China bank shares slump in Hong Kong after Goldman downgrades

SHANGHAI/HONG KONG  -Chinese banking shares listed in Hong Kong tumbled on Wednesday after Goldman Sachs downgraded top lenders including Agricultural Bank of China (AgBank) in a report that deepened worries over a sector already suffering from a weak economy.

The Hang Seng Mainland Banks Index tumbled 3.6 percent to near four-month lows, in its worst day in eight months.

Goldman said in a report on Wednesday that it had downgraded Agbank from “Neutral” to “Sell”, while cutting Industrial and Commercial Bank of China (ICBC) and Industrial Bank from “Buy” to “Sell”.

Investors are concerned about Chinese banks’ exposure to local government debt, earnings risks stemming from such debt, and diverging fortunes among individual banks, the Wall Street bank said.

The sector is already suffering from record-low margins as the government cuts interest rates to revive a flagging post-COVID recovery.

Agbank shares fell almost 3 percent in Hong Kong, the biggest one-day loss in eight weeks. The Hong Kong-traded shares of ICBC, China’s biggest lender, lost nearly 2 percent .

The banks’ China-listed shares saw smaller losses, with an index tracking the sector down 0.5 percent, in line with the broader market.

However, some investors said the market was over-reacting to Goldman’s outlook.

Chinese banks’ exposure to local government debts “is nothing new. Questions have been around this issue since 2018,” said Mark Dong, general manager of Minority Asset Management in Hong Kong, which holds China banking stocks.

He added that the report appears to be based on a wild guess of banks’ exposure to such debts, and “even if debt problems worsen, banks may not be asked by the government to bear most of the cost.”

Debt woes

Chinese local governments have set up financing vehicles, dubbed LGFVs, to finance infrastructure investment and economic growth. LGFV debts have swelled to over $9 trillion according to International Monetary Fund (IMF) estimates, posing a major systemic risk to the world’s second-biggest economy.

Goldman analysts expect China’s six largest banks to step up and take on more local government debt in a bid to reduce risks faced by smaller lenders, potentially eroding their margins.

Goldman said it expects dividend yields of the Chinese banks it covers would come in at 4-6% this year, two percentage points lower than before the adjustment.

In addition, the bank said that “dividend payout targets could come under increasing pressure, on weaker earnings growth” and high capital adequacy requirements.

The bank also revised down pre-provision operating profit estimates for large Chinese banks by 5-6% this year and next.

However, Jian Shi Cortesi, investment director at GAM Investments, said she sees limited earnings impact from banks’ local government debt exposure.

“I don’t expect that, if the local government debt goes into trouble, it will be the banks that shoulder that cost,” she said, expecting the central government to assume some of the costs.

In addition, she said, Chinese banks have adequate capital and loan loss provisions, so given their current valuations – many large lenders trade at 3-4 times earnings – “we wouldn’t say we avoid Chinese banks because of the local government debt issues.”