INVESTORS in China’s mainland stock market made a beeline for bank stocks last year, making the sector the market’s top performer despite the country’s sluggish economy, a slowdown in loan growth, and concerns about a deterioration in asset quality.
The reason? Dividends. Banks doled out cash payments to shareholders like confetti. And with their valuations hovering at close to record lows, the yields were among the most attractive in the market and double or triple those on Chinese government bonds (CGBs).
The characteristics of bank stocks – low volatility and high dividends – make them similar to corporate bonds and so they have become particularly attractive to large institutional investors, a macro analyst specialising in asset allocation at a major brokerage firm told Caixin.
Insurance and bank wealth management funds need to diversify out of government bonds to spread their risk, he said. “So, these types of funds are targeting the high dividends and high payouts of bank stocks.”
Now, analysts are debating whether the deeper problems afflicting the sector – tepid profit growth, rising nonperforming loans, falling net interest margins (NIMs), and deteriorating asset quality – will come to the fore and stall the rally in 2025.
China’s banks were stock market laggards for several years. Unlike go-go stocks in hot sectors such as technology and semiconductors, lenders were seen as boring and low-growth, and investors were worried about their underlying financial health.
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Bull run
Investors shrugged off those concerns in 2024 and the banking sector had a stellar year. It surged 34.4 per cent last year, the top performer among the 31 first-tier industries in the widely recognised Shenwan industry classification system set up by the research arm of Shenwan Hongyuan Securities.
Leading the pack was Bank of Shanghai, which soared 69 per cent, while Shanghai Rural Commercial Bank, Bank of Chengdu, and Shanghai Pudong Development Bank all jumped over 60 per cent. Bank of Lanzhou was the only lender to see its stock price decline, by 1.3 per cent.
The “Big Six” state-owned commercial lenders did particularly well. China Construction Bank and Industrial and Commercial Bank of China rose to 9.02 yuan and 7.04 yuan, respectively, on Dec 25, record highs for both stocks.
The surge in share prices might seem irrational given the unimpressive operating performance and fundamentals of the banks themselves.
In the first nine months of 2024, the combined revenue of the 42 mainland-listed banks fell by 1.05 per cent year-on-year, and net profit attributable to their parent companies grew by just 1.43 per cent. Net interest income, which contributes to the bulk of banks’ profits, fell at 30 of the 42 banks, while their combined NIM, a key indicator of profitability, stood at 1.57 per cent, 19 basis points lower than a year earlier.
Loan growth has also been muted. Central bank data shows that in 2024, yuan-denominated loans increased by 18.1 trillion yuan (S$3.37 trillion) – 4.7 trillion yuan less than in 2023 and marking the first annual decline in 13 years.
But investors overlooked the gloomy fundamentals in their search for safe, high-yielding assets at attractive prices.
Hungry for income
Yields on CGBs, which are classed as risk-free assets, plummeted last year as the People’s Bank of China (PBOC) focused on pumping liquidity into the financial system and cutting interest rates to stimulate lending. The yield on the benchmark 10-year CGB declined 88 basis points over the course of 2024, falling to below 1.7 per cent by the end of the year. Yields on other maturities also fell.
As yields dropped, income-hungry investors searched for other low-risk assets offering good returns in an environment of sluggish economic growth. They homed in on bank stocks because of their quasi-fixed-income characteristics – stable dividend-paying ability and high yields.
From 2019 to 2023, the banking sector’s average dividend yield was 4.9 per cent, the second-highest among 22 industries, according to research from Zheshang Securities. In 2023, the average rose to 6 per cent, some 0.3 percentage point higher than in 2022, according to the research.
As at Dec 31, the mainland-listed shares of China Minsheng Banking Corp, Ping An Bank and Xiamen Bank were all yielding between 8.1 and 8.4 per cent, while those of the “Big Six” state-owned banks ranged from 6.4 to 7.2 per cent.
Listed banks increased their payout ratios in 2023, a significant factor in boosting their share prices in 2024, Zheshang Securities analysts wrote in a recent report. Banks have relatively good operational stability, which suggests that during periods of slowing growth, their shares should perform relatively well, they wrote.
The overall dividend payout ratio for listed banks in 2023 was 29.3 per cent, 0.8 percentage point higher than in 2022 and the second-highest ratio in the past decade, surpassed only by 2014, they wrote. The ratio represents how much of a company’s net income is paid to shareholders.
Cash dividends and the payout ratio are expected to increase again for 2024 and 2025 partly because the government has been urging all listed companies not only to increase dividends but to pay them more frequently to help boost share prices. In April, the State Council released nine guidelines to promote the development of the stock market that included measures to encourage dividend payments.
