Chinese bank stocks delivered a solid performance in May, rallying 3.5% to outperform the MSCI Asia-Pacific index by 0.9 percentage points.
In May, mid-sized banks, as a group, outperformed big-4 banks by a large margin (4.3% for mid-sized banks vs. 3.2% for big-4 banks), which largely attributed to 16.6% MoM increase in CMB. Its outstanding NIM performance, solid capital position and easing NPL formation trend in CMB’s Q1 earnings caught investors’ attention and were main driver of its share price in this month. ABC was a leader among the big-4 banks with MoM gain of 5% due to its relatively low valuation. In contrast, PSBC was the only bank under our coverage with a negative performance and the MoM deduction was 7.1%.
Chinese banks now trade at an average price-to-book multiple of around 0.8 times. Among major lenders, only CMB trades above book value. China’s big four banks – ABC, Bank of China (3988.HK), China Construction Bank (939.HK) and Industrial and Commercial Bank of China (1398.HK) – trade in the range of 0.7 times to 0.9 times book value.
Hou argues BOC, CCB and ICBC still appear to be undervalued despite their recent gains.
With stabilizing NIM and NPL formation, we still think this level of valuation discounts the fundamentals of CCB, BOC and ICBC and any correction in the near term would represent good buying opportunities into these stocks.
Rising Chinese treasury yields could be a boon for the sector.
Interest rates across different lending products diverged in May. Driven by tight interbank liquidity, the term curve had parallel move up by 25~30 bps for treasury bonds with maturities less than 10ys in May. In addition, 5-yr AA- corporate bond yield was up by 33bps MoM and 5-yr AAA corporate bond yield was up by 27bps MoM to 4.93% at the end of May. At this level, corporate bond yields are now higher than bank loan rate, which may push borrowers back to indirect financing in the coming months.
Liquidity in the Chinese banking system also appears to be holding up, notes Hou.
In the month, P2P lending investment yield was down by 16bps MoM to 8.40%. Rates on discounted bills were flat MoM at 4.33% in May. The Wenzhou private lending rate, a proxy for private lending activities, was down by 10bps MoM at 15.9% in this month. The divergence in lending rate vs bond yield suggests the liquidity outside of interbank market could still be sufficient and the spill-over effect of interbank liquidity tightening has yet to take place.
But Hou urges investors to be selective when buying Chinese bank stocks given the sector’s recent rally.
At 0.8x of current P/B (2016A), we find the banks remain attractive from valuation point of view, especially with still attractive dividend yields. However, as banks have rallied ~12% YTD, investors need to be more selective on names. Overall we still favor quality names such as CCB, ICBC and BOC. Among the three banks, we see CCB has the best fundamentals and profitability and is our top pick for the sector. On the other hand, BOC has lagged in valuation recovery and may provide some catch up opportunities for investors.
By Isabella Zhong