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Why H Shares and A Shares “Grew Apart”
Aspire | 07 September 2015
By: Louis Wong
Articles (12) Profile

The divergence in valuation between dual-listed companies in China and Hong Kong has widened again recently.  The Hang Seng China AH Premium index, which measured the valuation gap, rose to 146.52 on 2 September, implying that the A shares of those dual-listed companies are trading at a 46.52 percent premium to the H shares. The divergence in valuation between AH shares of Chinese banking stocks also widened substantially in the last week. Take the Bank of China (BOC) as an example; its H shares dropped 4.8 percent between 26 August and 2 September, whiles its A shares rose 15.85 percent in the same period resulting in a 53.7 percent premium.

Lacklustre Results Due to Slowed Growth

The cause of decline in its H shares is mainly due to lacklustre interim results.  In the first half of 2015, BOC recorded a profit attributable to shareholders of RMB 90.7 billion, an increase of only 1.14 percent compared with the same period last year.  Return on average equity (ROE) declined to 16.31 percent from 17.28 percent in 2014 and return on average total assets (ROA) declined to 1.2 percent from 1.22 percent.  The Group achieved a net interest income of RMB163.39 billion, an increase of 4.29 percent, much lower than the 11.8 percent growth of broad money supply (M2) in the first half.   The Group reported a non-interest income of RMB75.48 billion, a decrease of 3.47 percent compared with the same period last year.  Non-interest income represented 31.6 percent of operating income, which shows that the Group’s earnings are still heavily dependent on interest income.

The People’s Bank of China (PBOC) lowered benchmark rates of RMB deposits and loans three times in the first half of 2015 and widened the floating range for RMB deposit rates.  Compared with the first half of 2014, the decline in the benchmark interest rates of RMB loans was larger than that of deposits, putting pressure on banks’ interest margin.  As a result, the Group’s net interest margin fell 9 basis points to 2.18% in the first half.

 Non-Performing Loans Growing Despite Heavy Impairment Losses

In the first half of 2015, BOC’s impairment losses on assets amounted to RMB28.57 billion, representing an increase of 2.86 percent year-on-year and accounting for more than 10 percent of the operating income of RMB238.8 billion. The impairment losses on loans and advances amounted to RMB27.51 billion, accounting for 96 percent of the total impairment losses on assets.  Despite the hefty impairment, the Group’s non-performing loans (NPLs) continues to rise.  As of 30 June 2015, its NPLs totalled RMB125 billion, an increase of RMB24.55 billion compared with the prior year-end.  The NPL ratio has increased by 0.23 percentage points to 1.41%.

The interim results of the other big four state-owned commercial banks more or less show the same picture with earnings growth ranging from 0.3% to 1.5%.  The combined NPL balance of the big five state-owned commercial banks increased by RMB136.4 billion or 26.96% in the first half of 2015, with Agricultural Bank of China posting a non-performing loan ratio of 1.83%, an industry high.

Then one may question why the A shares of Chinese banking stocks did not fall alongside their H shares counterpart.  One of the reasons is probably because China’s government is supporting the stock market through large-scale purchases of stocks with heavy index weighting.  On 2 September, the day before Beijing hosted a military parade to celebrate the 70th anniversary of the World War II victory over Japan, China’s largest state-owned commercial bank ICBC went limit up in the last half an hour of trading after being in the red most of the morning.

The outlook for Chinese banking stocks will remain challenging.  The sluggish interim results signal that borrowers are having trouble repaying loans.  Special-mention loans, a category that banks deem overdue but not yet impaired, are rising.  In addition to increasing bad loans, China’s slowing economy raises the likelihood of more interest rate cuts, which will further pressure banks’ net interest margin.  That explains why more and more Chinese banking stocks are falling below net asset value and yet that may not be a bargain.

Louis is one of the most experienced fund managers in Hong Kong and has more than 25 years of solid experience in the financial markets. He employs a strict criteria for choosing his stocks, which is deeply insistent on having a thoughtful and sophisticated analysis of the company before making any investment decision.

Please click here for more information about this author.


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