Similar growth rate, but different ROE and credit risks
Chinese lenders’ lower valuations mean they are seen as playing catch-up: ICBC, CCB, AgBank and BOC share prices rose 4.8-6.6% in March. Although their price-to-book value (P/E) ratio is low at 0.4x compared to 1.4x for Saudi peers as both have similar growth trajectories, it is still uninspiring. The expected return on equity (ROE) for Chinese banks is around 10% in 2024-25 (versus 13.5% for Saudi peers), with a high implied cost of equity of 25-26% in 2024-25 (more than double that 10%). (for Saudi competitors), reflecting ongoing systemic risks and sluggish revenue outlook.
Valuations of UAE peers also point to the cyclical economy and the risks of a slowing real estate market, with the implied cost of equity at 13%, the highest among Gulf lenders, and the P/E ratio 1.1 times lower than the regional competitors, despite the stock price rally since the pandemic.
Asset quality is stable at Saudi banks, unlike Chinese competitors
Chinese banks’ loan exposure to real estate developers represents 5-6% of their total loan book, according to our analysis, yet the share of Tier 1 “good loans” from the four major lenders remained surprisingly high at 96.5% of total loans in 2023, exceeding the 2023 level Saudi competitors. This suggests that Chinese banks’ credit downgrades have not yet been fully accounted for. Saudi lenders’ share of Stage 1 loans was 93% of the total in 2023, but that figure already takes into account the legacy burdens of the struggling contract sector. Similarly, UAE banks’ staging profiles take into account the ongoing real estate risk, which has recovered since the pandemic due to higher collateral values.
Chinese banks have set a high reserve of 180 basis points for Level 1 loans (versus 60 basis points for comparable Gulf banks), suggesting the buildup of a buffer to counteract a weakening in asset quality this year.
High margins ensure that Saudi banks’ ROE is higher than that of Chinese lenders
Margin headwinds mean that Saudi banks’ return on equity (ROE) has been lower than that of the UAE and its Gulf peers, but has still exceeded that of Chinese banks since the first quarter of 2022. Funding cost challenges aside, Saudi lenders’ net interest margin of 3% still exceeded the median of Gulf peers and significantly exceeded Chinese banks’ 1.7% (likely to continue to result in low profitability). The outperformance of UAE banks reflects ample liquidity, allowing them to benefit from the tightening interest rate cycle, while asset growth is more moderate compared to Saudi and Chinese banks.
Gradual interest rate cuts could improve the Saudi bank’s ROE as financing costs ease. Longer-term higher interest rates could slow further gains. The margin squeeze for the Chinese banks we track in 2024 is likely to continue as PBOC interest rate cuts and loan repricing outweigh lower deposit costs.
The CoR of Chinese banks could curb earnings per share during NPL spikes
Gulf and Saudi Arabia lenders have been in a low provisioning cycle since 2021, with the median cost of risk for Saudi lenders reaching 40 basis points in 2023, the lowest level since 2016 (supported by recoveries, strong economic indicators and a stable asset quality). Nevertheless, this value could normalize 5-10 basis points higher in 2024 to reflect a changing credit mix that is more tilted towards corporates and fewer recoveries.
Most Chinese banks we cover could reverse their borrowing cost declines this year, curbing profit growth, although more non-performing loan (NPL) reserves are likely to be released to take on new problem loans. In our downside case (where real estate NPL ratios triple across the 11 Chinese lenders we cover), non-performing real estate loans rise to 905 billion yuan by the end of 2024, from 267 billion yuan in June.
