The Chinese economy has been grappling with liquidity crunch for more than two years now. But the problem recently reached an alarming level. While high bad loan in a waning economy made it hard for the borrowers to repay loans, the surprise devaluation of yuan in mid August worsened the crisis (read: Inside The Crash in China ETFs).
This led to net foreign exchange outflows worth 723.8 billion of yuan in August that crumpled the Chinese banking system. Chinese banks are on their way to see the worst year in 13 years, per Wall Street Journal. Most of banking bellwethers reported lackluster first-half performances this year.
Some analysts including those of Moody’s expect Chinese banks’ profits to weaken further in the second half of this year hurt by piled up non-performing loans and fall in net interest margins. A plunge in fee income from stock-related services will also hit banking services hard as Chinese investments fell out of investors’ favor lately.
Is There Any Hope?
While the operating backdrop looks outright grim for the Chinese banks, a few recent developments could favor the bunch. First, despite the record monthly decrease in forex reserves, China had the biggest hoard of foreign reserves of $3.56 trillion at the end of last month. Added to this, the percentage of bad debt in total loans, though high from the last quarter, remained 13 by global averages.
Moreover, after the summer slowdown and a scorching sell-off in August, Chinese banks are now trading at bargain. The price/book value of Industrial and Commercial Bank of China’s Hong Kong-listed stock is 0.8 times, reflecting a 72.4% discount from the level seen in 2009, per Wall Street Journal. Several other big banks are also showing the same downtrend.
Of course this valuation pointer reflects bearish sentiments on these banking stocks. But on a positive note, it also indicates dirt cheap valuation for the Chinese banks. If this was not enough, the Chinese central bank appears to be going all out to infuse liquidity into the economy and cut rates and reserve requirement ratios (RRR), as it has done several times this year, to boost lending.
China also relaxed the methods for computing the reserve requirement ratios of banks. Per the 17-year old rule, banks were required to tally their RRR on a daily basis. “Under the changes, banks can report a daily RRR that is up to 100 basis points lower than the rate set by the PBOC, but their daily average RRR in the assessed period cannot fall under the required level,†per Reuters.
Per a report by Barrons.com, Nomura Securities approximates that this easing can free up to 1.3 trillion yuan, or 1% of total banking deposit. All these stimuli should result in higher lending which in turn should boost profits (read: Correction Seems Over: Time for China ETFs?)
Also, in August, total social financing rose 13% to 1.08 trillion and corporate-bond issuances more than doubled to 287.5 billion indicating that present activities may not be as bleak as it looks.
In a nutshell, relentless efforts by policymakers to boost loan growth and compelling valuation should stage the backdrop for China ETFs with heavy allocation to the financial sector, at least for the near term. Since no one knows what’s exactly cooking up behind the Great Wall and how long does it will take the country to return to top gear, caution needs to be practiced while playing these products.
Investors should note that the core China financial ETF Global X China Financials ETF (CHIX) was one of the best performers in the China equities ETFs space in the last one-week, four-week and one-year periods (as of September 15, 2015).
So, we highlight two finance-heavy China ETFs which have bottomed out and could turn around in the coming days. After all, China shares have been trending higher in recent sessions after a bloodbath and financial ETFs could very well cash in on this rising trend (read: 3 Ways to Play Surging China Stock Market with ETFs).
ETF Plays
Global X China Financials ETF (CHIX)
This ETF provides concentrated exposure to the financial segment of Chinese equity market by tracking the Solactive China Financials Index. In total, the fund holds over 40 securities in its basket with the top three firms – China Construction Bank, and Industrial & Commercial Bank of China and Bank Of China – dominating the fund’s returns at more than 9% share each. It is a large cap centric fund accounting for 85% of assets.
The fund has amassed $54.1 million in its asset base while trades in moderate volume of 150,000 shares per day on average. It charges 65 bps in annual fees and expenses. The fund is presently trading at a P/E (ttm) of 7 times, suggesting an appealing valuation.
The fund was up about 9% in the last one week (as of September 15, 2015) and has a Zacks ETF Rank of 3 or ‘Hold’ rating with a Medium risk outlook.
iShares China FTSE 25 Index Fund (FXI)
This is easily the most popular China ETF in the market, as over $5.7 billion is invested in the fund and average daily volume is over 30 million shares a day. The 51-stock product puts half of its weight in the financial sector.
This means that any news out of the financial sector can have a huge impact on the overall return of this famous ETF. China Construction Bank Corp, Industrial & Commercial Bank of China and Bank of China Ltd. are among the top-five holdings.
FXI charges 74 bps in fees and has P/E (ttm) of 9 times. The ETF added about 7.2% in the last five trading sessions and has a Zacks ETF Rank #3.
