Traders Bet on China Bank Rebound Amid Economic Revival

Options traders are turning bullish on China’s biggest lenders, betting that a revival in Asia’s largest economy and government growth measures will lift the shares from near record-low valuations.

Calls with an exercise price 10 percent above Industrial & Commercial Bank of China Ltd., the nation’s biggest lender, cost 3.7 points more than puts betting on a 10 percent slide at the end of last week, according to three-month options data compiled by Bloomberg. The ratio jumped to 4.3 on June 5, the highest since March 2012. The measure for China Construction Bank Corp., the second-largest lender, climbed to 3.7 on June 4, the highest since April 2011.

Hong Kong-traded shares of the largest state-controlled banks, known as the Big Four, climbed an average of 7.6 percent in May as policy makers said they would cut reserve ratios for some lenders and the central bank ordered mortgage loans to be expedited after housing prices slumped. Even after the rally, ICBC, China Construction Bank, Agricultural Bank of China Ltd. and Bank of China Ltd. are trading at an average of 5.3 times trailing earnings, compared with a multiple of 11.5 for the 167-member Bloomberg World Banks Index.

“There’s unjustified extreme pessimism on Chinese banks,” Nader Naeimi, Sydney-based head of dynamic asset allocation at AMP Capital Investors Ltd., which manages $131 billion, said by phone on June 3. “All the bad news for Chinese banks has already been baked into the price. While non-performing loans have been rising as a result of the slowdown, the economy is stabilizing and will likely pick up in the second half.”

Chinese manufacturing expanded at the fastest pace in five months in May, adding to signs of recovery in the world’s second-largest economy. Exports rose more last month than economists had estimated, a report showed yesterday.

Lending Boost

The China Banking Regulatory Commission on June 6 vowed to expand loans and cap borrowing costs, seeking to boost liquidity to the real economy by giving banks more capacity to lend. Reserve-ratio cuts for some rural lenders were announced in April. The cabinet has also pledged to speed spending for infrastructure projects, including railways.

“For long-term investors, it may be a good proposition to start nibbling at Chinese banks,” Pauline Dan, who helps manage $153 billion as the Hong Kong-based head of greater China equities at Pictet Asset Management Ltd., said by phone on June 3. “Should the government decide to trim the reserve ratio requirements for Chinese banks in a wider scale, that would be a good catalyst.”

The stimulus measures come as Premier Li Keqiang seeks to meet an official expansion target of about 7.5 percent this year. China’s economy is projected to grow 7.3 percent this year, which would be the weakest pace since 1990, according to a survey of analysts in May.

Housing Slump

Mainland home prices in May posted their first monthly drop since June 2012, according to SouFun Holdings Ltd., a real estate website operator. A slump in the sector threatens to limit any economic rebound and pressure policy makers to do more, with the People’s Bank of China last month ordering the nation’s biggest lenders to speed mortgage approvals.

While non-performing loans at Chinese banks have increased for 10 straight quarters to the most since September 2008, they accounted for only 1 percent of total loans at the end of March, compared with an average of 4.8 percent in the previous decade, China Banking Regulatory Commission data show. Chinese lenders are poised to report the highest proportion of bad debts since 2009, according to a forecast made by Bank of Communications Co. in May.

Bank Profit

Combined profits at the Big Four rose 12 percent last year, down from 15 percent in 2012. Declining earnings growth and rising defaults have curbed their ability to retain earnings to fulfill capital requirements. Bank of China and Agricultural Bank of China last month announced plans to raise as much as 180 billion yuan ($28.8 billion) in preferred stock.

“While Chinese banks are extremely cheap, we’re not yet fully comfortable investing in them,” Marco Mencini, who helps oversee $238 billion in assets as London-based head of equities for emerging markets at Pioneer Investment Management Ltd., said by e-mail on June 3. “Its hard to quantify the risks.”

Credit growth has dropped from a record in January, another sign of slowdown as China’s government acts to curb a $6 trillion shadow-banking industry and limit speculation in the property market while eliminating overcapacity and reducing pollution that’s shrouding cities across the nation.

Default Risk

Policy makers are trying to prevent defaults from spurring broader financial turmoil. A failed coupon payment by Shanghai Chaori Solar Energy Science & Technology Co. in March marked the first default in China’s onshore bond market. Zhejiang Xingrun Real Estate Co., a developer in eastern China, became insolvent with 3.5 billion yuan in liabilities the same month, with China Construction Bank holding 1 billion yuan of the debt.

The HSI Volatility Index, which tracks the cost of options on Hong Kong’s Hang Seng Index, dropped 1.2 percent today. Europe’s VStoxx Index, a measure of Euro Stoxx 50 Index derivatives costs, slid 8 percent on June 6. In the U.S., the Chicago Board Options Exchange Volatility Index, known as the VIX, lost 8.1 percent at the end of last week.

Implied volatility, used to gauge the cost of options, for three-month contracts with an exercise price 10 percent above ICBC climbed 12 percent from a three-year low of 18.88 on May 16, data compiled by Bloomberg show. Those for China Construction Bank added 4.5 percent in the same period.

ICBC Options

Among the four most-owned ICBC options, three were bullish. December HK$5.75 calls, with an exercise price 11 percent above the last close, had the third-largest open interest, data compiled by Bloomberg show.

Beijing-based representatives at ICBC and China Construction Bank declined to comment on options trading. Officials at Agricultural Bank of China and Bank of China didn’t immediately respond to e-mailed queries.

“A lot of the bad news in the banking sector has been priced in given the low valuations,” Audrey Goh, a Singapore-based investment strategist at Standard Chartered Bank Plc’s wealth management unit, said by e-mail on June 3. “Options offer investors a less capital-intensive way of playing the short-term upside for the banks, especially for investors expecting additional stimulus.”

Before it's here, it's on the Bloomberg Terminal.