What Counts at China’s Banks
April 9, 2014 Leave a comment
What Counts at China’s Banks
AARON BACK
March 26, 2014 9:02 a.m. ET
China’s widely loathed bank shares got a boost after one of the biggest state-owned lenders reported decent earnings. But a sustained rally won’t be possible until transparency improves.
Agricultural Bank of China 601988.SH 0.00% said Tuesday that net profit rose 15% in 2013, a tad better than estimates. Nonperforming loans rose, but many were also disposed of or written off. Bank of China followed up on Wednesday with a 12% gain in net profit, also slightly ahead of expectations.
On paper, China’s biggest banks are the very picture of financial health. The big four state-owned banks, on average, boast a 21% return on equity, a 1% nonperforming-loan ratio, a 10.2% common tier-1 equity ratio and a 6.5% dividend yield.
Investors simply don’t believe the numbers, so the share prices languish at near or below book value. Skepticism about the low level of nonperforming loans is one reason. Banks’ off-balance-sheet lending and improper risk-weighting of other loans make investors think the true capital levels are worse than they appear.
Many wealth-management products sold as a kind of high-interest deposit are technically off-balance-sheet. Customers often assume that banks stand behind the products and in a panic, they might be obliged to.
Another problem area is so-called trust beneficiary rights, essentially disguised loans to lightly regulated shadow banks known as trusts, which lend to property developers and the like considered higher risk. Banks often guarantee each other’s trust beneficiary rights and book the transactions as interbank exposures, meaning they have a risk weighting of just 25% under current rules.
If wealth-management products were brought onto balance sheets, and the risk-weighting on interbank trust exposures raised to 100%, the effect on capital ratios would be significant, calculates Bernstein Research. And that is before assuming any losses on those exposures.
Common equity tier 1 capital ratios would fall by 0.5 to 0.75 percentage point at the biggest banks, and by 1 to 1.2 percentage points at the midsize banks. Capital ratios at all the major Hong Kong-listed banks, except Industrial & Commercial Bank of China601398.SH +1.19% and China Construction Bank, 601939.SH +0.52% would fall below regulatory targets for 2018, putting shareholders at risk of capital raising that could dilute values.
China’s banks trade at such low valuations that they are prone to the occasional relief rally. But investors won’t get comfortable until the banks come fully clean.
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