The question for investors now is whether the bank stock rally can continue into 2025.
Zheshang Securities outlined several scenarios that could potentially end the bull run: an upturn in the economic cycle, a rise in risk-free interest rates, an increased appetite for risk among investors, exposure of systemic risks, and the end of high dividend yields.
Macroeconomic policy
One key factor will be how macroeconomic policy plays out.
“The Central Economic Work Conference set the tone for implementing a moderately loose monetary policy in 2025, which is a very loose level,” said the head of the financial market department at a joint-stock bank.
“If there are no other assets available to match the amount of liquidity injection, investors will be chasing after assets that provide a high degree of certainty, like CGBs and high-dividend bank stocks,” he said.
The government is widely expected to increase the fiscal deficit in absolute terms and as a percentage of GDP to support the economy, which will lead to an increase in the issuance of CGBs. The increase in supply could depress bond prices and lead to an increase in yields.
But if investors continue to favour safe-haven, low-risk assets, demand for CGBs will increase proportionately to the rise in supply and bond yields may not rise, which would be favourable for bank stocks.
Insurance funds increased their asset allocation to bank stocks because of the high dividends and that pulled in a lot of trading-oriented capital, a bond fund manager with a Shanghai-based mutual fund firm told Caixin.
The strategy is still popular “because in a prolonged low-interest-rate environment, this type of asset can at least provide stable returns and cash flow”, he said. “But now there’s just too much money chasing high-dividend assets.”
The current boom in demand for high-dividend stocks, driven by the decline in risk-free interest rates, is likely to peak in mid-January. Over the medium term, when asset allocation decisions and government stimulus policies are factored in, investors will need to shift their mindset towards economic recovery, Ni Jun, a banking analyst at GF Securities, wrote in a recent report.
Despite last year’s bull run, concerns remain about the fundamentals of the banking sector, especially in the current environment of uneven economic growth.
“There’s pressure on credit issuance, and in a low-interest-rate environment, NIMs are also narrowing, which is putting considerable pressure on banks’ performance,” the head of the asset and liability department at a listed joint-stock bank told Caixin.
Right now, the industry is stuck in a “grin and bear it” situation, he said.
Weak borrowing
Although the government has exhorted lenders to boost credit and the PBOC has cut interest rates several times, the appetite for borrowing among businesses and consumers has been weak, prompting many banks to turn to shady practices to help meet their targets. “Everyone is struggling to find good clients to extend loans to,” he said.
Rate cuts and pressure to raise savings rates to attract deposits have pushed the overall NIM for the industry below the warning threshold of 1.8 per cent, a rate set by the Self-Regulatory Pricing Mechanism for Market Interest Rates, a government-backed industry group, to ensure banks can maintain reasonable profitability.
Credit risk also remains a concern. Although the debt resolution and support policies released by the government in 2024 helped defuse some of the risks associated with real estate and the implicit debt of local governments, the transmission of these risks across the industrial chain cannot be overlooked.
And while measures to stabilise the real estate market and swap hidden local government debt into bonds are expected to shore up the quality of banks’ credit assets, other threats are emerging, notably in the retail and consumer sectors.
The hospitality and dining sectors in particular have been slow to recover from the pandemic, and companies’ ability to repay their debts is constrained by sluggish spending as households worry about unemployment and the prospects for higher wages.
Despite the surge in bank shares over the past year, investors remain wary. The price-to-book ratios of the 42 mainland-listed banks are still below one, which means their share prices are trading at a discount to their book value or net asset value per share.
This isn’t unusual – listed banks in other countries also have ratios below one, partly because investors worry about hidden risk exposures, such as trading activities that could lead to large-scale losses – but the size of the discount is hovering at a historic low.
On Dec 31, the average price-to-book ratio for the banking sector stood at just 0.61. The highest was China Merchants Bank with a ratio of 0.98, while China Minsheng Banking had the lowest at 0.33. Most other banks were around 0.5.
Figures from S&P Global Market Intelligence put the median price-to-book value of 27 mainland or Hong Kong-listed banks with assets of more than one trillion yuan at 0.44 as at August 2024, with China Merchants Bank at 0.83 and Shengjing Bank the lowest at 0.08.
The “Big Four” state-owned commercial banks – Industrial and Commercial Bank, Agricultural Bank of China, China Construction Bank and Bank of China – had ratios ranging from 0.4 to 0.44. CAIXIN GLOBAL