Last updated: November 5, 2013 10:27 pm

China bank shares find favour again

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Few sectors split opinion among investors in Asia like Chinese banks. As core plays on the state of China’s economy, their shares receive a regular battering whenever hard-landing concerns surface, yet soar at the earliest hint of economic revival.

Since late June, when a three-week cash crunch in the Chinese financial system abated, bank stocks have been on the rise. ICBC is up more than 22 per cent, China Merchants Bank has added 26 per cent and Minsheng Bank has risen 24 per cent.

The rally has found its footing on improving economic data as well as relief following the cash squeeze, during which interbank lending rates jumped to more than 25 per cent. Record low stock prices, to which many financials fell amid a painful sell-off in June, have also played their part.

“The major reason to hold these banks is valuation,” says May Yan, China banks analyst at Barclays. “Their valuations are undemanding and their return on equity is very high.”

Even after recent gains, ICBC trades at an estimated 2013 price to earnings ratio of 5.7 times, while Bank of China is even lower, at 5.4 times. That compares with an average of 7.9 times for all mainland companies listed in Hong Kong, in spite of the fact that the banks are among China’s most profitable listed companies, and the highest dividend payers.

Patricia Cheng, an analyst at Asia-focused brokerage CLSA, now has “buy” or “outperform” ratings on four of the top five Chinese banks listed in Hong Kong.

The rebound in bank stocks has been solid enough to tempt a number of small and midsized lenders to press ahead with long-delayed new listings. On Wednesday, shares in Bank of Chongqing will start trading in Hong Kong after its $600m initial public offering, while Huishang Bank will set the price for its $1.5bn Hong Kong listing.

More IPOs are expected in coming months as banks seize on the opportunity to raise capital via the equity market now that valuations have improved.

Signs from the recent IPO of relative minnow Huirong Financial are tentatively encouraging. The stock fell on its first day of trading last week but on Monday surged more than 7 per cent, edging back above its list price. It was the first Chinese bank to complete an IPO in Hong Kong since late 2010.

Whether there is appetite for a string of larger new arrivals is yet to be seen, with some investors already voicing frustration that banks are crowding the market.

The big four – ICBC, Bank of China, Agricultural Bank of China and CCB – together account for more than one-third of Hong Kong’s H-share index of mainland companies, while the iShares A50 exchange traded fund, one of the most popular ways for global investors to access China, counts five lenders among its top 10 holdings.

While the banks themselves are too big to ignore, so are the deeper problems that they face. As China’s key source of credit – the fuel that powers the world’s second-largest economic engine – banks are at the centre of concerns about the country’s large and growing debt pile. Though bad loans are not yet of a scale likely to threaten the health of the banking system, they are rising fast and add to doubts over asset quality caused by years of aggressive lending.

There are still some unresolved problems in the banking sector. Medium and long term we remain cautious

- Catherine Yeung, investment director at Fidelity

Nervousness lingers about the sector’s near- and long-term prospects. Only last month, the central bank was forced to step in again to calm fears of a rerun of the June cash crunch.

Widely expected reforms designed to move the economy away from investment and export-driven growth may also prove negative for bank stocks. China has vowed to liberalise deposit rates, a move that would erode what is now an effective guarantee of profits, while any attempt by the state to reduce its holdings in listed banks could also be a drag.

“There are still some unresolved problems in the banking sector. Medium and long term we remain cautious,” says Catherine Yeung, investment director at Fidelity. The asset manager’s regional funds are underweight Chinese banks, in spite of being overweight Chinese equities as a whole.

“We are finding a lot more interesting ideas outside the banking sector,” adds Ms Yeung.

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