Company Reports

As expected, China’s state-owned enterprise banks—Industrial and Commercial Bank of China, China Construction Bank, Agricultural Bank of China, Bank of China, and Postal Savings Bank of China—reported a year-on-year revenue decline of 2% on average in the first quarter, versus 0.6% growth in 2023. Though the contraction in net profit appeared weaker than expected when compared with the 2% growth in 2023, we expect revenue headwinds to gradually abate. Banks are on track to meet our full-year net profit growth forecast of 0.5%. We retain our fair value estimates of HKD 5 per H share for ICBC, HKD 6.20 per H share for CCB, HKD 3.50 per H share for ABC, HKD 3.50 per H share for BOC, and HKD 6.50 per H share for PSBC.

We retain our fair value estimate for Postal Savings Bank of China's, or PSBC, at HKD 6.5 per H share, as we leave assumptions largely unchanged after results which reported year-on-year net profit slowing to 1.2%. PSBC keeps dividend payout unchanged at 30%, resulting in a 1.2% increase in DPS to CNY 2.61 per share. We think the market may be disappointed by its weaker-than-expected growth in net profit and DPS. Net profit growth was dragged by a 12.4% increase in deposit agency fee rate, which resulted in deteriorating cost/income ratio. Average net interest spread of the Big Four banks fell to 1.44% in 2023, triggering the adjustment threshold for deposit agency fee rate schedule. We expect PSBC and its Postal Group parent will start a comprehensive review and renegotiate the agency fee rate in 2024.

Postal Savings Bank of China boasts a strong retail deposit base with market share of 9.5% in China. Its strong deposit base was supported by its inherent advantage in the rural banking market because of its long-term operations in postal savings and remittance outlets. It operates the largest branch network, covering all cities and nearly 99% of counties. The strong deposit base does not come without costs. PSBC must pay agency fees to its parent for deposits absorbed through agency outlets that were owned by its parent, which contribute over 60% of total deposits, making its overall funding costs higher than those of the moaty Chinese banks.

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.

No-moat-rated Postal Savings Bank of China's, or PSBC's, first-quarter results surprised with a 27.5% year-on-year increase in fee income, slightly exceeding our expectations. Net interest income was resilient, growing 1% year on year, indicating a decent improvement from the 0.5% decline in fourth-quarter 2022, despite significant pressures brought by loan repricing. Overall, we think the results are largely in line with our expectations and reaffirm our thesis that PSBC should benefit from the strong growth potential given the underserved financing demands in rural areas despite the challenging market environment. Our fair value estimates of CNY 5.70 for A-shares and HKD 6.50 for H-shares are unchanged, and we think the H-shares remain undervalued, trading at 0.6 times 2023 price to book value.

Postal Savings Bank of China’s 2022 total revenue and net profit growth unsurprisingly decelerated to 5.1% and 11.9%, from 7.8% and 14.5%, respectively, in the first nine months of 2022. To reflect lower net interest margin assumption in 2023, we reduce our A-share fair value estimate to CNY 5.70 (from CNY 6.00) but retain it at HKD 6.50 per H-share, after accounting for a slightly stronger Chinese yuan. H-shares are undervalued, trading at a historically low 0.5 times 2023 price/book value. The H-share price fell 5% on March 31 following news that PSBC issued new A-shares to China Mobile priced at CNY 6.64. We don't believe the added capital, which lifts its common equity Tier 1, or CET1, ratio by 62 basis points to 9.98%, reflects any current balance sheet weakness, but rather that PSBC would benefit from the added capital base to meet lending demand in its core rural and small and midsize markets. As the shares are issued at a premium, they have negligible impact on our fair values. However, EPS growth will be diluted to mid single digits, though we expect net profit growth to stay at about 10% in 2023.

Postal Savings Bank of China boasts a strong retail deposit base with market share of 9.5% in China. Its strong deposit base was supported by its inherent advantage in the rural banking market because of its long-term operations in postal savings and remittance outlets. It operates the largest branch network, covering all cities and nearly 99% of counties. The strong deposit base does not come without costs. PSBC must pay agency fees to its parent for deposits absorbed through agency outlets that were owned by its parent, which contribute over 60% of total deposits, making its overall funding costs higher than those of the moaty Chinese banks.

