China's mega banks are boasting higher profits, but investors still aren't buying their stocks

Key Points
  • Hong Kong-listed shares of China's big four banks were mixed even though all of them reported higher profits and wider margins last week.
  • Investors fear that Chinese authorities, facing a slowing economy and worsening tensions with the U.S., may abandon plans to deleverage and the banking industry could see bad debt pile up again.
The prospects of Chinese banks are turning brighter: Fund manager

The latest earnings reports from China's big four banks showed improvements across key financial metrics, but some investors remain worried that things could get worse for lenders in the world's second-largest economy.

Such concerns arose after the country's central bank, the People's Bank of China, made several moves to loosen monetary conditions as economic growth slows and as trade tensions with the U.S. worsen. That made investors fear that Chinese authorities may abandon plans to reduce harmful debt in the economy, which could hurt the banking industry.

"It may mean helping the struggling corporates ... If that's the case then we will be less optimistic about the outlook because, eventually, we will be going back to a couple of years ago when Chinese corporates struggled and relied on credit to sustain," Frank Tsui, fund manager at asset manager Value Partners, told CNBC's "Street Signs" last week.

"That will put pressure on the banks," Tsui added.

Three of the big four Chinese banks saw their shares in Hong Kong fall last week. Industrial and Commercial Bank of China tumbled 0.87 percent, China Construction Bank declined 0.58 percent and Bank of China was down 0.28 percent. Agricultural Bank of China bucked the trend with a 2.15 percent climb on stronger earnings.

Their Shanghai-listed shares fared better. CCB was up 1.28 percent over the week, and ABC and BOC both inched up around 0.6 percent. ICBC was the only big four bank that ended the week in the red on the mainland after declining 0.91 percent.

The mixed performance on the stock markets came despite all banks showing an increase in net profits in the first six months of 2018. Net interest margin — which measures lending profitability — across the four banks also improved from last year's levels.

Importantly, bad debt levels at the four lenders stayed below the total national non-performing loan ratio of 1.86 percent. The NPL ratio measures the proportion of overdue debt to total loans.

"I think the market concern is more about the asset quality outlook," Chen Shujin, an analyst at Huatai Securities, told CNBC's "Squawk Box" last week.

Chen noted that the latest financial statements did show "some deterioration" in the quality of retail loans, and the amount of loans that could turn bad have also risen. A loan is typically considered "non-performing" after payment is overdue for 90 days or there are doubts about the debtor's ability to repay that debt.

At a crossroads

The earnings results for China's big four banks are closely watched as a proxy for the health of the Chinese economy. The four lenders together account for around 30 percent of total assets in China's banking sector, which is the largest in the world.

Shares of the four banks are also heavily weighted on Hong Kong's Hang Seng Index and Shanghai's SSE Composite Index, so their stock movements often dictate the direction of the broader markets in Greater China.

To Value Partners' Tsui, the large Chinese banks are now at a crossroads and their stock performances largely depend on the scale of monetary policy easing that Chinese authorities choose to implement. An easing move means injecting more money into economy, which lowers interest rates. While that encourages businesses and consumers to spend more, such an action could also mean China halting its effort to deleverage.

"I think chances are we're not looking at a very bearish outlook," he said, adding that Chinese authorities are still emphasizing the importance of deleveraging and the country's economic growth is still on track.

To some investors, the current share prices of the large Chinese banks present a buying opportunity.

"The China banks reported earnings and they were largely in line (with expectations), pretty good results in fact, so we're not too nervous there," Sarah Lien, Eastspring Investments' client portfolio manager, told CNBC's "Capital Connection" last week.

"We feel comfortable that the risks are largely priced in at these levels," she added.

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