Top Chinese Banks' Profit Comeback Augurs Higher Valuations

(Bloomberg) -- China’s biggest banks are set for a boost in valuations as analysts expect a strengthening economy will fuel loan demand and margins.

Nomura Holdings Inc. and Huatai Securities Co. are among those that raised target prices this week after Industrial & Commercial Bank of China Ltd. and its two largest peers posted better-than-expected profits, which grew at the fastest pace in three years.

“We definitely believe more re-rating will be in front of us," Victor Wang, a Hong Kong-based analyst at China International Capital Corp., told Bloomberg Television. “Most of the time, banking is not a bad business when macro stabilizes. The numbers will be getting better going forward.”

He predicts an 89 percent upside gain for ICBC shares and 79 percent increase for China Construction Bank Corp. Nomura’s analysts raised ICBC’s price target to HK$10.42 from HK$8.86 on a better operating outlook and expect the bad-loan cleanup to accelerate in the next two years.

Top Chinese Banks' Profit Comeback Augurs Higher Valuations

China’s Big Five, which control more than a third of the nation’s $40 trillion in banking assets, are staging a comeback thanks to improvements in borrowers’ repayment ability and higher demand for loans. They are also benefiting from President Xi Jinping’s crackdown on excessive debt, which is forcing smaller banks to turn to big lenders to borrow money.

Banking shares rallied in Shanghai and were trading mixed in Hong Kong as the benchmark Hang Seng Index sank. ICBC’s stock has gained 8.6 percent in Hong Kong this year while Agricultural Bank of China Ltd. surged more than 23 percent. Still, the top lenders are trading at an average 0.76 times their forecast book value.

Read More: China Banks See Wider Margins, Better Asset Quality

ICBC’s net interest margin widened by 6 basis points while the spread expanded by 3 basis points at AgBank. Both banks’ nonperforming loan ratios dropped for the first time since at least 2013, and senior executives said at press conferences that they expect the benign asset quality trend to continue.

Together with Bank of China Ltd. and Bank of Communications Co., combined profits at the Big Five probably grew about 3 percent last year, the fastest expansion since 2014, according to analysts’ estimates. That’s projected to pick up to about 8 percent in 2018 as rising global interest rates boost margins.

Turning Point

Their results are partly flattered by a poor 2015 and 2016, when concerns intensified about rising bad loans across China’s financial sector. Asset quality has since improved as economic growth accelerated in 2017 for the first time in seven years. Another sign of optimism emerged this month, when the regulator was said to have lowered bad-loan provisions to a minimum 120 percent from the previous 150 percent, freeing up more cash for lending.

"The message is the banking regulator is more or less confident that the worst time for NPL buildup is now already behind us," Wang said. "We are at the turning point that margins will go higher from now. We have strong demand for credit, however the supply is tightly controlled. That helps the banks to raise the loan yield."

ICBC’s bad-loan coverage ratio, which measures provisions against soured credit, climbed to 154 percent by December. At AgBank, the buffer surged to 208 percent while CCB’s coverage ratio rose to 171 percent.

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