Who is buy­ing Chi­nese bank shares?

Financial Mirror (Cyprus) - - FRONT PAGE - By Chen Long

Few seg­ments of global eq­uity mar­kets have been more re­viled in re­cent years than the shares of China’s big state banks. As cor­po­rate debt lev­els in China bal­looned, es­pe­cially among state-owned en­ter­prises, and eco­nomic growth slowed, in­ter­na­tional in­vestors shied away from the H-shares of state banks listed in Hong Kong, fear­ing an almighty ac­cu­mu­la­tion of un­rec­og­nized bad loans on their bal­ance sheets. This cagi­ness was re­flected in bank val­u­a­tions. Take In­dus­trial and Com­mer­cial Bank of China, China’s largest bank by as­sets, for ex­am­ple: from a price to book ra­tio ap­proach­ing 5x in late 2007, the valu­a­tion of its H-shares tum­bled to just 0.65x in May of this year—a slump mir­rored in the val­u­a­tions of the other big Hong Kong-listed main­land banks.

But since May things have changed. Hshares in ICBC have climbed 30%, eas­ily out­per­form­ing the broader Hong Kong mar­ket, which has gained a rel­a­tively mod­est 17%. The shares of other Hong Kong-listed state banks have also risen strongly, in a rally which has pushed the P/B ra­tios of the Chi­nese banks up to between 0.65x and 0.9x. But although fears of an im­me­di­ate debt cri­sis in China may have re­ceded in re­cent months, in­ter­na­tional con­fi­dence in the trans­parency and so­lid­ity of state banks’ bal­ance sheets re­mains shaky to say the least. So who is buy­ing?

The an­swer can be found in the flow data for the south­bound chan­nel of the Shang­haiHong Kong con­nect scheme, which pro­vides main­land in­vestors with a sluice gate in China’s cap­i­tal con­trols through which they can buy Hong Kong-listed stocks. For most of the first 18 months after the scheme’s 2014 in­tro­duc­tion, south­bound in­ter­est was rel­a­tively lim­ited. There was a brief surge of en­thu­si­asm in early 2015 when the main­land mar­ket was boom­ing. But when the bub­ble burst, in­ter­est cooled, and for most of last year main­land in­vestors held less than half the RMB250bn ag­gre­gate quota of Hong Kong stocks al­lot­ted to them un­der the scheme.

In the last few months, main­land in­ter­est in buy­ing Hong Kong stocks has re­vived. Heavy south­bound flows saw the un­used bal­ance of the ag­gre­gate quota shrink from RMB117bn in early May to less than RMB45bn in early Au­gust. With the trend im­ply­ing that south­bound pur­chasers would reach the ceil­ing of their per­mit­ted quota well be­fore the end of the year, last month the main­land au­thor­i­ties took ad­van­tage of the an­nounce­ment of the launch of the com­ple­men­tary Shen­zhen-Hong Kong con­nect scheme to scrap the south­bound ag­gre­gate quota en­tirely, no longer set­ting a limit on the value of Hong Kong stocks main­land in­vestors can hold (although restric­tions still ap­ply to the in­di­vid­ual stocks ap­proved for pur­chase and on the pace of buy­ing).

When main­land in­ter­est in Hong Kong-listed shares be­gan to pick up, in­ter­na­tional in­vestors gen­er­ally as­sumed that buy­ers would fo­cus on

how­ever, “new econ­omy” stocks such as in­ter­net gi­ant Ten­cent, which is not listed on China’s do­mes­tic mar­ket. In fact, between the be­gin­ning of May and mid-Au­gust, al­most two-thirds of south­bound flows—some HKD53bn went into bank shares. Some went into HSBC, re­garded lo­cally as both a yield play and a hedge against pos­si­ble ren­minbi weak­ness. But the bulk went into ICBC and China Con­struc­tion Bank, with HKD25bn go­ing into CCB alone.

It is un­re­al­is­tic to imag­ine that main­land re­tail in­vestors are be­hind these flows. Such heav­ily-con­cen­trated buy­ing smacks of China’s “na­tional team”, the group of state funds headed by China Se­cu­ri­ties Fi­nance Cor­po­ra­tion and Cen­tral Hui­jin In­vest­ment which last year weighed in to sup­port the col­laps­ing main­land A-share mar­kets. If so, and if the na­tional team is in­deed buy­ing the Hong Kong-listed shares of Chi­nese state banks in such heavy vol­ume, the ques­tion is: Why?

There are a cou­ple of pos­si­ble rea­sons. The first is that the main­land au­thor­i­ties are anx­ious to make a suc­cess of the open­ing of China’s do­mes­tic A-share mar­ket to in­ter­na­tional in­vestors via the north­bound chan­nels of the stock con­nect schemes. So far how­ever, in­ter­na­tional in­vestors have been dis­tinctly un­der­whelmed; as of midAu­gust they held less than half of their al­lot­ted quota of main­land stocks.

That’s no sur­prise. Many of the blue-chips listed in Shang­hai are also avail­able in Hong Kong, and at much cheaper val­u­a­tions. So main­land of­fi­cials may well rea­son that to pro­mote in­ter­na­tional in­ter­est in the main­land mar­ket, they must first close the valu­a­tion dif­fer­en­tial with Hong Kong. And the eas­i­est way to do that is to buy the Hong Kong shares of the big main­land state banks, which make up a third of the H-share in­dex by cap­i­tal­iza­tion. If that is in­deed their in­ten­tion, they have been par­tially suc­cess­ful. Since May, the over­all A-share/Hshare pre­mium has nar­rowed from 40% to 23%.

The sec­ond pos­si­ble rea­son is that the main­land au­thor­i­ties are pre­par­ing China’s state banks for a fu­ture re­cap­i­tal­iza­tion to strengthen their bal­ance sheets. How­ever, Chi­nese reg­u­la­tions for­bid state-owned com­pa­nies from sell­ing shares at be­low book value, in or­der to avoid “losses of state-owned as­sets”. As a re­sult, if the au­thor­i­ties want to is­sue new shares to help re­cap­i­tal­ize the banks, they must first push up their P/B ra­tios. And if they want to is­sue new shares via a sec­ondary of­fer­ing in the in­ter­na­tional mar­ket, that means buy­ing enough Hong Konglisted stock to push the P/B valu­a­tion of the H-shares above 1x.

These two ex­pla­na­tions are by no means mu­tu­ally ex­clu­sive. And the im­pli­ca­tions as far as in­ter­na­tional in­vestors are con­cerned are much the same. If the hy­pothe­ses are true, main­land pur­chasers will carry on buy­ing the H-shares of Chi­nese state banks un­til ei­ther the valu­a­tion dis­count to Ashares closes or un­til H-share val­u­a­tions climb above book value. In short, it looks as if the buy­ing mo­men­tum will con­tinue.

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