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.

We reduce our fair value estimate for no-moat Postal Savings Bank of China, or PSBC, to CNY 6 from CNY 6.30 per A-share and HKD 6.50 from HKD 7.60 per H-share after its third-quarter results. The new valuation reflects our less optimistic outlooks for net interest margin, or NIM, in coming quarters and downward pressures on fee income amid heightened capital market volatility and subdued investor sentiment. The larger decline in the H-share valuation was also attributable to recent RMB depreciation, and we are using an exchange rate of 1.08 CNY/HKD. We reduce our NIM projection for 2022 and 2023 by 4 and 2 basis points, respectively, and lowered 2022 fee income growth by 10%. The bank is undervalued, trading at below 0.5 times 2022 price to book ratio. We believe PSBC's strong growth momentum and low-risk assets justify valuation premium against SOE peers.

Postal Savings Bank of China boasts a strong retail deposit base with market share of 10% in China. Its strong deposit base was supported by its inherent advantage in the rural banking market because of its long-term operations in postal savings and remittance outlets. It operates the largest branch network, covering all cities and 98.9% of counties. The strong deposit base does not come without costs. PSBC must pay agency fees to its parent for deposits absorbed through agency outlets that were owned by its parent, which contribute over 60% of total deposits, making its overall funding costs higher than those of the moaty Chinese banks.

Postal Savings Bank of China boasts a strong retail deposit base with market share of 10% in China. Its strong deposit base was supported by its inherent advantage in the rural banking market because of its long-term operations in postal savings and remittance outlets. It operates the largest branch network, covering all cities and 98.9% of counties. The strong deposit base does not come without costs. PSBC must pay agency fees to its parent for deposits absorbed through agency outlets that were owned by its parent, which contribute over 60% of total deposits, making its overall funding costs higher than those of the moaty Chinese banks.

We retain our fair value estimate for no-moat-rated Postal Savings Bank of China, or PSBC, at CNY 6.30 per A-share and HKD 7.60 per H-share after the bank posted strong results. Total revenue and net profits grew 10.1% and 14.9%, respectively, year on year. Total revenue growth beat our assumptions for high-single-digit growth, driven by hefty growth in fee income which was partly offset by slowing interest income. The results reflected PSBC’s strong growth momentum in its rural lending and wealth management businesses, leveraging its 40,000 distribution outlets and 637 million retail customers across China.

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 retain our fair value estimate for no-moat Postal Savings Bank of China, or PSBC, at CNY 6.30 per A-share and HKD 7.60 per H-share after the bank posted strong results. Total revenue and net profits grew 11.4% and 18.6% respectively from 2020 and the results were in line. Total revenue growth continued to accelerate quarter on quarter driven by strong growths in fee income and investment income. The results reflected PSBC’s strong growth momentum in its microfinance and wealth management businesses, leveraging its 40,000 distribution outlets and 637 million retail customers across China. Such growth was the highest among state-owned enterprise, SOE, banks. We expect PSBC's strong growth momentum to continue during our five-year forecast period, thanks to great potential in asset mix optimization and an extensive network that benefits from the robustly growing wealth management business in less-developed markets. H-shares are trading below 0.7 times forward price/book ratio. PSBC’s annualized return on equity increased 2 basis points to 11.86% from 2020. We believe PSBC deserves a valuation premium against SOE peers, thanks to its strong growth momentum and strong returns on equity. The dividend per share increased 18.7% to CNY 2.474 per 10 shares and the dividend yield was high at 4.7%. The payout ratio was steady at 30% over the past three years; we expect this to remain above 30% in 2022.

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.

Postal Savings Bank of China boasts a strong retail deposit base with market share of 10% in China. Its strong deposit base was supported by its inherent advantage in the rural banking market because of its long-term operations in postal savings and remittance outlets. It operates the largest branch network, covering all cities and 98.9% of counties. The strong deposit base does not come without costs. PSBC must pay agency fees to its parent for deposits absorbed through agency outlets that were owned by its parent, which contribute over 60% of total deposits, making its overall funding costs higher than those of the moaty Chinese banks.