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.

Bank of Communications', or BoCom’s, first-quarter results were largely in line. The results highlight a stronger-than-expected net interest income growth at 2% year on year, versus the 3% decline in 2023, underpinned by a smaller-than-expected contraction in net interest margin, or NIM, despite slowing loan growth. First-quarter NIM contracted 6 basis points year on year to 1.27%, versus the 20-basis-point decline in 2023, and rebounded 5 basis points from the fourth quarter. Despite such a positive surprise, we do not expect the declining NIM trend to reverse in 2024. BoCom’s NIM contraction is likely smaller than SOE peers, due to 1) its relatively high reliance on interbank funding benefited from lower interbank rates, 2) efforts to reduce high-cost corporate agreement deposits, and 3) double-digit growth in high-yield retail consumption and small business loans. Despite easing funding cost pressure, the average loan rate of strategic customers declined 3 basis points sequentially. As competition for quality borrowers and term deposit migration continues, we expect NIM to trend down in coming quarters and retain our projection for 2024 NIM at 1.16%.

We maintain fair value estimates on the H-shares of Industrial and Commercial Bank of China, or ICBC, at HKD 5, China Construction Bank, or CCB, at HKD 6.2, Agricultural Bank of China, or ABC, at HKD 3.5 per, Bank of China, or BOC, at HKD 3.5, and Bank of Communications, or BoCom, at HKD 6 as results were largely in line and we leave our key assumptions unchanged. H-share prices are undemanding for all SOE banks, but our preferred picks are CCB, ICBC, and CMB on their strong capital position, above-peer return on risk weighted assets, and steady dividends.

The China banks’ cumulative, nine-month net profit growth was largely in line with our expectations, with decent loan growth partly offsetting declining net interest margin and soft fee income. Industrial and Commercial Bank, Bank of Communications, China Merchants Bank, and Postal Savings Bank, saw 0.8%, 1.9%, 6.5%, and 2.4% growth in net profit, respectively, year on year. Agricultural Bank of China reported higher profit growth at 5%, but the improvement was mainly driven by a lower tax rate on higher investment in government bonds. Among the China banks that reported results, Agricultural Bank and China Construction Bank reported steadier net profit growth at 3.1% and 5%, versus 3.4% and 3.5% in the first half, thanks to their resilient loan and fee income growth.

Striving to become China's leading wealth-management bank, Bocom is building its international presence and developing a wide range of financial service businesses. The bank achieved solid progress in the transformation, as evidenced by its rising retail customer base, customer assets under management, and a booming credit card business. Its deposit base remained weaker than those moaty peers, resulting in higher funding costs for the bank. We expect Bocom still has a long way toward its goal of being a leading wealth management bank.

Our valuations for Agricultural Bank of China, Bank of China, Industrial and Commercial Bank of China, and Postal Savings Bank of China are unchanged following interim results that are largely in line with our expectations. We expect Postal Savings Bank and Bank of Communications to deliver 2023 stronger-than-peer earnings growth. All state-owned-enterprise banks, including China Construction Bank, which reported results earlier, are undervalued, trading at a historic trough of 0.3-0.4 times 2023 price/book ratio and about a 9% dividend yield, except for Postal Savings of about 7%. Postal Savings shows better growth momentum, but Agricultural Bank and China Construction are our top picks given above-peer provision coverage, stable credit quality, lower exposure to retail banking—which faces near-term challenges—and high return on equity. These factors should mean resilient growth in net profit and book value. We are confident these well-capitalized banks can deliver stable dividend income during an economic downturn.

First-half 2023 revenue and net profit growth of 4.8% and 4.5%, respectively, at the Bank of Communications, or BoCom, were largely in line with our expectation. Net interest margin, or NIM, is declining—as are peers—but at a much lesser 2 basis points in the second quarter from the first quarter as the bank was able to allocate more funds to higher-yield foreign currency bonds. While we expect pressures to remain, we believe BoCom's ongoing asset and liability mix optimization and the June deposit rate cut will help deliver relatively steady NIM.

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.

Bank of Communication’s first-quarter results are largely within our expectations. First-quarter revenue and net income grew 5.5% and 5.6%, respectively, year on year, with Bocom benefiting from net gains arising from trading activities. As with its state-owned peers, the bank’s net interest income contracted 4% year on year. However, Bocom’s 8% contraction in fee income was larger than that of most state-owned peers. Bocom’s wealth management-related fee income was negatively affected by capital market volatility in the first quarter as well as a high base in the same period last year. Positively, management noted meaningful recovery in the demand for wealth management products and credit card consumption starting in March. We expect Bocom’s fee income growth to recover starting from the second quarter, as the base effects will become favorable in coming quarters, along with the recovery in consumer confidence. Thus, we continue to forecast midsingle digits in full-year fee income growth.

Bank of Communications', or Bocom’s, full-year 2022 total revenue slowed to 1.3% year on year from 5% in the first three quarters, as fourth-quarter fee income fell 6.2% from 2021 levels. Despite the slowing revenue growth, net profit growth remained relatively steady at 5.2%, partly on provision release, which we had expected.

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.

The largest five SOE banks: Industrial and Commercial Bank of China, or ICBC; China Construction Bank, or CCB; Agricultural Bank of China, or ABC; Bank of China, or BOC; and Bank of Communications, or Bocom; released third-quarter results end of October. The mixed results reflected mounting challenges to top line growth given the dim consumer outlook, heightened capital market volatilities, and exchange losses related to banks’ overseas assets. We expect headwinds to continue in the first half of 2023.

Striving to become China's leading wealth-management bank, Bocom is building its international presence and developing a wide range of financial service businesses. The bank achieved solid progress in the transformation, as evidenced by its rising retail customer base, customer assets under management, and a booming credit card business. Its deposit base remained weaker than those moaty peers, resulting in higher funding costs for the bank. We expect Bocom still has a long way toward its goal of being a leading wealth management bank.

In line with peers, Bank of Communications', or Bocom's, first-half 2022 result continued to show profitability growth, but weaker economic conditions led to net profit growth decelerating in the second quarter. First-half total revenue was up 7.1% against the same period last year while higher credit cost and operating expense led to net profit increasing at a slower pace of 2.9% to CNY 44.1 billion, missing our expectation for a mid-single-digit increase. The slowing revenue growth was attributable to a larger-than-expected year-on-year contraction in second-quarter fee income of 11% on a 18% decline in bank wealth management income, versus a 9% increase in first-quarter total fee income. We have reduced our 2022 fee income growth forecast by 2 percentage points, but the change is not enough to move our valuation.

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.

We retained our A-share fair value estimate at CNY 5.50 per share and H-share fair value estimate at HKD 6 per share after no-moat Bank of Communications, or BoCom's 2021 results. The results highlighted a rebound in net interest margin, or NIM, strong fee income growth, and improved credit quality. Total revenue growth was in line, which accelerated by 1.6 percentage points to 9.4% from 7.8% for the first three quarters. Growth in pre-provisioning operating profits, or PPOP, slowed to 9.2% from 11.4% in the first three quarters on increased operating expenses and the expiration of tax relief for employee social insurance expense in 2021. However, the 11.9% year-on-year net profit growth slightly exceeded our expectation for a high-single-digit growth, due to higher-than-expected reduction in credit costs.

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.