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Time To Buy Battered China Banking Sector?

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News flow over the last couple of years has been consistently bad for Chinese financial institutions. Not surprisingly, the stock prices of Chinese financial institutions have also dropped dramatically, especially over the last year. A Citi Research report released last week points out that major Chinese bank PE ratios have dropped from the mid-20s in 2008 to the single digits today, and that prices have moved low enough to become attractive despite significant risks. Citi analysts Minggao Shen and Ben Wei suggest clients can find value and remain Overweight in the China banking sector.

Two possible scenarios

Shen and Wei argue that there are two possible scenarios for China’s banks over the next few years. “The best path is “gain after pain”. New lows in the banking sector valuation are possible if reform pricks bubbles first and is then followed by a solid rally. Another possible path is that the banking sector may be re-rated, driven by the near-term sentiment normalization, and then de-rated again similar to those in Korea and Japan.”

China’s gradual reform most likely scenario

The analysts base their current Slightly Overweight rating on the China banking sector on the belief that a “soft landing” including gradual financial industry reforms is the most likely path forward. They point out that the Chinese leadership is sensitive to economic “bubbles” of all sorts, and are confident that the banking authorities will take whatever steps are necessary to deflate asset bubbles and guarantee the integrity of the financial system.

Rising money market rates

Shen and Wei also highlight the risks involved in the recent trend toward rising money market rates in China. “The surging money market rates in recent months have raised new concerns for the banking sector. Higher market rates will raise the cost of funding in the banking sector and, more importantly, it increases the risk of defaults and thus rising NPLs.”

They also point out, however, that there are both structural and cyclical reasons for the recent rise in short-term rates, and while it is definitely something to keep a close eye on, they do not see it as a fly in the soup of their China banks thesis.

China Bank Performance

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