We are overweight on China Banking sector. The sector benefited from a better than expected growth in social financing, and implementation of an easier credit and monetary policy. With social security fund reforms and the opening up of China’s financial market, a large amount of capital will flow into China’s A-share market. Based on market cap weight and dividend yield, the banking sector will benefit greatly, and the valuation is expected to be boosted.
Bank Performance Review: The banking sector in CSI 300 rose 9.65% as of 15 May, underperforming than the CSI 300 Index. Since April 10, social finance exceeded expectations in the first quarter, the relative performance of the sector to the CSI 300 began to strengthen. On May 6, the People’s Bank of China (PBOC) announced the reserve requirement ratio reduction, further narrowing the gap of the banking sector’s relative performance.
We also noticed an internal differentiation of the banking sector. The financial supply reform in 2019 emphasised the increase in the number of small and medium-sized banks and the proportion of its businesses, resulting in an improvement in its strategic position. The regional banks performed outstandingly, with an average increase of 26.81%, outperforming the CSI 300 Index by 4.23%. The leading banks include Ningbo Bank (38.72%), Jiangsu Bank (24.79%) and Nanjing Bank (20.52%).
With the implementation of an easing credit and monetary policy, China banking sector’s asset fundamentals are in a favorable and improving position. The expansion of capital pushed the banking sector into increasing its loan volume. We believe that asset expansion will be the key factor in profit growth in the banking sector.
1. Capital and Liquidity improvement. The central bank lowered the reserve requirement ratio (RRR) by 1% in early 2019 and announced to further reduce the RRR on May 6 for small and medium-sized banks. Externally, the China Banking and Insurance Regulatory Commission (CBIRC) supports banks in replenishing capital through multiple channels and promote the issuance of perpetual bonds. Perpetual bond will be classified as tier one asset starting from 2019. On January 25, 2019, the Bank of China successfully issued the first bank perpetual bond. The Bank of China issued the RMB 40bn perpetual bond which was more than two times subscription.
In 2019, the core tier one capital of commercial banks rose to RMB16.56tn, up 15.88% YoY. At the end of April, loans rose to RMB148.64tn, increased 12.9% YoY.
We believe that lowering RRR and issuing perpetual bonds will further expand banks’ capital. The increase in capital will encourage a greater willingness of banks to supply loans.
2. Asset quality. With the implementation of the tax reduction policy in 2019, saved about RMB0.95tn tax expense for companies. We observed decline in non-performing loans. We expect the asset quality of China’s banking industry to remain stable. In the first quarter of 2019, the provision coverage ratio for NPL is 192.17%. Under the background that regulators reduce the regulatory requirement of provision coverage ratio to 120%-150%, the industry has more risk-resistant space.
Long-term institutional funds are expected to continue to flow into China’s A-share market. The banking sector, which has a larger share of market cap, is expected to benefit from this and get its valuation boosted.
- Firstly, the opening up of China’s financial market will attract foreign investments to the A-share market. Including QFII expansion, MSCI FTSE flagship indexes include China A-share. MSCI announced on February 28 that the inclusion factor of A-shares would be increased from 5% to 20% in three steps. Among the 241 large-cap stocks currently included in the MSCI Emerging Market Index, 22 are bank stocks, accounting for 30.47% of the total market cap. Based on the current size of the fund to track the MSCI Emerging Markets Index (about $1.8tn), we estimate it will bring about $14.31bn for the banking sector.
- Secondly, social security funds, insurance and other institutional funds reform are accelerating and expected to increase its investment in the China A-Share market. In February 2019, Yi Huiman, Chairman of the CBIRC proposed to further open up A-Share market for various institutional investors, such as social security funds. Considering the large size of insurance and social security funds, the long assessment interval and its main objective, the bank shares with high dividend yield are expected to become an attractive investment.
In the first quarter of 2019, the use of insurance fund in equity assets began to rise, but it is still at a historically low level. In the first quarter of 2019, the balance of insurance fund utilisation reached RMB 17.05 tn, of which equity investment accounted for 12.38%, up 0.67% from the end of 2018. If the balance of insurance fund utilisation increases by 11.74% YoY (the same as in the first quarter of 2019) and the proportion of insurance fund stock and fund investment rises to 15.95% (the historically high level), the incremental fund of A-share market will be RMB 704bn.
Also, we expect the pace of social securities fund investing in China A-share to accelerate. Since May 1, the policy of reducing the social security premium by RMB300bn has been implemented in 27 provinces, and the social security premium rate has been reduced from 20% to 16%. The reduction of the social security premium rate by 4% points poses a challenge to preserving and increasing the value of the pensions fund. Under such conditions, the authorities may increase the weight of investment in the A-share market.
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