Shenwan Hongyuan Group Co., Ltd. released a research report expressing optimism toward the banking sector, emphasizing the significance of stock selection in 2026, with high-quality banks expected to lead the recovery toward 1x price-to-book (PB) ratio. On one hand, the trend of "insurers allocating to bank stocks" is ongoing, and insurer capital is projected to remain a crucial driver for sector valuation recovery in 2026. On the other hand, stock selection should center on two main themes: 1) the asset expansion theme, focusing on high-quality city commercial banks achieving balance sheet growth amid marginal improvements in fundamentals; and 2) the property sector improvement theme, targeting joint-stock banks poised for a turnaround as they benefit from eased pressure due to strengthened real estate policies. Shenwan Hongyuan's key views are as follows:

Since the second half of 2025, bank stocks have underperformed, primarily due to capital flow pressures. Currently, four reasons support the firm's positive outlook on bank valuation recovery: 1) Outflows have subsided: Index fund outflows have concluded. Between January 10 and early February, net outflows from the CSI 300 and SSE 50 totaled nearly RMB 700 billion, with bank stocks seeing approximately RMB 80 billion in outflows, which no longer pose a capital constraint. 2) Holdings are at historic lows: Active fund allocations to banks are at record lows. In Q4 2025, mutual funds' heavy positions in banks accounted for less than 2%, with valuation premiums for several high-performing banks significantly narrowing relative to the sector. 3) High dividends: The sector's dividend yield has rebounded to 4.7%, matching levels seen in Q4 2024 when insurers increased their holdings, indicating sustained interest from long-term capital. 4) Stable performance: Bank revenue and earnings in 2026 are expected to outperform 2025, supported by the central bank's efforts to stabilize net interest margins (NIM) and effective risk mitigation aiding earnings stability.

Against this backdrop, the firm emphatically advocates that "bank alpha will outperform beta in 2026," highlighting the importance of stock selection in a mild inflation environment. Objectively, in the past two years of "index-like performance" for bank stocks, selective stock picking had limited impact. However, with sector valuations rising and premiums for quality stocks shrinking, the value of individual stock selection is now prominent. A notable shift is that as the "15th Five-Year Plan" begins, regional economic growth targets are clear, and a rebound in the Producer Price Index (PPI) may be a key driver for "expectation recovery." Historically, bank sector rallies often lead in narratives of mild inflation recovery. The deflator turned positive in February after 36 months of decline; if price indices trend upward and traditional sectors like real estate recover, investors are likely to seek elasticity and discrepancies between fundamentals and valuation repair, making bottom-up stock selection increasingly critical.

For the full year, the firm is optimistic about two main themes, with two types of banks potentially leading valuation breakthroughs: 1) Asset expansion theme: Credit resources equate to revenue elasticity, exemplified by high-performing city commercial banks. Earlier improvement in net interest income will directly determine revenue recovery elasticity, driven by the logic chain: "effective monetization of expansion resources → steady balance sheet growth, achieving expansion momentum ahead of the sector → better volume offsetting price declines, or even volume growth with stable prices → coupled with significant liability-side cost improvements → net interest income growth driving revenue elasticity." Banks with these characteristics are typically high-quality regional city commercial banks. 2) Property improvement theme: Policy repair expectations equate to turnaround opportunities for joint-stock banks, particularly those solidifying fundamentals earlier. Since the start of the year, continuous real estate policy easing and clear government stabilization goals suggest that if core city housing prices show clear stabilization signals this year, it would directly benefit joint-stock banks constrained by property sector risks. Focus should be on joint-stock banks that have already reduced real estate exposure, resolved legacy issues, and established solid fundamental bases.

Regarding bank fundamentals, the firm anticipates that pressure on stabilizing revenue and earnings in 2026 will be less severe than in the previous year, yet investor expectations still lag: 1) "Interest rate cuts do not equate to further profit declines." Regulatory efforts to protect NIM are a prerequisite for expanding countercyclical monetary policy space. Even if rate cuts occur, deposit rate reductions would likely offset the impact. For banks, a stable interest rate environment provides a window for NIM stabilization (estimated NIM declines to narrow to mid-single digits year-on-year, with sequential stabilization possible and some banks maintaining flat NIM year-on-year). 2) "Risk disposal does not mean the banking system bears the burden alone." The firm believes risk mitigation allows banks to trade time for space, ensuring a smooth transition in asset quality. Shared responsibility among stakeholders may result in lower-than-expected impacts on credit costs and profits. Banks with stronger risk control, earlier proactive reductions in real estate and business loans, and maintained "low non-performing loan formation and high loan loss provision ratios" are better positioned to achieve profit recovery and stable return on equity (ROE).

Risks include: NIM stabilization falling short of expectations; weak real economic demand, with economic recovery slower than anticipated; and unexpected disturbances from certain developer risks or exposures in long-tail customer segments.