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Tomorrow, China’s two largest banks – the world’s two largest banks in fact – report their earnings for the 4th quarter and the full year 2018.

We take this opportunity to revisit the valuations of China’s 4 largest state-owned banks.

And we come to the conclusion that their valuations are abnormally low and constitutes a pricing anomaly that will not last for long!  

In 35 years in finance, analyzing stocks and companies, we have never come across such a compelling investment case.

Having worked for one of these groups as CEO of their Swiss subsidiary, we know full well that the accounting and auditing standards used are up to par with Western standards, and fears of foreign investors are misplaced.

Even taking the catastrophic scenario of massive non-performing loans having to be written-off and the worst economic scenario that is to be expected in China, value is still compelling in the Chinese large banks.

We do not know if tomorrow’s numbers will surprise positively or if the banks will chose to pass a maximum of bad news in 2018, buy what we know is that the consensus is clearly negative and that all the bad news is already in the prices.

Investing in equities is all about fundamentals.  

Perception is important, but at one point the logic of accounting and true book value prevails.

By definition, banks are the transmission gear at the heart of any economy. They are the conduit that collects savings and lends to corporations enabling growth and efficient allocation of capital.

They are at the center of the payment system and no one in the 21st century can live without a bank account. 

As such, banks are a CALL OPTION on the health and rate of growth of any economy and they are at the same time the most solid, and the most protected corporations in any economy. There are no other industries that benefit form a TOO BIG TOO FAIL insurance policy or that are submitted too direct state supervision apart from the healthcare industry.

In the case of China, a 1.3 Billion people economy growing at 6 % plus, the four largest State banks have been growing fast. 

They employ between 200’000 and 450’000 people each and have typically between 250 and 450 million clients, one and a half the size of the US population.

With Assets of US$ 4 Trillion, ICBC is bigger than the German economy and would rank as the 5th largest country on the planet. It is also twice the size of the largest American bank.

No.1 — Industrial and Commercial Bank of China (ICBC)

Country: China
Assets: $4 009 bln.

Industrial and commercial Bank of China (ICBC) – is the largest and richest bank in the world.  It controls almost 1/5 part of all banking in China. The Bank was founded in 1984 and now has more than 460.000 employees. It is headquartered in Peking and 70% of its share capital is owned by the Chinese Government, making it one of the safes banking risk available today.

No.2 — China Construction Bank Corporation

Country: China
Assets: $3 400 bln.

CCB was founded in 1954 and created for government exchanges. It was then redeveloped into a commercial bank and focused on infra-structure and real estate financing. The bank has more than 14’000 branches and employs 372.000 employees.

Country: China
Assets: $3 235 bln.

ABoC was founded in 1951 by Mao Zedong to finance collective farms, peasants and workers. The bank is headquartered in Peking, has 24.000 branches and employs 477’000 people. It is now a general retail and corporate bank with a strong presence in rural China and provincial cities.

No.4 — Bank of China ltd

Country: China
Assets: $2 780 bln.

Bank of China is one of the oldest and most reliable banks in China. It was created in 1912 and was the Central Bank of China until the 1970s where the PBOC was separated and Bank of China became a full commercial Bank.

Bank of China is the most international of the Chinese banks with subsidiaries in most of the large cities in the world and it is also the leader in terms of Private Banking and wealth management.

The sheer size of these state-owned banks makes them amongst the safest investment in the world :  

They are way TOO BIG TO FAIL and 
the Chinese Government derives significant revenues from their dividends.

Bad Loans

For years, the Chinese banking system and the four large state banks were the main and only vehicle to finance the extraordinary growth that took China form one of the poorest nation of the planet in 1978 to the second largest economy of the world in 2018.

As a result, these banks had to finance many inefficient state-owned enterprises and accumulated a book of non-performing loan from these legacy enterprises. 

However, since the development of the Chinese capital markets – China has now the second largest bond market in the world and the third largest equity markets in the world – the four largest banks have become truly commercial operations driven by their profits and safety ratios.

A huge debate has been running for years between western analysts about the truth and sincerity of the Chinese banks Non-performing loan classifications and portfolio, but since these banks are listed on the NYSE and their auditors are major western houses such as Price Waterhouse, it can be said that they follow the same rules and risk management processes than the comparable western banks.

Moreover, the Chinese Government has imposed for years now a provisioning ratio of 150 % of the Non-performing loans when compared to the 70 – 80 % ratio usually practiced by banks such as HSBC or CITIGROUP.

As such, the provisions accumulated by the four largest Chinese banks are humongous and a large proportion of the legacy loans inherited from the previous decades ahem been transferred to special purpose asset management companies with the backing of the State for their amortization over the long period.

Today, it is considered the the cleaning-up of the legacy portfolios of the four largest Chinese big banks is almost complete and that profitability should Strat to grow from 2019 onwards.


To give an idea of the growth of these financial giants at the heart of the Chinese economy and soon of the world Economy, suffice to look at the growth of their EQUITY CAPITAL over the past ten years, bearing in mind that this growth came entirely organically from retained profits after dividend distributions.

Typically, earnings have been growing at between 7 and 10 % and pay-out ratios face amounted to 30 % of net earnings.

1398 HK – Industral and Commercial Bank of China

In the past 12 years, the net equity of ICBC was multiplied by 4.1, growing from Yuan 380 Bln to 1.58 Trillion. 

In the next ten years, if the same rate of return on equity of 14 % is achieved, ICBC’s net equity will again multiply by 3.7 times to reach nearly US$ 1 Trillion.

939 HK – China Construction Bank

China Construction Bank’s returns have been even more impressive, reaching a net equity of 1.8 Trillion, multiplied by 4.7 x in 10 years. 

