Company Reports

We retain fair value estimates for Bank of Communications, or BoCom, at HKD 6.0, China Merchants Bank, or CMB, at HKD 48, China Citic Bank, or Citic, at HKD 5.7, and China Minsheng Bank, or CMBC, at HKD 3.6 per H share. For Bank of Ningbo, or BONB, the FVE is CNY 27 per A share. The banks' interim results aligned with our expectations for net profit growth ranging from flat to low single digits in 2024. H shares of these banks appear undervalued, trading between 0.2 times-0.7 times 2024 book value, with attractive dividend yields of 6.5%-8.5%, except for BONB, with 3% dividend yield in A stock market. Despite weak net interest margin, or NIM, for CMB, we favor it due to its superior return on equity, steady dividends, and upside potential if consumer sentiment in China recovers.

Driven by improved investor sentiment for China banks with stable dividend payments and a historic property rescue package introduced in May, the Hang Seng Mainland Banks Index rallied over 20% in the second quarter. But it pulled back sharply on profit-taking and investors’ concerns that the easing measures were not sufficient to turn around struggling property sales. H-shares of most China banks remain undervalued, with 2024 price/book modestly increasing to 0.2-0.5 times. Dividend yields remain attractive at 6%-8%. With A-share counterparts trading at a 35% premium to H-shares on average, we expect the regulators’ push for higher and more regular dividend payouts, as well as the expansion of eligible exchange-traded funds on Stock Connect, should gradually narrow the valuation gap for Chinese dual-listed banks. Amid sluggish economic growth in China with no major recovery in property sales and consumer spending anticipated in 2024, we prefer defensive state-owned banks, including China Construction Bank, or CCB, and Industrial and Commercial Bank of China, or ICBC, and leading retail-focused bank China Merchants Bank for stable dividends, strong capital returns, and better earnings visibility.

China Merchants Bank, or CMB, and China Minsheng Bank, or CMBC, reported a deeper year-on-year decline in first-quarter revenue of 5% and 7% versus the 2% and 1% decline in 2023. China Citic Bank’s results were stronger than expected, with revenue increasing 5% year on year, driven by stronger-than-expected growth in fee and investment income, which benefited from falling interest rates. The net profit trend weakened further, with net profit contracting 2% and 6% for CMB and CMBC, respectively, and increasing 0.4% for Citic, year on year.

China Citic Bank’s 2023 results were in line, with year-on-year net profit growth softening to 8% from 9% in the first half. We retain our fair value estimate of CNY 5.20 per A share/HKD 5.70 per H share. Citic outperformed joint-stock bank peers in net interest margin performance and earnings growth in 2023 owing to strong retail lending growth and stable credit quality after a four-year derisking campaign to clean up risky assets in its corporate banking segment. Unlike retail-heavy Ping An Bank, which proactively scaled down its high-yield but risky consumption and personal business loan books in 2023, Citic reported double-digit growth in these two loan categories. Though we expect the derisked corporate loan book will continue to support Citic’s asset quality in 2024, we are concerned that such strong retail loan growth may pressures its retail loan quality should the credit cycle further deteriorate in 2024.

We retain our fair value estimates for China Construction Bank, or CCB, at HKD 6.20 per H-share (CNY 6.00 per A-share) and China Citic Bank, or Citic, at HKD 5.70 per H-share (CNY 5.20 per A-share) as both results were largely in line.

Corporate banking is China Citic Bank's flagship business, which boasts a solid customer base of large-scale state-owned enterprises. This is thanks to its strong connection with its parent China Citic Group, one of the largest SOE conglomerates, with businesses covering financial, real estate, infrastructure, energy, resources, manufacturing, and construction. Serving nearly 700,000 corporate customers, the bank specializes in trade finance, cash management, and custodian services.

China Citic Bank's, or Citic's, first-half results were largely in line, with quarter-on-quarter improvement in both revenue and net profit growth. We retain our fair value estimate of CNY 5.20 per A share (HKD 5.70 per H share). H shares are undervalued, trading at a historical trough of below 0.3 times 2023 price/book. We expect the bank's stable credit quality and limited exposure to property sector should help ease market concerns. Management's asset-derisking efforts over the past four years have showed positive progress and we expect this trend will continue to support Citic's asset quality in 2023, despite rising risk from real estate sector loans. The results also highlight the fact that the bank is gaining increasing synergies from its parent group in customer engagement, wealth management, and comprehensive financing businesses, as evidenced in its faster-than-peer retail credit expansion and recovery in fee income growth in the second quarter.

