The recent surge in bank stocks can be attributed to an increased allocation of funds towards high-dividend banks and key index-weighted stocksAs banks continuously enhance the stability of their dividend returns, the dividend investment rationale for bank stocks is becoming more robustOn one hand, already high cash dividend rates are likely to maintain an upward trend; on the other hand, some banks are planning to implement interim dividends to reward shareholders sooner.

Beginning in 2023, the investment logic surrounding bank dividends has gradually garnered the attention and appreciation of the marketThat very year, state-owned banks, which are traditionally known for their high dividend payouts, experienced a significant valuation recovery, with their stock prices rising markedly above those of the banking sector and the CSI 300 index

In 2024, the high dividend strategy started to ripple out from large state-owned banks to smaller banks, allowing the banking sector to achieve considerable excess returns compared to the CSI 300 index.

Previously, investors tended to overlook bank stocks predominantly due to the availability of investment options with higher returnsMoreover, there was a prevailing belief that the dividend yields from bank stocks were unstable, leading to a preference for high-growth investment targets instead, with state-owned banks receiving relatively little attention despite their substantial dividend payout attributes.

However, with a shift in economic momentum and declining interest rates, the comparative advantages of bank dividend yields have become evidentSome banks have begun marginally increasing their cash dividend rates and are planning to initiate interim dividends, thereby reinforcing the dividend rationale

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As the dynamics of the Chinese economy transition and credit growth slows, the growth potential of bank stocks appears to diminish while their dividend characteristics strengthen, drawing greater focus and appreciation from the market.

Fund holdings are shifting toward high-dividend banks.

Since the end of 2022, various investment channels have funneled funds into the banking sector, sparking both structural and sector-wide ralliesThe concept of "Chinese Special Valuation" gained traction in 2023, and since 2024, an expansion of ETFs has propelled a comprehensive rise in bank stocks.

In the latter half of 2023, significant net purchases of broad-based index ETFs by state-backed funds marked a turn in market dynamics, with passive funds becoming a vital source of new market capital

Bank stocks, which make up over 13% of the CSI 300 index's total weight, have seen a continuous increase in holdings due to this expansion of passive funds.

Active equity fund positioning in bank stocks remains relatively low, with no substantial increases noted since 2024. However, recent trends show that public funds are increasingly favoring high-dividend bank stocks, leading to an uptick in their representation within the market value of heavily-held stocks.

The sustainability of the dividend logic for bank stocks will mainly hinge on future interest rate trendsFrom a medium to long-term perspective, considering the current interest rate reduction cycle, there remains a necessity and scope for further declines in China’s interest ratesAlthough inflationary pressures must be taken into account, real interest rates continue to sit at elevated levels since 2016. Hence, to spur demand, a further reduction in the interest rate is essential.

In an environment characterized by slower asset expansion and capital consumption, banks are positioned to provide investors with higher cash dividend returns

When contrasting China’s national banks’ cash dividend rates with those of international banks, it is apparent that there exists ample room for enhancement.

The stock prices of banks are influenced by the market’s evaluation of risks in key sectors.

Assuming a reasonable price-to-book (PB) valuation for bank stocks, the determination of stock prices is intrinsically linked to the market's assessment of net asset value per share, which serves as the fundamental reason behind fluctuations in bank valuationsThis assessment is contingent upon the evaluation of risks within major banking sectors, including corporate lending (real estate, city investment) and retail lending (mortgages and non-real estate). Improvements in the market’s perception of certain assets will subsequently restore confidence in net asset value, driving stock prices upward.

Structurally speaking, in recent years, the banking industry has actively optimized its loan structures, with the proportion of housing loans in total bank loans witnessing a persistent decline

The rate of non-performing loans (NPLs) from corporate real estate loans has significantly tapered since 2023, suggesting a potential reduction in the generation of NPLsFor instance, China Merchants Bank reported a 36.6% year-on-year decrease in the generation of NPLs from its real estate loans in 2023, and the bank anticipates a continued decline in NPL generation within the real estate sector through 2024.

Since 2022, while the rate of non-performing personal mortgage loans has seen some increase, it remains at relatively low levels, indicating manageable risksAs of the end of 2023, the rate of non-performing mortgage loans among listed banks stood at 0.47%, significantly lower than the overall non-performing loan rate.

Regulatory bodies have emphasized the need for ongoing prevention and resolution of risks in key sectors, with real estate risk ranked as the most significant

The government has introduced various measures to stabilize the real estate market, including support for government acquisitions, credit easing policies, revitalizing idle land, coordinating financing mechanisms, and ensuring the completion of buildingsThe regulatory stance on stabilizing the real estate market and mitigating risks has firmed up, alleviating fears of a 'hard landing' in the sector.

Furthermore, with the ongoing progress in local government debt, the market has significantly improved its evaluation of risks associated with urban investment assets held by banksIn response, regulators have continuously rolled out policies for financial support aimed at addressing local debt risks.

