- China banks have solid capital ratio to weather economic cyclicality
- China banks’ earnings and dividend payouts are resilient
- Valuations are at trough, offering attractive upside
- China banks fit well into our CIO Barbell Strategy construct as an income generator
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Concerns over lending to local government financing vehicles (LGFV) and property sector have impacted sentiment towards China banks.
China banks have solid capital ratio to weather economic cyclicality.Their capital adequacy ratio stands at 14.9% and Tier-1 capital adequacy ratio at 12.0% (Figure 1). Exposure across all sectors of the economy allows banks to spread out risks and diversify the sector’s mix. China’s economy is still expected to register GDP growth of c.5% for 2023 and 2024, respectively. We believe the negativity regarding LGFV and property sector lending is overblown. The sector’s nonperforming loan ratio has stayed low, between 1.6%-1.7%, since the early part of the last decade and is likely to remain within a manageable range. As a systemically important sector, we believe the government will provide sufficient support when necessary.
Figure 1: China banks are well capitalised
Source: Bloomberg, DBS
China banks’ earnings and dividend payout are resilient.Over the past 12 years, even during prolonged or sharp economic downturns, banking sector’s earnings per share (EPS) and dividends per share (DPS) have remained largely resilient (Figure 2). This further anchors China’s large banks as credible income generators.
Figure 2: Resilient earnings and dividend distribution
Source: Bloomberg, DBS
The six largest state-owned enterprise banks currently offer investors dividend yields north of 8% (Figure 3). Even if we assume banks earnings were to fall 20% in an extreme bear case scenario, dividend yields will remain attractive at above 6%. Furthermore, at 30% payout ratio, banks are merely distributing the minimum stipulated by the authority. As such, there is upside room for them to raise the payout ratio in the event of an earnings decline.
Figure 3: China financials total return, 31 Dec 2021 – 10 March 2023
Source: Bloomberg, DBS
Valuations are at trough, offering attractive upside.China banks are trading at two standard deviations below mean and nearly 0.4x price-to-book. As the valuations are at low levels (Figure 4) while the fundamentals remain supportive, there is limited downside.
Figure 4: A sector too important to fail
Source: Bloomberg, DBS
At dividend yields of 7-8% and steep valuation discount, investors are paid to wait.
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