Godzilla Stomps the Chinese Banks

Date: Mon, 30 Aug 2010 11:55:13 +0800
Subject: Godzilla stomps the Chinese banks

 

Everyone knows that China needs to boost domestic consumption and today John Wadle has an idea they might do it by changing things around for the banks. Note attached. Consumption as a percentage of GDP in China continues to fall: it was 46% in 2000 and last year was only 36%.

A recent study out suggests it may really be only 31%, vs. 70% in the US or the 50-55% normal in other low consumption Asian countries. This is because China uses the “Japanese growth model” which takes wealth away from households and funnels it towards the corporate sector subsidizing them by restraining wages, undervaluing the currency and keeping the cost of capital too low, according to Michael Pettis, a finance professor at Peking University.

As seen with Japan, this leads to massive overinvestment, misallocation of capital and industries that need these hidden subsidies to survive. Having lived in Japan for several years before, I can tell you it sucks to be a consumer there. Declining real interest rates only exacerbate the imbalance.

Japanese growth model

As evidence of slower construction and infrastructure investment becomes more apparent, China may be forced to boost deposit rates and cut mortgage rates to stimulate consumption. Most of the H-share China banks are trading at the same PE multiples indicating investors aren’t differentiating much between them. Clients don’t seemed positioned for this change. The change is likely because:

  •  Demand deposits pay only 36 bps and mortgages are currently 4.5 – 5%, so Chinese banks are now earning mortgage spreads almost double that of other Asian markets.
  • We estimate a 1% drop in mortgage rates from 5% -> 4% lowers interest payments (existing mortgages are variable rate) and would boost disposable incomes 6 – 12%.
  • With retail deposits at 83% of GDP, a 1% rise in retail deposit rates would boost consumer incomes RMB 300 bn, or 0.8% of GDP.
  •  Banks are earning ROAs of 1.21% on average and can afford to lower mortgage/deposit spreads.

Action:

  • Avoid CMB (3968 HK): most expensive with the most downside here as 23% of loans are mortgages.
  • Avoid BoC (3988 HK): has the lowest margins thanks to cheap FX loans and 18% of loans are mortgages.
  • Buy BoCom (3328 HK): below average PPOP/loan margins but diversification and falling cost/income ratio means 1.1% ROAs are stable
  • Buy CCB (939 HK): very high PPOP margin and strong capital offset 19% exposure to mortgages. BAC overhang not an issue until August 2011.

Top Pick:

  • China Citic Bank (998 HK): less exposure to mortgages and with only 2.6% market share in loans will grow faster than the others. Post rights issue trading at 7X
  • 2011 PER makes this the cheapest bank in the sector and it trades at an unsustainably high discount of 22% to the A-share and the only bank to do so. This means nobody is looking at this one.

$$$$$$$

Animals in China are normally treated as food so the new pet craze amongst urbanites with some cash is unprecedented. The latest fad is to dye your pet to look like something it isn’t. Industrial strength coloring is likely used (regular Chinese hair tonics) without asking the pets if this new look is “them.” Good news for FMCG companies and veterinarians. One way to stimulate consumption?

This is a dog.

This dog has lost his dignity and his friends:

I guess nobody wants to see things as the really are:

$$$$$$$

You can get our research by typing MASR <Go> on Bloomberg.

Cheers.
Derek Hillen, CAIA


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