By Shuli Ren
Are Chinese banks cheap enough, now that they trade at only 0.8 times book and offer handsome dividends?
Not yet. According to CLSA, about 15-19% of bank loans are non-performing, well above the official statistic of 1.6%.
Part of the big discrepancy comes from how Chinese banks recognize non-performing loans. In the West, commercial banks call a loan non-performing if they are more than 90 days due. In China, a loan past 90-days due is non-performing only when the banks expect a loss. But when the borrowers are state-owned enterprises, technically they have Beijing&’s backing and presumably their loans will be paid in full some day, so it is difficult for bank loan managers to characterize them as &“non-performing&”, said CLSA strategist Francis Cheung.
CLSA derived its 15-19% non-performing loan ratio estimate based on Chinese companies&’ financial statements. For instance, a company&’s loans are classified as non-performing if its operating income is less than interest expenses (in technical terms, EBITDA/interest expense < 1), or if its net debt is larger than 5 years of operating income (a fairly standard treatment, according to Cheung).
While slowly moving, Chinese banks will have to recognize bad debt faster, as they will be moving to Basel III by 2018. After all, China&’s largest banks are also listed in Hong Kong.
And at the current valuation, Chinese banks have not priced in enough bad debt. CLSA estimates that banks on average only recognize 8.5% non-performing loan ratios assuming 12% return-on-equity going onward. In the last quarter, we saw Chinese banks&’ profit margins continued to fall. They are way short.
Year-to-date, China Construction Bank (939.Hong Kong) fell 10.5%, ICBC (1398.Hong Kong) dropped 14.9%, Bank of China (3988.Hong Kong) retreated 12.3%, Agricultural Bank of China (1288.Hong Kong) was down 15.3%. The iShares China Large-Cap ETF (FXI) fell 8.5%, the iShares MSCI China ETF (MCHI) dropped 8.5%, the Deutsche X-Trackers Harvest CSI 300 China A-Shares ETF (ASHR) was down 13.7%.