China Banks’ Golden Era Fades as Crunch Raises Default Risk
Chinese banks’ valuations are close to their lowest on record as the nation’s interbank funding crisis exacerbated investors’ concern that earnings growth will stall and defaults may surge as the economy slows.
Industrial & Commercial Bank of China Ltd., the world’s largest lender by market value, ended Hong Kong trading last week at 5.3 times estimated earnings, data compiled by Bloomberg show. The Beijing-based bank may report profit of $41 billion for 2013, according to the average of 17 analysts’ estimates. Wells Fargo & Co. (WFC), with net income forecast at $20 billion, trades at 11 times earnings.
Investors’ disenchantment with Chinese banks reflects concern that a crackdown on shadow banking and measures to direct new credit away from repaying old loans and toward boosting economic productivity will undermine earnings and trigger a surge of bad loans. President Xi Jinping also signaled last week that China’s new leaders will tolerate slower growth.
“The golden era of banking is over,” said Mike Werner, an analyst at Sanford C. Bernstein & Co. in Hong Kong who recommends clients buy shares of ICBC and divest mid-sized Chinese lenders. “Investors have to recognize that more market discipline is going to be imposed upon the banks.”
Shares of ICBC and its three largest local competitors -- China Construction Bank (939), Agricultural Bank of China Ltd. and Bank of China Ltd. -- fell by an average 12 percent in Hong Kong last month, erasing the year’s gains and underperforming the 7.1 percent decline in the benchmark Hang Seng Index.
The shares dropped by an average 9 percent in Shanghai, where the broader market of Chinese stocks also declined, with the CSI 300 Index (SHSZ300) losing 16 percent on the month and entering a bear market June 24.
ICBC fell 2.9 percent to HK$4.75 in Hong Kong trading today, declining for the first time in four days. Construction Bank dropped 3.8 percent to HK$5.28 and Agricultural Bank lost 1.6 percent to HK$3.15. The Hang Seng Index slid 0.7 percent.
The plunge was precipitated by money-market rates climbing to records on June 20 as the People’s Bank of China refrained from addressing a cash crunch in the world’s second-biggest economy, despite the slowest growth since 1999. Premier Li Keqiang’s government, which set a 7.5 percent goal for China’s expansion in March, is cracking down on informal lending and deposit-collection activities that have undermined attempts to cool property prices and local-government borrowing.
Policy makers are concerned that large borrowers who have been living off “cheap credit” in China will begin defaulting as the economy slows down, Eswar Prasad, who teaches economics at Cornell University in Ithaca, New York, said in an interview with Bloomberg Television. That in turn could have a “cascading effect” within the financial system, he said.
“There are enormous vulnerabilities in these state-owned enterprises and in the banking system,” Prasad said on June 27. “Ultimately, the banking system is where a lot of the bodies are buried.”
Money-market rates, which eased after the central bank started to inject funds selectively, may remain elevated for the rest of the year, May Yan, a banking analyst at Barclays Plc in Hong Kong, wrote in a June 27 note to clients. Interbank funding costs will be higher in the second half than the first six months as lenders may be unwilling to offer credit to each other, she forecast.
The decision to let banks’ short-term borrowing costs climb may force lenders struggling to repay costly deposits raised through wealth management products to curtail new credit to companies and households as well, Charlene Chu, a senior director at Fitch Ratings in Beijing, said on June 21. The slowing loan growth will be “a further drag” on the economy, she forecast.
The interbank cash crunch led to ICBC’s brief displacement last week as the world’s most valuable bank for the first time since September 2008. San Francisco-based Wells Fargo (WFC) took the top spot before ICBC reclaimed it on June 28 following a rebound in its shares.
Still, the funding crunch wasn’t a watershed moment for the banks’ shareholders, according to Sophie Jiang, an analyst at Religare Capital Markets in Hong Kong.
“People have been quite worried about Chinese banks,” Jiang said by telephone. Investors’ sentiment moved “not from bullish to bearish, it’s from cautious to more cautious.”
Wang Zhenning, a Beijing-based spokesman for ICBC, declined to comment when contacted by phone. Agricultural Bank’s press office had no immediate comment, while calls to Bank of China and Construction Bank weren’t answered.
China’s top four state-run lenders, all of which are based in Beijing, were transformed with the help of more than $650 billion in bailouts from almost insolvent institutions with spiraling defaults a decade ago. They went on to raise a combined $64.5 billion through first-time share sales starting in 2005, with Agricultural Bank’s July 2010 offering raising $22.1 billion in Hong Kong and Shanghai.
Valuations of China’s top banks have been tumbling since October 2007, when the three publicly listed lenders of the time traded at an average 26 times their estimated earnings. Share gains failed to keep pace with profits that soared as China’s policy makers allowed unprecedented amounts of new credit to bolster economic growth, while regulatory control over borrowing costs and deposit rates protected lending margins.
The four biggest banks, which together account for more than 40 percent of the nation’s outstanding loans, posted combined earnings of 716.2 billion yuan ($117 billion) for 2012, more than double the $51.9 billion in earnings at JPMorgan Chase & Co. (JPM), Bank of America Corp., Citigroup Inc. and Wells Fargo.
The Chinese banks’ earnings growth has been overshadowed by concern that new lending -- meant to bolster investments in factories, railways, roads and ports -- is instead being used to repay older debt, and that a sharper slowdown in the economy may trigger bankruptcies and defaults.
Bad loans at China’s commercial lenders have already climbed for six straight quarters, the longest streak in at least nine years. Non-performing loans rose 20 percent from a year earlier to end the first quarter at $86 billion, accounting for 0.96 percent of total lending, according to the China Banking Regulatory Commission.
Those figures don’t reflect the real amount of debt because of the ways banks move loans off their books, Fitch’s Chu said in April. Some loans are bundled and sold to savers as wealth-management products, which pay more than regulated deposits, she said. Other assets are sold to non-bank institutions, including trusts, to lower the bad-debt levels.
China’s aggregate financing, which tallies bank loans, corporate bonds, equity raising and other off-balance-sheet credit to provide a broad picture of funding, surged 50 percent in the first five months to a record $1.5 trillion, the central bank said last month. About a third of that went to entrusted loans, trust lending and bills, which together with underground lending are known as shadow banking.
Shadow lending flourishes in China because an estimated 97 percent of the nation’s 42 million small businesses can’t get bank loans, according to Citic Securities Co., and savers are seeking higher returns than banks pay on deposits. The industry may be valued at 36 trillion yuan, or 69 percent of gross domestic product, JPMorgan estimated in May.
The risk in the financial system is increasing as shadow banking expands and institutions make more highly leveraged investments, the official Xinhua News Agency said in a June 23 analysis.
Such concerns are keeping some global investors away from Chinese banking stocks.
The average price to earnings ratio for ICBC, Construction Bank and Bank of China had fallen to 5.2 by the end of last week from 19 at the end of 2007, according to data compiled by Bloomberg. Meanwhile, for the top three U.S. banks, the gauge dropped to 10 from 12.
ICBC’s price-to-earnings valuation of 5.3 is a far cry from its October 2007 high of more than 29, and closer to the October 2011 level of 4.9, data compiled by Bloomberg show.
The Chinese banking system’s vulnerability may have even bigger implications for the nation, where profits by the largest lenders account for about half of the earnings of all the companies publicly traded in the nation, Henry Cai, Asia chairman of corporate finance for Deutsche Bank AG, said at a conference in Shanghai on June 27.
“The challenges facing Chinese banks today is unprecedented,” Cai said. “The industry’s growth needs to be more market-oriented and diversified.”
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