Reforms in China banks poised to be next catalysts

Reform plans could improve NPL visibility.

Reform plans for China banks that have been recently announced, if successfully implemented, are seen to be the keys to improving the visibility of Chinese banks' NPLs in the medium to long term (MLT).

According to a research note from Barclays, these could, in turn, help Chinese bank shares to break out of their range-trading pattern, in its view.

BOCOM announced on 28 July 2014 that the bank is proactively studying a mixed-ownership reform plan.

The State-owned Assets Supervision and Administration Commission (SASAC) also unveiled a reform plan for six large state-owned enterprises (SOEs) on 15 July 2014.

In addition, the Political Bureau of the CPC Central Committee has also approved a plan for comprehensive fiscal reform recently.

Here's more from Barclays:

Recently approved fiscal reform could add visibility to banks’ LGFV and property

NPL outlook: We believe the new fiscal reform could:

1) increase transparency of local governments’ balance sheets;

2) broaden financing access through bond financing; and

3) diversify revenue streams and improve financial sustainability through new taxes and reducing reliance on land sales.

If successfully implemented, concerns over LGFV debts and property NPLs would be partly mitigated, in our view.

SOE reform could be positive but execution will be complicated and results remain to be seen: The key approaches to improve SOE efficiency in the newly announced SOE reforms include:

1) diversifying equity ownership through partial privatization and holdings by new government investment companies; 2) giving SOE management and employees stock incentives and promoting modern corporate governance methods; and 3) macro-wise, cutting the government’s degree of intervention in the economy.

These reforms have the possibility of helping China’s economic rebalancing, thereby improving the banks’ asset quality.

However, greater efficiency at SOEs remains to be seen, in our view, as we see many hurdles at the execution level.

China banks near-term and long-term investment strategies: For the past few months, we have had a positive call on China banks. We believe

1) more long-term reform announcements, 2) A-H share through-train to be launched in October, 3) further macro loosening and economic growth recovery, and 4) good 1H14 results could support bank share performances in the next 2-3 months.

For the longer term, we now turn marginally more positive on China banks given the reform outlook.

We believe that significant NPL increases and ROE deterioration are priced into the China banks’ current valuations and that any improvement in visibility as a result of the above-mentioned reforms could lead to a potential sector re-rating.

Among the large H-share China banks, we believe BOC (rated OW, our top pick) could be a beneficiary from such structural reforms, mainly due to its high exposure to SOE lendings and the aggressive loan extension to LGFVs during the 2009 stimulus measures.

In addition, among the mid-size H-share banks, BOCOM (EW) and CITIC Bank (EW) could be beneficiaries of management stock incentive plans.