Bloomberg News

Chinese Banks’ 22% Profit Jump May Fail to Boost Valuations

October 25, 2011

(Updates with BOC Hong Kong in 18th paragraph.)

Oct. 26 (Bloomberg) -- China’s four biggest banks, forecast this week to report higher third-quarter earnings than the four largest U.S. lenders, may be stuck with valuations near record lows amid investor concern that bad loans will rise.

Industrial & Commercial Bank of China Ltd., the world’s most-profitable lender, and its three biggest local rivals may report a 22 percent gain in combined third-quarter net income to 164 billion yuan ($25.8 billion), according to the median estimate of eight analysts surveyed by Bloomberg. That’s 41 percent more than the $18.3 billion posted by the top four U.S. banks including JPMorgan Chase & Co. in the most recent quarter.

Shares of China’s biggest banks have fallen an average 23 percent this year as policy makers’ efforts to curb inflation by raising rates spurred concerns that loans to developers, small companies and local governments may sour. An economic slowdown, a slump in the property market, reports of manufacturer defaults in China’s informal credit market and Europe’s debt crisis may continue to weigh on valuations, which dipped to a record low at the end of last month.

“Chinese bank shares are unlikely to rally in the foreseeable future, or at least in the rest of the year, given the uncertainties not only in China but also those globally,” Wilson Li, a Shenzhen-based analyst at Guotai Junan Securities Co., said by telephone on Oct. 24. Guotai Junan is China’s top- ranked arranger of domestic corporate bond sales, according to Bloomberg data.

Slower Growth, Inflation

China’s economy grew 9.1 percent in the third quarter, the slowest pace since 2009, as government officials tightened lending rules and export demand weakened. Inflation moderated to 6.1 percent in September after reaching a three-year high of 6.5 percent in July.

Bad debts at Chinese banks may climb to 1.5 percent by the end of next year, and 1.8 percent by December 2013, according to the median estimate of seven analysts surveyed by Bloomberg.

The four biggest lenders reported an average bad-debt ratio of 1.16 percent at the end of June. Loans are classified as nonperforming debt typically when principal or interest payments are overdue for more than 90 days, according to filings with the Hong Kong Stock Exchange.

Property Slump Risk

A slump in property prices would cut into developers’ income and curtail their ability to service loans or take on additional credit, leading to defaults, said May Yan, a Hong Kong-based analyst at Barclays Capital Inc. Exporters and small companies may face a similar problem as economic expansion slows and inflation drives up costs of raw materials.

China’s banking regulator asked lenders to increase capital buffers and expand their reserve base this year to avert a banking crisis following a $2.8 trillion two-year credit boom that began in 2009. Investors’ concerns escalated after Fitch Ratings said in April that it’s “not inconceivable” the bad- debt ratio may climb to 30 percent, without specifying a timeframe.

“Ultimately, potential losses will prove to be much smaller than what people are expecting,” said Victor Wang, a Hong Kong-based analyst at Macquarie Capital Securities Ltd. “However, for these things to fully play out, it will take a very long time.”

China’s four biggest banks, all of which are based in Beijing, are trading at an average 1.07 times their estimated 2012 book value, according to data compiled by Bloomberg. The average for JPMorgan, Bank of America Corp., Citigroup Inc. and Wells Fargo & Co., the four largest U.S. banks by assets, is 0.61 times.

Lack of Catalysts

Among the Chinese lenders, Construction Bank’s valuation is the highest at 1.18 times, having dropped from a record of 4.14 in October 2007, while ICBC is second at 1.15, down from 4.09. Agricultural Bank is at 1.14 and Bank of China at 0.79.

A “fair valuation” would be closer to 1.5 times to 2 times book value, Mike Werner, a senior analyst at Sanford C. Bernstein & Co. in Hong Kong, said in a telephone interview.

“The banks are pricing in some very negative scenarios,” he said. “What I don’t see is what the catalyst will be for those price-to-book values to increase.”

The cost of protecting the debt of Bank of China against non-payment for five years rose to 343 basis points on Oct. 4, the highest since the peak of the global financial crisis in 2008, according to data provider CMA. A basis point is 0.01 percentage point. The credit-default swaps have since fallen to 260. A decline signals improving perceptions of credit quality.

ICBC Profit

ICBC may report tomorrow that third-quarter profit climbed 26 percent to 53.7 billion yuan, according to the analysts’ median estimate. Profit growth at ICBC and its rivals will be driven by increases in fee income and lending, said Yan.

Bank of China, the nation’s third-largest lender, may say earnings grew 16 percent to 31.6 billion yuan, while Agricultural Bank is likely to post a 40 percent gain when both lenders report today, the data show. Construction Bank is set to report a 13 percent increase to 44.8 billion yuan on Oct. 28.

BOC Hong Kong (Holdings) Ltd., a unit of Bank of China that’s traded on the Hong Kong Stock Exchange, is also scheduled to report today after the market closes.

Investors’ focus this week when the banks report earnings will be on asset quality and provisions for bad debts, said William Fong, a director for Asian equities in Hong Kong who helps manage $49 billion at Baring Asset Management Ltd.

“It doesn’t mean that we are facing a very big banking crisis,” Fong said by telephone yesterday. “We know the banks in China, we know their operations, so we are not as scared as the market.”

--Editors: Chitra Somayaji, Sheridan Prasso

To contact the reporters on this story: Stephanie Tong in Hong Kong at stong17@bloomberg.net; Nathaniel Espino in Hong Kong at nespino@bloomberg.net

To contact the editor responsible for this story: Chitra Somayaji at csomayaji@bloomberg.net


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