IT’S going to take more than record-low valuations to convince David Herro that now’s the time to buy shares of Chinese banks.

    The manager of about US$30 billion at Harris Associates LP, who’s been scouring global markets for beaten-down stocks during this year’s selloff, says lenders from Asia’s biggest economy aren’t cheap enough after they sank to all-time lows relative to net assets, earnings and dividends last month.

    While such gauges of value would normally be irresistible to bargain-hunting investors, these aren’t normal times for Chinese banks.

    Bad debts are surging after the economy slowed to its weakest pace in a quarter century last year and analysts say the problem will only get worse after banks ramped up lending to record levels in January.

    As loan losses erode capital buffers, shareholders face the unpleasant prospect of lower dividend payouts, dilution from the issuance of new equity, or a combination of both.

    “We still have concerns about credit quality,” said Herro, one of Morningstar Inc.’s “money managers of the decade” in 2010. His flagship Oakmark International Fund, which had its biggest weighting in financial shares and allocated more than a quarter of its money to Asian stocks at the end of 2015, has been avoiding Chinese banks for at least five years.

    Slumping bank stocks are by no means unique to Asia’s largest economy. The industry is getting pummeled around the world as falling interest rates narrow banks’ profit margins and a slowing global economy hurts revenue. China stands out, though, for the severity of its selloff.

    Shares of the nation’s four big banks — Industrial & Commercial Bank of China Ltd., Bank of China Ltd., China Construction Bank Corp. and Agricultural Bank of China (AgBank) — sank to an average 0.64 times net assets on Hong Kong’s bourse earlier last month, the lowest level since AgBank listed in 2010. That’s a 24 percent discount relative to MSCI Inc.’s global index of financial stocks, versus 10 percent as recently as April. Price-to-earnings ratios in China are 80 percent lower than international peers, while the four big banks have an average dividend yield of 8.4 percent, twice as high as the global index.

    Bears say Chinese banks are cheap for good reasons, chief among them the prospect for a surge in bad debt. Government figures show nonperforming loans jumped to a nine-year high of 1.27 trillion yuan (US$195 billion) in December, or 1.67 percent of the total. New loans swelled to a record 2.51 trillion yuan in January, fueling concern that banks are throwing good money after bad to keep struggling borrowers afloat.

    While opinions differ on the amount of troubled loans, Hayman Capital Management’s Kyle Bass, a hedge fund manager who grabbed headlines this year with his bearish views on China, has warned that the bad-debt ratio may reach 10 percent. Analysts at China International Capital Corp., who have a more sanguine view on the economy, are predicting a level of 8.1 percent.

    “As a medium-to-long-term investor, I wouldn’t want to own the banks,” said John-Paul Smith, the U.K.-based founder of research firm Ecstrat, whose warnings about the dangers of investing in Chinese banks since at least 2011 have foreshadowed a US$104 billion slump in the combined market value of the four big banks. “Dividend yields at this level are clearly not sustainable — the market is rightly discounting a significant level of asset impairment.”

    Even if pessimists are overestimating the potential for loan losses, analysts still see dismal growth prospects for Chinese banks as interest rates fall and Internet-based providers of financial services invade lenders’ turf. (SD-Agencies)