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Chinese banks:Better earnings quality should drive big banks

Banking quarterly data 2Q17: wider divergence between big and smaller banks

Big banks' PPOP in line, with NIM expansion and stable asset quality

CBRC: 1H17Commercial Bank Profit Grew by 7.9% YoY (CBRC, Aug 14)

DB Research

    The CBRC released 2Q17 operating data for China’s all commercial banks, withquarterly net profit at Rmb477bn, up 11.6% yoy (1Q17: +4.6%). The earningsrecovery was driven by moderating NPL formation, lower credit cost and mildNIM expansion (Fig 1). For the big banks, we see gradual improvements inearnings quality, characterized by an NIM recovery, lower NPL ratio andstronger provision coverage. Hence, we expect the big banks to report solid2Q17 results, which should help drive a re-rating. In contrast, joint-stock banks(JSBs) slowed asset growth notably and reported further NIM contraction amidfinancial deleveraging. We stay cautious on JSBs. Top picks: ICBC and BOC.

    The big 4Chinese banks reported 3Q17PPoP up 9% yoy (2Q17: 8%), in linewith our forecasts: a solid set of results, as evidenced by continued NIMexpansion (up 5bps qoq), stable NPL formation and stronger provisioncoverage. The quality difference between the big 4and other banks haswidened further, the latter showing weak funding strength and inferior assetquality. Among the big banks, CCB and ABC delivered relatively strongerresults. We see BOC's numbers as solid, with less NPL formation and thestrongest NII growth, which didn't warrant the share price correction today.

    The CBRC released 2Q17operating data for China’s all commercial banks, withquarterly net profit of Rmb477bn, up 11.6% yoy (vs. 1Q17: 4.6%). 1H17sectorprofit grew by 7.9% yoy. The earnings recovery was driven by moderating NPLformation, lower credit cost and mild NIM expansion. Big banks saw betteroperational trends and joint-stock banks (JSBs) slowed asset growth notablyand reported further NIM contraction. We highlight key trends below:

澳门新永利国际平台登录,    Chinese Banks - July 2017banking volume – A temporary rebound in creditGrowth

    NIM trend: big banks (recovered) vs. JSBs/city banks (compressed)

    Stronger NII growth for big banks given strong deposit franchise

    NIM for the entire banking sector was up 2bps qoq to 2.05% (1Q17down19bps). Specifically, big five banks’ NIM was up 3bps qoq, while JSBs &city commercial banks’ NIM both down 2bps qoq.We estimate the annualized NPL formation to be 85bps in 2Q17, higherthan 49bps in 1Q17but still lower than 126bps in 2016. As a result, banksonly set aside credit cost of 92bps, similar to 89bps in 1Q17and muchlower than 136bps in 2Q16. Sector NPL ratio was flattish qoq at 1.74%.Big five banks saw NPL ratio dropped by another 4bps qoq to 1.60%, whilerural financial institutions saw rising NPL ratio (up 26bps qoq to 2.81%).Sector NPL coverage ratio down 1.6ppt qoq to 177.2%.China’s domestic banking assets amounted to Rmb236.5tr as of June 2017,up 11.4% yoy (vs. 16.5% in 2016). Total banking asset growth slowed from16.5% yoy in 2016, which was mainly dragged down by slower growth ofsmaller banks, especially JSBs. Total assets of joint-stock and city/ruralbanks (44% of total banking assets) slowed notably to 12% yoy in end-June from 19% in 2016(JSBs down to 8.4% from 17.2% in 2016). Incontrast, the Big Five banks (36% of total banking assets) are growing theirasset base modestly faster at 8.8% yoy vs. 6.9% in 1H16.On capital, sector CET-1down 15bps qoq to 10.64% in 2Q17. Liquiditycoverage ratio improved to 123% (vs. 119% in 1Q17).

    The PBOC reported July 2017new loans of Rmb826bn and new TSF ofRmb1.22trn, both exceeding consensus estimates. Adding back strongmunicipal bond issuance of Rmb845bn, system credit growth rebounded to15.4% yoy from 14.7% in June (Fig. 1). We attribute the stronger-thanexpectedcredit data to 1) banks bringing off-B/S shadow credit into on-B/S, and 2)accelerating bond financing on lower rates. Given the still healthy macro data,we expect the financial deleveraging campaign to continue in order to deleverfinancial markets and contain the asset bubble. Thus we maintain our forecastthat system credit will fall to 13%-14% yoy by end-2017.(Hans Fan, 85222036353)

    NIM for the entire banking sector was up 2bps qoq to 2.05% (1Q17: down19bps), due to gradual asset repricing. Average yield for new corporate loanspicked up 40bps YTD. Specifically, big banks’ NIM was up 3bps qoq, whileJSBs & city commercial banks’ NIMs were both down 2bps qoq (Fig 4). Thisshows continuing funding pressure for smaller banks. We think NIM pressurewill continue for JSBs in the near term, given still elevated market rates andmore intense competition for deposits.

