China Financials – Dividend Narratives
Share prices of China banks have experienced volatility over the past months (Figure 1). This is primarily due to news regarding certain groups of homebuyers’ refusal to service their mortgage obligations on unfinished residential projects amid suspension of construction works and delayed deliveries by a number of cash-strapped developers.
Investors may be wondering what the impact of the boycott in mortgage repayments are on the banking sector as these repayments are used to fund the working capital of real estate developers. Headline news have painted a cautious picture of the impact to real estate and its related sectors. However, the direct real estate sector as a percentage of China GDP is low at 6%-7% since 2010 (Figure 2).
Our fundamental investment thesis on China banks is predicated on their ability to provide steady income through attractive yields of 6-7% which fit well on the income side of the CIO Barbell Strategy. Over the past few years, China banks have endured economic challenges brought about by the pandemic and have maintained dividend payments. It remains a strategically important sector to the government.
Figure 1: China banks
We believe the recent issue of select homebuyers’ refusing to service their mortgages should not pose any inherent long-term risk to China’s overall economic trajectory and the banking sector.
Figure 2: Real estate as a percentage of GDP (1995 – 2021)
While the list of halted projects as at the end of 2021 was estimated at CNY466b (USD70b), this value is a manageable 0.4% of China’s gross domestic product. These projects would have reached a certain level of construction progress and we believe they are mostly commercially viable for developers and relevant parties to resume construction in order to realise full project payment and entice homebuyers to continue servicing their loans.
Figure 3: Value of halted projects (CNYb)
Source: China Real Estate Information Corp, Bloomberg Intelligence, DBS
Knowing the importance of the real estate sector to the local economy and the implications to consumer confidence, China is likely to introduce government-driven solutions to resolve the stalemate. Possible resolutions include:
- Special purpose bond issuance by local or provincial governments
- Banks to extend loans at specific project levels
- Regulators to work with creditor banks to restructure the outstanding developer loans
- Local authorities and industry peers to take over the completion of these projects
It is important that the gridlock is ultimately resolved, given the wide range of stakeholders involved – local government bodies, commercial banks, building contractors, construction firms, material suppliers, real estate developers and their employees, as well as homebuyers. Nonetheless, we believe these homebuyers will eventually resume the mortgage servicing so as not to impact their domestic personal credit rating which was implemented since 2014. From the banking sector standpoint, non-performing loans (NPL) ratio has stayed at 1.7% over the past 5 – 6 years (Figure 4) and is likely to stay within a manageable range as banks take prudent steps to maintain asset quality. Take the four largest banks as example. They have set aside loan loss provisions of 250% as at the end of March 2022 (Figure 5), amounting to CNY2.8t collectively. This will play a pivotal role for banks in maintaining stable balance sheet quality, cushioning the impact of economic volatility.
Figure 4: China banking sector NPL ratio (December 2006 – June 2022)
Figure 5: Average loan loss provision of China’s 6 largest banks (December 2010 – 1Q22)
Among China financials, our preference remains with large state-owned banks that have strong balance sheets with higher loan loss provisions, NPL ratios lower than industry average, and large capital bases. Large banks can tap cheaper funding from their larger current-account-saving-account (CASA) deposit base, have more diversified loan book composition and lower percentage of exposure to real estate mortgages.
Large state banks in China distribute 30% of their net profit after tax in the form of dividends (Figure 6), which we think is sustainable as evidenced over various cycles. The following chart (Figure 7) shows the four largest state banks offer average dividend yield of 8%-9% based on current share prices; admirable dividend returns by any standard.
Figure 6: Consistent and sustainable dividend payout ratio at 30%
Figure 7: Attractive dividend yield of 8%
To put things into perspective, investments in China H-shares listed banks since 2010 would have generated a total return of 60% contributed by accumulation of dividend income (Figure 8), in spite of prices remaining flat.
Figure 8: The power of dividend accumulation (2010 = 100)
The recent selloff was primarily due to investors’ concerns about NPLs caused by the mortgage boycotts, but the scenario should reverse once resolutions are reached.
The sector’s price-to-book multiples corrected further to 0.5x (Figure 9) after the recent selloff, although the sector’s fundamentals remain largely intact. While near-term volatility is likely to persist, investors should not be demoralised by the recent chain of events as we expect upcoming policy initiatives.
As such, we advocate our constructive view on China large banks for their attractive dividend yield, balance sheet strength, and the government’s unwavering commitment to maintain the wellbeing of the world’s second largest economy, including the stability of its banking sector.
Figure 9: China banks at steep valuation discount
The information published by DBS Bank Ltd. (company registration no.: 196800306E) (“DBS”) is for information only. It is based on information or opinions obtained from sources believed to be reliable (but which have not been independently verified by DBS, its related companies and affiliates (“DBS Group”)) and to the maximum extent permitted by law, DBS Group does not make any representation or warranty (express or implied) as to its accuracy, completeness, timeliness or correctness for any particular purpose. Opinions and estimates are subject to change without notice. The publication and distribution of the information does not constitute nor does it imply any form of endorsement by DBS Group of any person, entity, services or products described or appearing in the information. Any past performance, projection, forecast or simulation of results is not necessarily indicative of the future or likely performance of any investment or securities. Foreign exchange transactions involve risks. You should note that fluctuations in foreign exchange rates may result in losses. You may wish to seek your own independent financial, tax, or legal advice or make such independent investigations as you consider necessary or appropriate.
The information published is not and does not constitute or form part of any offer, recommendation, invitation or solicitation to subscribe to or to enter into any transaction; nor is it calculated to invite, nor does it permit the making of offers to the public to subscribe to or enter into any transaction in any jurisdiction or country in which such offer, recommendation, invitation or solicitation is not authorised or to any person to whom it is unlawful to make such offer, recommendation, invitation or solicitation or where such offer, recommendation, invitation or solicitation would be contrary to law or regulation or which would subject DBS Group to any registration requirement within such jurisdiction or country, and should not be viewed as such. Without prejudice to the generality of the foregoing, the information, services or products described or appearing in the information are not specifically intended for or specifically targeted at the public in any specific jurisdiction.
The information is the property of DBS and is protected by applicable intellectual property laws. No reproduction, transmission, sale, distribution, publication, broadcast, circulation, modification, dissemination, or commercial exploitation such information in any manner (including electronic, print or other media now known or hereafter developed) is permitted.
DBS Group and its respective directors, officers and/or employees may have positions or other interests in, and may effect transactions in securities mentioned and may also perform or seek to perform broking, investment banking and other banking or financial services to any persons or entities mentioned.
To the maximum extent permitted by law, DBS Group accepts no liability for any losses or damages (including direct, special, indirect, consequential, incidental or loss of profits) of any kind arising from or in connection with any reliance and/or use of the information (including any error, omission or misstatement, negligent or otherwise) or further communication, even if DBS Group has been advised of the possibility thereof.
The information is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. The information is distributed (a) in Singapore, by DBS Bank Ltd.; (b) in China, by DBS Bank (China) Ltd; (c) in Hong Kong, by DBS Bank (Hong Kong) Limited; (d) in Taiwan, by DBS Bank (Taiwan) Ltd; (e) in Indonesia, by PT DBS Indonesia; and (f) in India, by DBS Bank Ltd, Mumbai Branch.