1288 HK – Agricultural Bank of China

Agricultural Bank of China saw its Total Equity multiply by 5.1 in the past eight years.

3988 HK – Bank of China

And Bank of China saw its Total Equity increase by a multiple of 3.9x over the period.

With a return on equity of 12 % per annum, and a CAGR in net equity of 12.38 %, BOC net equity will reach US$ 800 Bln. in 10 years time.

Book Value

Stock prices are supposed to reflect the value of a company. Its existing value first and then the potential revenue flow that can be expected from its ownership in the future via retained earnings and distributed dividends.

The biggest anomaly in today’s pricing of China’s four largest big banks is that by trading at a HEFTY DISCOUNT TO BOOK VALUE not only they DO NOT VALUE the Existing Value of the company, but they put strictly NO VALUE ON THE FUTURE FLOW OF EARNINGS of China’s banks.

China’s four big banks trade at discounts to Book value that range from 19 % for ICBC to 40 % in the case of Bank of China, meaning that not only 40 % of the accumulated net equity should be wiped out in bad loans but also ALL the future flows of earnings.

To give an comparison, the US SP500 Index trades on a 3.4 x P/B ratio, or a 240 % premium to book value. Comparable US banks trade on 1.1 or 1.5 x Book Value.

In the following tables, the financial ratios of the four largest big banks are displayed.

Price to Book is to be found under “P/B” and at 0.81 for ICBC, it means that you are actually acquiring the company at a 19 % discount to its accounting value, and that is taking no future earnings into consideration. The other banks trade at between 21 at 39 % discount to their book value.

Return of Equity appears under “ROE”and they range from 12.1 % for Bank of China to 14.5 % for China Construction Bank.

NPA to Total Loan” represents the ratio of Non Performing Loan when compared to the Total Loan Book and it ranged from 2.3% for Agricultural Bank to 1.5 % for China Construction Bank.

“LLR to Non-Perf Ast” shows the rate of provisioning of the non-performing assets. It ranges from 148 % to 166 %, meaning that even if the actual size of Non Performing Loans was 50 % higher than the actual amounts classified as such, they would still be provisioned.

1398 HK – Industrial and Commercial Bank of China

939 HK – China Construction Bank

1288 HK – Agricultural Bank of China

3988 HK – Bank of China

To illustrate how unusual this situation is, nothing better than looking at the charts of these stocks over the past 10 years, during which their net equity increased between FOUR and FIVEFOLD.

Their Stocks Still Trade at the same Price they were trading at 10 years ago. 

1398 HK – Industrial and Commercial Bank of China

Since 2006, the stock price of ICBC has barely budged. The average price recorded since 2007 stands at 5.42 as does the regression price while the accounting value of the company has been multiplied by FIVE.

It is now trading at a 19 % discount to Book value and its earnings represent 14 % of its equity EVERY YEAR, even if they do NOT GROW at all year-on year, its net equity will rise by 370 % over the coming next year.

In fact, analysts do expect earnings not only to continue being there but even growing at around 6.65 % per annum over the long term.

If that is the case, then just taking the actual stock price as stable over the next five years and just adding the next five years expected earnings – in the form of dividend or retained earnings – would then give the following increase in the stock price

As is normally the case, at 5 x earnings, the stock value will double in five years just thanks to the accumulation of earnings over these 5 years, and that still leaves it at a discount to its book value.

939 HK – China Construction Bank

There again, China Construction bank still trades at the same price it was trading at 10 years ago despite a FIVE times increase in its net equity.

Analysts do not expect earnings to disappear or the bank to even make a loss, but on the contrary, expect some earnings growth at the rate of 6.85 % per annum.

Based on the current stock price of HKD 6.8, which is already at a discount to Book value, adding the 5 years of earnings ( through distribution or retained earnings ) gives a forward five years value of HKD 12.01, and that is still a discount to the then 13.82 Book value.

1288 HK – Agricultural Bank of China

Agricultural Bank of China had its IPO in July 2010 and the stock is currently trading at the same level it traded then despite the increase in the value of the Net equity from 400 Bln. to 1.5 Trillion over the past eight years.

Analysts expect an increase in earnings and in fact in acceleration to 7.70 % per annum

The addition of these five years earnings to the current stock price gives a value of HKD 6.61 – an 81 % increase – and will still be 19 % discount to the then Net Asset Value

3988 HK – Bank of China 

Bank of China trades where it was trading at in 2006 – 12 years ago – and its Discount-to-Book value is 39 %. Over the period the of the bank Net Equity has increased FOURFOLD.

The data and tables above highlight an extremely unusual situation and point to an end of the period of under-performance of Chinese Banks.

Granted, the growth rate of the Chinese banks profits will no longer be 12 % per annum, and probably more like 7 % per annum, but even if they did not grow at all, THE NET EQUITY OF THESE BANKS WOULD CONTINUE TO GROW SUBSTANTIALLY.

Even if their was NO Growth in earnings, current earnings represent 16.7 % of the current stock price, meaning that the Total Equity would continue to grow at a 16 % clip per annum. 

The Chinese economy will continue to grow at 5 – 6 % over the coming five years, Banks are at the center of the Economy, the cleaning-up of the banks’s balance sheet is close to being complete now and valuations cannot keep on going deeper into discount for ever.

As a matter of comparison, we provide below the ratios of Wells Fargo, the most domestic of the US large banks and 11th largest bank in the world.

WFC trades at 11.8x earnings, twice the ratio of the Chinese banks, at 1.3x book value, twice the ratio. of the Chinese banks, its non-performing loan book stands at 0.7 % of total loans and its provisioning ratio is 141 %.