A tale of two Chinas


Chris Wright
Published on:

Why being positive on Chinese macro and the big four banks, but bearish on the rest of the financial sector, is not a contradiction in terms.


The week of September 11 brought a glut of conferences to Hong Kong and Singapore, united by one thing: people being very positive about China.

That was to be expected at the Hong Kong Trade Development Council’s we-love-the-motherland Belt and Road Summit, where one could hardly imagine Hong Kong chief executive Carrie Lam, or the senior members of China’s National Development and Reform Commission and various key ministries, saying anything negative.

But the CLSA event – whose China day on the Tuesday is a highlight when some of the best analysts in the industry let loose on their outlook for the mainland – was also uncharacteristically cheerful.

Nicole Wong regional head of property research, said changes in policy “are going to make the property market a lot safer than we have always known it to be.”

An Patricia Cheng, head of China financial research, explained her overweight recommendation on Chinese banks, saying she had “more confidence about bank asset quality” and that there was “a lot more downside protection than before.”


By Thursday, the Milken Institute’s annual summit in Singapore was underway, where a panel including heavy hitters like Morgan Stanley’s China CEO, Wei Sun Christianson, and JPMorgan’s vice-chairman for Asia Pacific, Jing Ulrich, was similarly effusive.

Around 80% of the companies JPMorgan covers in China have surpassed or met earnings targets, Ulrich said, and “the macro environment looks more stable than at any time in the last several years.”

How can we square this, then, with an environment in which China was downgraded by Standard & Poor’s the very next week, with the rating agency saying that credit growth has increased economic and financial risk?

An environment in which Bank of Communications (BoCom) was downgraded by Moody’s the week before these conferences, and where UBS argues that shadow loan books in China are now equivalent to 19% of national GDP and have the potential to pose systemic risk?

Perhaps because of an increased bifurcation between what is good about China and what isn’t.

The Moody’s downgrade of BoCom, for example, “is driven by its weaker funding profile when compared to other state-owned Chinese banks, as well as its pressured profitability as a result of an environment of increased market funding costs,” the rating agency says.

BoCom has a weaker deposit base than the big four and the cost of its interest-bearing liabilities is greater.

Similarly, UBS’s view on the threat of shadow loans is that “this is a sleeper issue that is now highly concentrated in regional banks and, to a lesser extent, the smaller joint-stock banks… a conclusion that favours the big four banks.”


And although CLSA has an overweight on the sector, a closer look shows that its top picks are China Construction Bank, for having the best disclosure of its bad debts, and Agricultural Bank of China, which has the clearest stated target for non-performing loan reduction.

Both are big four state-owned lenders and are aspiring to a level of transparency you do not see further down the banking hierarchy.

It is possible, then, to think that China is doing fine while its smaller banks are in a world of trouble. At both a macro and micro level, China is performing: GDP growth exceeded market expectations for the first half, even some steel-makers are turning a profit and regaining pricing power, the currency has stabilized, FX reserves are climbing again, renminbi internationalization is proceeding as China would like it to and the Belt and Road Initiative creates a powerful engine for outbound activity from Chinese state- and private-sector enterprises.

It is possible for all of this to be true as well as the following: that the debt-equity swap mechanism to reduce state-owned bad debts has so far been a failure, that some banks have been flat-out stupid in their exposures, that reform of state-owned enterprises has been sluggish and that imperilled banks will not regain a surer footing until that reform makes some tangible progress.


It is odd but explicable to favour the big four banks in investment recommendations but also to believe that shadow banking reform to date has done nothing but move risks off the balance sheet, creating even worse transparency and leverage than before.

And you do not have to go too far down the curve to be alarmed.

China Merchants Bank, for example, is among the top 10 in the country by assets and its share price was up 60% this year at the time of writing, with growing profitability and falling NPLs, yet it has Rmb2.1 trillion ($318 billion) of wealth management products outstanding, most of it off balance sheet, and is thought to have been putting weaker loans into other vehicles called asset management plans to sell them to investors and improve official bad-loan figures.

“We are not on the cusp of catastrophe and the risks are still concentrated at the individual bank level, largely outside of major listed names,” says UBS’s Asian financials research director Jason Bedford.

That’s the point: a growing gap between big banks that are anchored to China’s macroeconomic robustness and those that may have trouble ahead.