Cheap Chinese banks may offer value in 2012

After being shunned by investors for the past two years, there is finally a glimmer of hope that China’s banks may once again offer an attractive opportunity.

However, investors are being drawn back by cheaper valuations and more accommodative government policies, rather than any fundamental improvement in China’s banking businesses.

China’s recent monetary policy loosening has created an opportunity to recoup losses suffered during 2011, according to J.P. Morgan Asset Management, which is particularly optimistic about investments in the Chinese banking industry, despite a fair amount of concern over the sector.

“There is a meaningful prospect for earnings per share upgrades, especially as analysts have become more negative for 2012. Taking into account the prevailing domestic and external environment, our prognosis is for a gradual normalisation in the share price of Chinese banks. Their valuations have fallen below 2008 financial crisis levels, which we think are too depressed,” said Howard Wang, head of the Greater China team at J.P. Morgan’s asset management arm.

China cut reserve requirements for commercial lenders in early December for the first time in three years, dropping the ratio to 21% for large commercial banks and 17.5% for small and medium-size banks. Policymakers have indicated that China will cut reserve requirements further in 2012 to pump liquidity into the country’s banking system.

Analysts forecast that this easing will promote an overall rebound in Chinese stocks. The MSCI China index lost 20% during 2011 and 38% during the past four years. After two consecutive years of losses, the Shanghai A-share index is down 58% since the end of 2007. “In the last 16 years, the Shanghai A-share index has never suffered losses in three consecutive years. The market is probably ripe for a rebound around the Chinese New Year,” said Shen Minggao, head of China research at Citi.

Barclays Capital also sees value in Chinese banks, supported by upcoming policies. “China’s government is turning more accommodative in terms of monetary and fiscal policies to support growth,” said May Yan, head of China banks research at Barclays.

“More tangible policy or reforms would likely be announced later this year, including the possibility of setting up a ‘financial Sasac’ to own and manage state-owned financial institutions,” she said.

Sasac (or the State-owned Assets Supervision and Administration Commission) acts as the board of directors to China’s more than 100 large state-owned firms and often decides how much they should pay the government in dividends. However, financial institutions in the country do not fall under Sasac’s scope.

Government policy aside, China’s banking industry is still facing many challenges. Earnings have grown substantially during the past decade, but in some ways the banks themselves have changed little since the 1990s. And bad loans are once again at the fore after a lending binge in 2009, with Fitch Ratings warning that the cash cushion at most Chinese banks has thinned considerably during the past couple of years.

According to the credit rating agency, China’s banking system is increasingly distressed thanks to a combined result of excessive lending and a policy orientation that relies too much on credit controls and low interest rates, and prioritises the state sector ahead of private companies and savers.

To attract sustainable investment into its banking industry, China must eventually address these fundamental problems.