time soon.”
Last year, ICBC got about 75 percent of its revenue from net interest income, the difference between what it collects from lending and pays on deposits. That compared with 53 percent at HSBC and 45 percent for JPMorgan, data compiled by Bloomberg show.
To change the model, Chinese lenders can bolster fee-based services -- such as credit cards, investment banking, and trade settlement and clearing -- and expand overseas, according to Tang, of Northeast Securities. ICBC aims to boost the proportion of its earnings that come from abroad to 10 percent in coming years from about 4 percent now.
“Banks are moving in the right direction by becoming more creative in offering fee-based services, but they need to speed up,” Tang said.
Under China’s implementation of Basel III rules, systemically important banks need a minimum Tier 1 capital ratio of 9.5 percent, with total buffers of 11.5 percent, before the end of 2018. Requirements for smaller banks are 1 percentage point lower.
While most big Chinese banks meet the requirement, the five biggest banks and their smaller rivals including China Merchants Bank Co., China Citic Bank Corp., China Minsheng Banking Corp. and Chongqing Rural Commercial Bank Co. may need an extra $117 billion by 2018 to maintain a 1 percentage point buffer over China’s minimum, Antos estimates.
The banks lag behind global lenders including HSBC as well as Singapore’s Oversea-Chinese Banking Corp. and Hong Kong’s Hang Seng Bank Ltd.
Lower retained earnings may add pressure on Chinese banks to sell more common equity to boost their Tier-1 capital ratios as they expand their balance sheets. Minimum common-equity levels are part of standards designed to ensure that banks can absorb financial losses.
At SWS Research, Xue said that until China liberalizes interest rates, banks will probably remain hooked on loan growth and hungry for capital. She doesn’t expect the government to meet a timetable, stated by central bank Governor Zhou Xiaochuan in March, of freeing deposit rates within two years.
“We’ll just have to keep waiting,” Xue said.