Large Chinese banks will release 2023 interim results in late August. We expect that stabilized loan yields after the first-quarter loan repricing, mild consumption recovery, a favorable base effect, and a generally benign credit quality outlook supported by government policies will translate to improved second-quarter growth in both revenue and net profits compared with the first quarter. We expect second-quarter net profit growth to increase by 2 or 5 percentage points to 4% to 9% for six state-owned enterprises from the first quarter’s level, primarily driven by higher revenue growth and lower credit costs.

The Hang Seng Mainland Banks Index has declined 11% from its recent peak in early May. We attribute the decline to increasing concerns about downward pressure on banks’ net interest margins, or NIMs, and growing risks related to debts of local government financing vehicles, or LGFVs, amid a weak economic recovery and struggling land sales. We believe SOE banks have smaller exposures to LGFV debt and that their credit quality is better than peers given strong bargaining power to implement prudent borrower selection. Monetary and fiscal easing and the government’s strong support for troubled regional banks also limit systemic risks, in our view. That said, we believe the ongoing LGFV loan restructuring is likely to weigh on banks’ NIMs and the classification of restructured loans as special-mentioned loans will also increase provision expenses for banks. We maintain our fair value estimates for Chinese banks as we already factored in a NIM reduction of 10-25 basis points this year and expect credit costs to trend in line with our existing forecasts.

China Citic Bank’s first-quarter revenue contracted at a larger-than-peer pace of 5% year on year, dragged by the 0.9% and 11.5% declines in net interest income and fee income, respectively. The contraction in net interest income was largely in line, as the 8% year-on-year loan growth was offset by a 15 basis point decline in net interest margin.

The large Chinese banks will release 2022 results in late March and first-quarter 2023 results in late April. Pressures on net interest margin are likely to rise in the first quarter. However, the accelerating recovery in China’s economy since reopening reaffirms our expectation for asset risks to be contained. This allows banks some flexibility in their already-high provision levels, which should enable them to smooth net profit growth despite significant revenue pressures. But we do see a wider divergence in profitability in 2023 as slowing revenue growth results in less leeway to manage earnings growth. Those banks that can benefit from a rebound in retail lending and wealth-management services, which we expect in mid-2023, should present buying opportunities along with stronger earnings performance.

China Citic Bank's 2022 results were slightly better than our expectations. Total revenue and net profits in 2022 grew 3.3% and 11.6% respectively from 2021. Growth in fourth-quarter revenue and preprovision operating profits were resilient at 3.3% and 1.5% respectively, flat from the level in the first three quarters and despite mounting industrywide challenges in the fourth quarter. We believe stronger-than-expected earnings growth was underpinned by two positive trends, including a quarter-on-quarter increase in net interest margin and improved credit quality outlooks as management noted the speed of bad debt formation has peaked thanks to its efforts of cleaning up the loan book during 2019 to 2022, and China’s policy easing. The bank’s NPL ratio and NPL formation rate both declined to a new low of 1.27% and 1.22% respectively since 2014. The NPL balance contracted 3.3% from 2021. In contrast to flat or declining provision coverage ratios of its peers in a challenging 2022, Citic reported a 20-percentage-point increase to 201% from 2021. The corporate NPL ratio improved 33 basis points to 1.72%, with NPL ratios of property and construction loans declining 55 and 107 basis points respectively from 2021.

No-moat China Citic Bank, or Citic's third-quarter results reflected significant industrywide headwinds, including sluggish retail credit demand, falling asset yield and rising capital market volatility. However, the bank's financial data showed marginal improvement during the quarter. Growth in the first-three-quarters total revenue, pre-provisioning operating profits, and net profits further improved to 3.4%, 1.5% and 12.8% against the year-ago period, up 0.7, 0.4 and 0.8 percentage points from the first half. The improvement was attributable to accelerating loan growth, mild recovery in fee income, and lower provisioning against the year-ago period. Leveraging its solid customer base of large state-owned enterprises, CITIC's loan book increased 7.3% year on year. The stronger asset growth and mild recovery in fee income translated to better earning resiliency for the bank compared with the previous quarter. However, first-nine-month net interest margin, or NIM narrowed 3 basis points from the first half level on higher credit allocation to corporate loans.

