Macquarie Equity research is out with a new report on the massive investment landscape in China. Their ‘proprietary analysis suggests Chinese residents are diversifying their financial assets on a large scale’. The analysts estimate Rmb28trn (US$4.5trn) assets have already been invested into 10 non-deposit domestic financial product categories (on top of Rmb43trn retail deposits). They also estimate another Rmb36trn (US$5.8trn) will be moved into these products in the next 5 years. Below is a summary from the new note out today on this topic.
We view this active asset relocation trend as one major driver for many asset classes. Investors should be fully aware and prepared for this trend.
Banks: life becomes tough but they have to fight the battle
- China banks have to live with a structurally lower retail deposit growth in the long run because Chinese residents will save less and invest more to lift overall returns. We estimate retail deposit CAGR will slow to 5% in the next five years, significantly slower than the 18% during 2007-12;
- We suggest banks embrace such a structural trend, not resist it. They should invest in systems, know-how and people, as well as trying to obtain related business licenses to maximise their revenue from these products. We estimate annual commissions and management fees generated from the entire retail AUM will reach Rmb371bn in five years (Fig 3).
Brokers are well positioned but execution is key
We view brokers well positioned in this asset relocation theme. They have good assess to equity, bond, futures, mutual fund and PE product markets and can now offer home-made competitive investment products directly.
Key risks: Under-coordinated and opaque regulation
We view spot regulations as insufficient, opaque and under-coordinated. Regulatory volatility can be a key risk for both retail investors and related financial firms.
We believe one good way to understand China’s financial market reforms is to observe and analyse peoples’ behaviour. This report involves a lot hard work across many asset categories, trying to provoke thoughts on the following questions:
- What are the available financial investment channels for Chinese residents?
- How big is each market and what are their basic features?
- What is the basic risk / return profile?
- Who regulates these products / markets and what are the recent developments?
- Are there any high-level conclusions or likely trends that can guide our investments and provoke serious thoughts?
# 1: Chinese residents already diversify financial assets and the trend will continue
The next table is a very simplified but convenient comparison of the 10 financial products available to Chinese retail investors. We estimate a total of Rmb28trn (or US$4.5trn) retail assets have already been invested into these products, out of which trust products, bank WMPs and equities each account for one quarter of total.
After putting all the pieces together, the number comes in much bigger than our original expectation, as this is equivalent to 64% of retail bank deposits. Clearly China retail investors ALREADY have and will CONTINUE to diversify their financial assets.
# 2: Bank retail deposit growth is set to slow
This report also reveals our current deposit growth forecasts for China banks look overly optimistic. China banks will face meaningfully lower deposit growth going forward, which will probably push up funding costs, stretch balance sheets and also impact sector regulation (likely resulting in loosened LDR control).
We estimate non-deposit financial AUM will have an 18% aggregate CAGR in the next five years (the range is wide from 10% in PE investments to 35% for BIPs), resulting in the total non-deposit financial AUM more than doubling from Rmb28trn now to Rmb63trn. That means bank retail deposit growth could potentially drop to 5% p.a.
This means bank deposits will only account for 47% of China residents’ total financial assets in 5 years time, down from today’s 61%. Back in 2008, the ratio was 73%.
# 3: Also an Rmb371bn annual revenue pool in the medium term
Based on our estimates, we believe financial companies can make around Rmb371bn annual revenue from providing management, brokerage, and custodial services on the Rmb63trn non-deposit retail AUM in five years’ time. These are very high quality, fee-based, low risk revenues that investors are willing to pay high multiples for.
With boundaries between financial subsectors becoming increasingly blurred, we would encourage financial firms, banks included, to invest in systems, talents, technology, internal procedures, product R&D, etc. The best way to deal with this structural change is to embrace it, not to resist it.
# Which banks are doing a better job in this area?
We believe we are still in the early days of witnessing a large scale and continuous asset reallocation for Chinese residents. This also means banks’ ability to participate and compete is more or less similar. However we believe smart banks will continue to invest and gradually establish their leading positions in niche business areas, ultimately delivering stronger profitability and less volatile earnings (given these revenue are much less correlated to economic or asset quality cycles).
Among large banks The Industrial and Commercial Bank of China (I.C.B.C.) (SHA:601398) (HKG:1398), is clearly best positioned. The bank has been the #1 custodial service bank in China for 15 years. By 2012, Rmb4.0trn assets are receiving The Industrial and Commercial Bank of China (I.C.B.C.) (SHA:601398) (HKG:1398),’s custodial service. The bank is also China’s leading bond trading bank, leading Rmb settlement and clearance bank, leading cash management bank, leading bond underwriter and leading bank
card service provider.
Among small banks CMB had the best client base but MSB is catching up very quick. Given they have 2-3% national market share each, servicing high-end customers could already be a decent business for their fee franchise. BCOM claims it wants to become a leading wealth management bank but so far we have not seen convincing delivery.
# Brokers are probably best positioned for this trend
We see brokers best positioned for this trend.
- From a product perspective, their BIPs have the most flexible product design and underlying investible assets arrangement, making them attractive to investors;
- From a regulatory perspective, CSRC is trying to lift profitability and encourage higher operating leverage for brokers, meaning the regulatory environment remains supportive in the medium term;
- From a licensing perspective, brokers have direct access to the equity, bond, and private equity markets and can acquire licenses to conduct mutual fund and futures business. No other financial institutions have such vast flexibility to conduct such a wide range of business.
# We welcome discussion and thoughts
We did not make any rush changes to our forecasts, ratings or target prices. Clearly the overall conclusion from this piece of research is that the trend is bad for banks but good for brokers.
However we also realize that considering 1) this is a multi-year trend; and 2) China banks are already trading at 1.0x P/B or even lower, the impact for target prices should be rather limited.
As for brokers, we have a totally different problem. Despite of the overall positive outlook, these small firms (relative to banks) currently are making single digit ROE but already trade at much higher multiples. However after the recent share price pullback and after conducting this research, we view brokers as increasingly attractive.
We welcome any discussion and suggestions you may have on how to link the long-term structural theme with stock or industry analysis. The following valuation comparison table represents our current estimates and fair value judgment for listed China banks / brokers.