Seeking Alpha

Chinese Banking Focus For 2018

by: Christopher Balding

Stress management is the focus.

Underlying capital metrics continue to deteriorate.

Will drive asset price changes.

The Chinese banking theme for 2018 is stress management. To the credit of Chinese banking regulators, they do seem to be following through more than in previous attempts to reduce out of control credit growth but it must be emphasized that this only means that they have been exercising moderately and cut down on the cheesecake not cut it out. There is a long way to go to sustain their deleveraging fervor.

The problem that Chinese bank regulators are encountering is simple and was entirely predictable: the financial system had been put under such pressure that making small changes is causing significant pass through disruptions. Consequently, while the CBRC and others are making valiant efforts, their primary focus is stress management to make sure that their attempts to reign in credit growth do not cause significant disruptions.

There are a couple of areas where we see this most acutely. First, interest rates. Much of the financial system leverage had the impact of pushing down Chinese interest rates. As the PBOC and CBRC attempt to pull back on that financial system leverage, that will push up money market and bond yields. Especially with the Fed on track to continue raising, there is high probability Chinese yields will continue to drift upwards in 2018. Especially where they are now at holiday loss from liquidity injections, look for interest rates to move higher.

Second, commodity prices will continue drifting down. A major driver of commodity price inflation we saw in 2016 and 2017 was shadow sector capital inflows. If shadow sector inflows just flatten, expect commodities like coal, steel, iron ore, and aluminium, to name a few, to continue their downward drift. With most inventory levels high, we see very low probability of any sustained upward price movement. This matters as this drove the industrial profit rebound and NPL decline we saw in 2018. With mining and metals prices stagnating, look for profit growth here to decline. Given the Chinese role in global price discovery in this market, we would advise watching this sector closely.

Third, we are watching Chinese banking stocks very closely. We believe that this sector will come under increasing price stress for a number of macro economy and sector reasons. With shadow banking balances flattening, this is pushing large amounts of balances onto the formal banking sector. Given their already strained loan to deposit ratios and other capital metrics, this capital shift will only add to their stress. Add in the large flow of secondary rights offerings from banks raising capital given their elevated stock prices, important for P/B ratios required for secondary offerings, we expect significant increase in capital prices via both dilution and higher yields through products like perpetuals that are a favourite of Chinese banks.

The Chinese banking system drives the economy. The ongoing attempts by Chinese banking regulators to tamp down credit growth will change asset prices and profit opportunities.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.