China's top four banks posted better-than-expected quarterly profits this week, even as their stock market valuations remain the lowest in Asia, highlighting how pessimism about slowing Chinese economic growth is overshadowing resilient profitability in the sector.
After years of break-neck gains, profit growth at Chinese banks is expected to slow sharply this year as new loan growth moderates and profit margins get squeezed by policy reforms allowing banks to offer higher rates on customer deposits.
This, along with concerns about a rise in non-performing loans as the slowing economy and rising indebtedness pressure borrowers, have driven China bank share prices down hard this year. Chinese banks are trading at rock-bottom valuations despite reporting profits that would still be the envy of lenders in other markets.
"Since last year the market has been extremely suspicious of the Chinese banking sector," said Jiang Jianqing, chairman of Industrial and Commercial Bank of China (ICBC), the world's largest bank by market capitalisation.
"They've pressured our (price-to-earnings) and (price-to-book) ratios to low levels. Such good profits, such good returns, such good quality. We think it's a little bit unfair," Jiang told a news conference in Beijing.
The China Banking Association said last month it expects net profit growth for China's 17 listed banks to slow to 8 percent in 2013 from 19 percent in 2012.
But this week the Big Four – ICBC, China Construction Bank , Agricultural Bank of China and Bank Of China – reported combined first-half earnings growth of 12.5 percent,and all beat analysts' estimates for second-quarter earnings.
Still, an index tracking Shanghai-listed banks has fallen 9.1 percent this year, underperforming a 7.6 percent decline for the broader Shanghai Composite Index.
"Some investors may think that single-digit percentage growth is unexciting, which is why the sector is only trading at about par to book," said Grace Wu, a Daiwa Securities analyst in Hong Kong.
Chinese bank shares are the cheapest in the Asia-Pacific region with a 12-month forward price-to-earnings ratio of 4.8, and the third cheapest in the world after Argentina and Bahrain, according to Thomson Reuters Starmine data.
The top four banks' mean price-to book ratio is at a historic low of 1.1, according to StarMine.
"Based on the strong correlation between (returns on equity) and (price-to-book) ratios for the top 100 global banks, the Chinese banks are trading at a sizeable 50 percent discount to their global peers," Michael Werner, China bank analyst for Bernstein Research in Hong Kong, wrote in a note on Wednesday.
CAUTIOUS ON OUTLOOK
China's bank chiefs have also been cautious, even gloomy, in their public remarks about the second half of the year even while reporting expectation-beating results.
"Interest rate liberalization will have a rather large negative influence. It will shrink our net interest margin," Bank of China chairman Tian Guoli said at a press conference in Hong Kong on Thursday.
China's banks are expected to win approval for the issuance of tens of billions of yuan in negotiable certificates of deposit, Reuters reported exclusively last week, in a move that would constitute another step towards liberalising China's domestic interest rates.
Pang Xiusheng, vice president at China Construction Bank, said at a news conference on Monday that CCB expects a rise in bad loans in the second half of the year.
In a sign that more loans may turn sour later this year, ICBC reported that overdue loans not designated as non-performing rose to 69.2 billion yuan, or 0.73 percent of all loans, from 0.71 percent at end-2012.
That contrasts with official non-performing loan (NPL) levels, which remained steady across the big four banks. At AgBank, for example, the non-performing loan ratio fell to 1.25 percent in the first half from 1.27 percent at the end of March. But overdue loans not yet designated as NPLs rose to 94.5 billion yuan as of end-June from 87.9 billion at the end of December.
Indeed, some analysts have warned that attractive profits in the first half were due in part to less robust provisioning against bad loans. AgBank set aside 10.0 billion yuan in the second quarter, down from 10.8 billion in the same period last year.
While industry-wide average net interest margins rose slightly to 2.59 percent in the second quarter from 2.57 percent in the first quarter, data from China's banking regulator show that is still lower than the 2.75 percent margin in the fourth quarter last year.
Banks have in part compensated for declining interest margins by bolstering the fees and commissions they make from selling other products.
For ICBC, for example, fee-based income rose 23 percent in the January-June period, much faster than the 5.8 percent rise in interest income. BOC's fee income also jumped, rising 24.0 percent to 69.0 billion yuan. ($1 = 6.1202 Chinese yuan)
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