Corporate banking is China Citic Bank's flagship business, which boasts a solid customer base of large-scale state-owned enterprises. This is thanks to its strong connection with its parent China Citic Group, one of the largest SOE conglomerates, with businesses covering financial, real estate, infrastructure, energy, resources, manufacturing, and construction. Serving nearly 700,000 corporate customers, the bank specializes in trade finance, cash management, and custodian services.

No-moat China Citic Bank's second-quarter results reflected significant industrywide headwinds, including weakening credit demands, falling asset yields, and intense deposit competition. Six-month total revenue growth slowed to 2.7% from 4.1% year on year in the first quarter, dragged by an 8.9% contraction in the second-quarter fee income versus a 4% growth in the first quarter. Despite the weaker-than-expected top-line growth, six-month net profit growth at 12% year on year beat our expectation at a high-single-digit growth. This was attributable to lower credit costs as credit quality saw marginal improvement. We thus lower our 2022 credit costs assumption by 8 basis points, which was offset by lower fee income growth forecast by 6 percentage points, leaving our fair value estimate of CNY 5.20 per A-share and HKD 5.70 H-share unchanged.

Corporate banking is China Citic Bank's flagship business, which boasts a solid customer base of large-scale state-owned enterprises. This is thanks to its strong connection with its parent China Citic Group, one of the largest SOE conglomerates, with businesses covering financial, real estate, infrastructure, energy, resources, manufacturing, and construction. Serving nearly 700,000 corporate customers, the bank specializes in trade finance, cash management, and custodian services.

We maintain our fair value estimates for the majority of our Chinese bank coverage after the media reported an increasing number of homebuyers across China are refusing to repay mortgage loans for delayed projects. While we expect the imminent impact on banks' credit quality is small, the news reflects challenging liquidity conditions for private developers and weak consumer confidence. We believe this may lead to a weak recovery of the wealth management business—especially for private bank business—as investors are likely to have little mood for financial products linked to the property sector. Hence, we modestly lower fair value estimates for the two retail-oriented banks China Merchants Bank, or CMB, to HKD 68 from HKD 70 per share; and Ping An Bank, or PAB, to CNY 24 from CNY 26 per share, to factor in lower wealth-management-related income growth in 2022.

Eight Chinese banks in our coverage universe: state-owned Industrial and Commercial Bank of China (ICBC), China Construction Bank (CCB), Agricultural Bank of China (ABC), Bank of China (BOC), Bank of Communications, Postal Savings Bank of China (PBOC), and joint stock banks China Citic Bank (CITIC) and China Minsheng Bank (CMBC) released first-quarter results at end-April. The largest five state-owned, or SOE, banks reported first-quarter net profit growth at around 6% to 7% year on year. PSBC topped the list, delivering strong and resilient growth at 18%. While CITIC posted 11% earnings growth, CMBC's net profit declined 7% year on year. We retained our fair value estimate of these banks as results were largely in line. Shares of these banks are trading at historical low valuation levels.

No-moat China Citic Bank's, or Citic’s, 2021 results showed a 5% increase in total revenue and 13.6% growth in net profit from 2020. We attribute the stronger-than-expected growth to fast-growing non-interest income and reduction in credit costs. We believe the bank has achieved some positive outcomes from its three-year business reform since new management came on board in 2019. These included a strengthening wealth management business, enhanced corporate customer mix, and credit quality. We expect Citic’s “New Retail Banking” strategy to help enhance its deposit base in the long run, but we anticipate the slowing economy and easing policies to continue posing greater-than-peer pressures on its NIM in coming quarters.

Following The People's Bank of China's 10-basis-point cut to the borrowing rates of one-year medium-term lending facility, or MLF, and the seven-day reverse repurchase agreements on Jan. 17, we revisited potential impacts on Chinese banks. We previously expected two to three rounds of 5-basis-point cuts to the Loan Prime Rate, or LPR, in the first half--the 10-basis-point MLF rate cut is expected to translate to a 10-basis point cut to one-year LPR and a 5-basis-point cut to five-year LPR on Jan. 20. This indicated downward pressures on NIM are more front-loaded than we previously expected. In reference to the previous rate cut cycle, our models now factor in a total of 25- and 10-basis-point cuts to one-year and five-year LPRs, respectively, in 2022. We also see policy tools to ease the pressure, including a reserve requirement rate cut, RRR, a change in the deposit rate-setting method, and lower interbank rates as results of the key policy rate cut.