Company Reports

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.

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.

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.

Industrial and Commercial Bank of China, or ICBC, is China's largest bank. We think its leading scale efficiency and funding advantages endow it with a narrow economic moat.

Industrial and Commercial Bank of China’s first-quarter performance was largely within expectation. Total revenue declined 1% year on year, driven by the 5% and 3% respective contractions in net interest income and fee income, while net profit was flat year on year. We leave our main assumptions and our fair value estimates of CNY 4.60 for the A-shares and HKD 5.00 for the H-shares unchanged. As with its peers, ICBC is trading at a historically low 0.4 times 2023 price/book value. However, while we think ICBC will continue to benefit from its strong deposit franchise and operating efficiency, we currently have a preference for Agricultural Bank of China and China Construction Bank, if among the state-owned banks; and for China Merchants Bank and Ping An Bank, as we anticipate fee income growth to strengthen in second-half 2023.

Industrial and Commercial Bank of China's, or ICBC’s, net profit growth for full-year 2022 came in at 3.5%, decelerating from the 5.6% growth in the first nine months and weaker than we expected. Revenue growth for full-year 2022 was weaker than peers and contracted 2.6% from the 2021 level. We believe the 19-basis-point year-on-year contraction in net interest margin, or NIM, was the major factor contributing to its weaker-than-peer top-line growth. H-shares fell 2.11% on March 31 as investors are disappointed about its larger-than-peer NIM contraction. But we believe such risks are more than priced in as we believe the NIM contraction was mainly driven by a deposit-concentrated funding and unfavorable deposit mix change. We expect a potential deposit rate cut and the improving business sentiment to gradually reverse the migration to term deposits in 2023, and this should ease ICBC’s funding costs more so than peers. As such, we leave our main assumptions unchanged and retain our fair value estimates of CNY 4.60 for the A shares and HKD 5 for the H shares. The stock is undervalued, trading at a historically low 0.4 times 2023 price/book value.

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.

Shares of Asian banks in our coverage declined again Thursday morning after Credit Suisse’s 24% drop overnight to below CHF 1.70 per share reignited concerns about global financial stability that emerged last week with the failure of Silicon Valley Bank. In terms of systemic risk, we see very low risk of bank runs occurring anywhere in Asia given policy support from each government and the absence of problematic large institutions like Credit Suisse which could become vectors of contagion. Japanese banks are the most susceptible in Asia, in our view, to worries over financial stability in the United States or Europe due to their greater linkages with these regions. Next in terms of vulnerability, in our view, is the Korean banking system, which depends on having access to U.S. dollar liquidity. However, we think the U.S. Federal Reserve, or the Fed, can be relied upon to set up a currency swap arrangement with the Bank of Korea again if needed to ensure stability. The Fed has a continuous unlimited swap agreement with the Bank of Japan.

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.

Industrial and Commercial Bank of China, or ICBC, is China's largest bank. We think its leading scale efficiency and funding advantages endow it with a narrow economic moat.

Industrial and Commercial Bank of China, or ICBC, is China's largest bank. We think its leading scale efficiency and funding advantages endow it with a narrow economic moat.

Industrial and Commercial Bank of China reported 4.2% and 4.9% year-on-year growth in first-half total revenue and net profits respectively, slowing from the 6.5% and 5.7% growth in the first quarter. The results were largely in line to meet our full-year net profit growth forecast of 4.9% and we retain our fair value estimates of CNY 5 for the A shares and HKD 6 for the H shares. Positively, 4.2% revenue growth was flat from the first half of 2021 despite the economic challenges in 2022. This was attributable to accelerating loan growth and higher investment income during 2022, which helped largely offset the negative impact of falling net interest margin and subdued fee income growth. We expect ICBC’s second-half loan growth to remain strong as management noted the loan project reserve increased by 27% year on year to CNY 1.4 trillion.

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.

Industrial and Commercial Bank of China, or ICBC, is China's largest bank. We think its leading scale efficiency and funding advantages endow it with a narrow economic moat.

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.

Industrial and Commercial Bank of China, or ICBC, is China's largest bank. We think its leading scale efficiency and funding advantages endow it with a narrow economic moat.

In its fourth quarter, narrow-moat Industrial and Commercial Bank of China reported 6.8% and 10.3% year-on-year growth in revenue and net profits, respectively, largely flat with the 7% and 10.1% growth for the first three quarters. The 10.3% growth in net profits slightly exceeded our expectation for high-single-digit growth on lower-than-expected fourth-quarter credit costs. The results highlighted a stabilizing net interest margin and credit quality improvement. We believe the results are a testimony to ICBC's strong deposit base and ability to optimize its liability structure, which enabled the bank to achieve a 3-basis-point decline in average funding costs compared with the average 4-basis-point increase for China Construction Bank and Agricultural Bank of China. We retain our fair value estimates of CNY 5 for the A shares and HKD 6 for the H shares as a modestly lower credit cost assumption is offset by lower projected NIM in 2022, given the government’s more accommodative policy stance to buffer against the economic shocks from repeated COVID-19 outbreaks and increasing geopolitical risks.

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.