While the risk assessments of real estate and urban investment sectors have seen notable improvements, risks in the retail non-real estate segment have slightly deteriorated

Earlier market concerns regarding the quality of bank assets were primarily centered on real estate and urban investment sectors; however, the introduction of consistent policies has greatly improved these risk evaluations, contributing to the anticipated evolution of the bank sector in 2024. Conversely, persistent non-performing loans generation in the retail non-real estate segment requires close scrutiny regarding upcoming developments and shifts in market risk perceptions.

Influenced by the speed of economic recovery post-pandemic, the growth of residents' employment and income, as well as the withdrawal of policies allowing deferred repayments, there has been an uptick in the generation rates and overall non-performing rates within the retail non-real estate domainSpecifically, in 2023, the non-performing rates for credit cards and personal operational loans among listed banks have significantly increased, while the rates for consumer loans have declined

This may be attributable to various banks accelerating the issuance of consumer loans while reallocating their resources towards these loans, thereby exerting pressure on the actual non-performing loan generation rates and causing marginal deterioration in the risk assessments of retail non-real estate loans.

Despite the increasing risk exposures associated with retail non-real estate loans, the contribution of these assets to the overall non-performing loan scale of most banks remains relatively minorTherefore, even if there is a rapid generation of non-performing loans in these sectors in the short term, the overall impact on the asset quality of banks is less significant compared to substantial corporate non-performing loans, rendering the associated risks manageable.

The comparative advantages of bank dividend yields are becoming increasingly evident.

From the perspective of bank fundamentals, asset yields face continued downward pressures

The re-pricing impact of two LPR reductions in 2023 and inadequate credit demand have resulted in a decline of 18 basis points (bps) in the yields of interest-bearing assets for listed banks in the first quarter of 2024 compared to the start of the yearIn terms of asset categories, state-owned banks, joint-stock banks, city commercial banks, and rural commercial banks experienced declines of 17 bps, 20 bps, 16 bps, and 27 bps, respectively, indicating that future yields on interest-bearing assets may continue to face downward pressures.

Regarding new loans, the reductions in the LPR in February and July 2024 will exert an average drag of 3.3 bps on net interest margins (NIM) for listed banksFor different bank categories, the impacts on NIM for state-owned banks, joint-stock banks, city commercial banks, and rural commercial banks are projected to be 4.1 bps, 3.1 bps, 3 bps, and 2.9 bps, respectively

Additionally, insufficient effective credit demand suggests that there may be further LPR reductions ahead.

In terms of existing loans, the re-pricing due to the LPR rate cuts may cause fluctuations in the NIM in the first quarter of 2025. Additionally, there is potential for the rates of existing mortgage loans to declineIf the rates of existing mortgage loans were to be adjusted to match those of newly issued loans, then it is estimated that this could impact the NIM of listed banks by around 5 bpsLastly, some local city investments are still in the process of resolving their debts, wherein previous high pricing levels may continue to see reductions.

From a comprehensive view of both sides of the asset and liability equations, despite the downward pressures on asset yields, an acceleration of improvements in the cost rates of liabilities may provide effective support, thus mitigating the decline of NIM

It is anticipated that after 2024, there will be a stabilization in the NIM trends on a quarter-by-quarter basis, with year-on-year declines progressively narrowing.

Revenue streams are showing improvement, with the year-on-year declines in NIM expected to narrow, leading to a rebound in the growth rates of net interest incomeThe narrowing year-on-year decline in NIM, along with the anticipated slowdown in the growth rate of interest-bearing assets, suggests that the growth rates of net interest income may recover on a quarterly basis throughout the second half of the yearSince the fourth quarter of 2023, the bond market has performed favorably, allowing banks to realize high returns on bond investmentsGiven the central bank’s guidance to stabilize long-term bond rates, it is forecasted that the decline in these rates will slow down, and coupled with the high base effects observed in the fourth quarter of 2023, the growth rates of other non-interest income may gradually decline.

In conclusion, while the contribution of other non-interest income may weaken, the expected recovery in net interest income growth rates alongside a narrowing of year-on-year declines in NIM indicates an interchange between net interest income and other non-interest income, suggesting that banks may see a rebound in their year-on-year revenue growth rates during the latter half of the year.

As China's economic momentum shifts and interest rates decline, the comparative advantages of dividend yields among bank stocks become more pronounced

In the medium to long term, there remains both necessity and space for further declines in China’s interest rates, suggesting that high dividend bank stocks could possess sustained investment and allocation value over an extended period.

With the sustained improvement in the stability of bank dividend returns, the investment rationale for bank stocks revolving around dividends continues to strengthen: on one hand, cash dividend rates, which are already relatively high, may continue to rise; on the other hand, several banks plan to implement interim dividends to reward shareholders sooner.

This cycle of bank stock rallies is fundamentally driven by an increased demand for the allocation of funds towards high-dividend banks and key index-weighted stocks