    Funding strength remains key differentiator, leading divergent trends in netinterest income (NII) growth (Fig 3). Given their strong deposit franchise, bigbanks were able to record largely stable funding costs. As net interbanklenders, they also benefited from higher market rates. Hence, their NIM wasbetter than expected, + 5bps qoq. With stable asset growth, big banks' NIIgrowth accelerated to 13.3% yoy. However, other banks were hit by fundingpressure and tighter regulations. These smaller banks are heavily reliant onwholesale funding, which were 33% of liabilities (Fig 7). As such, the highermarket rates have pushed up their funding costs (Fig 6). Reflecting tighterrules, smaller banks were forced to scale back on-B/S shadow banking (i.e.receivable investment), resulting in deposit declines, upping their funding cost.Stable NPL formation for big banks but pressure persists for other banksThe asset quality trends of big and smaller banks continued to diverge. Weestimate that the big four banks recorded a lower NPL formation rate of 62bpsin 3Q17, in line with 55bps in 2Q17and 71bps in 1Q17(Fig 11). They seizedthe chance to top up provision coverage (up 4.4ppt to 165%). For instance,ICBC lifted its provision coverage from 141% in 1Q17to 148% in 3Q17.

    Chinese Banks - Better earnings quality should drive big banks' re-rating

    Asset quality risk further relieved; NPL formation stayed low

    However, asset quality pressure persists for smaller banks, which recorded ahigher NPL formation rate of 120bps in 3Q17. This is because smaller banksadopted a loosened NPL classification standard, with loans overdue more than90days higher than the NPL balance. We note that several joint stock bankswere still under pressure with elevated NPL formation rates in 3Q17, includingSPDB (290bps), PAB (279bps), CNCB (118bps) and INDB (113bps). BOCQ alsoreported a higher NPL formation rate of 180bps in 3Q17. With weak PPoPgrowth, the smaller banks had to save credit cost and reduce NPL coverage.

    The CBRC released 2Q17operating data for China’s all commercial banks, withquarterly net profit at Rmb477bn, up 11.6% yoy (1Q17: +4.6%). The earningsrecovery was driven by moderating NPL formation, lower credit cost and mildNIM expansion (Fig 1). For the big banks, we see gradual improvements inearnings quality, characterized by an NIM recovery, lower NPL ratio andstronger provision coverage. Hence, we expect the big banks to report solid2Q17results, which should help drive a re-rating. In contrast, joint-stock banks(JSBs) slowed asset growth notably and reported further NIM contraction amidfinancial deleveraging. We stay cautious on JSBs. Top picks: ICBC and BOC.(Hans fan, 85222036353)

    We estimate annualized NPL formation to be 85bps in 2Q17, higher than49bps in 1Q17 but lower than 126bps in 2016. As a result, banks only set asidecredit cost of 92bps, much lower than 136bps in 2Q16. Sector NPL ratio wasflattish qoq at 1.74% (Fig 6). Big five banks saw NPL ratio falling further by4bps qoq to 1.60%, while rural financial institutions saw rising NPL ratio (up26bps qoq to 2.81%). We expect strict implementation of supply-side reformsand moderated property risks to relieve overall asset quality. However, forsmaller banks with higher shadow banking exposure and looser NPLclassification, the pressure could persist.

    BOC: buy on dips; top pick retained

    Banking asset growth slowed, dragged mainly by JSBs

    BOC H-share corrected 3.5% today after results, which seems unjustified. Themkt is mainly concerned about asset quality (NPL ratio + 4bps) and NIM (-1bps). However, we urge investors to focus on NPL formation rate, a moreaccurate indicator of asset quality trends. BOC's NPL formation rate actuallyfell to 68bps in 3Q17vs. 80bps in 1H17, on our est. Its NIM was dragged byBOCHK temporarily, but we expect NIM for BOC domestic and BOC HK toexpand further in 1H18. Meanwhile, BOC recorded the strongest NII growthamong peers. BOC remains our top pick: a key beneficiary of better industrialprofits, US rate hikes and "Belt and Road" initiatives.

    China’s domestic banking assets amounted to Rmb236.5tr as of June 2017, up11.4% yoy. Total banking asset growth slowed from 16.5% yoy in 2016, whichwas mainly dragged down by slower growth at smaller banks, especially JSBs.

    Total assets of joint-stock and city/rural banks (44% of total banking assets)slowed notably to 12% yoy at end-June from 19% in 2016 (JSBs down to 8.4%from 17.2% in 2016). This was mainly because smaller banks slowed shadowbanking asset growth when facing tighter regulations (Fig 12). In contrast, theBig Five banks (36% of total banking assets) are growing their asset basemodestly faster at 8.8% yoy vs. 6.9% in 1H16.

    2Q17 – expecting NPAT growth of 4.6% yoy with better quality at big banks

    We expect the 17 listed banks under our coverage to report NPAT growth of4.6% yoy in 2Q17 (Fig 17). Big banks could see gradual improvements inearnings quality with a strong recovery in PPoP (11% yoy, excluding BOC’sNCB disposal gain) and a stronger coverage ratio. But JSBs are likely to besubjected to NIM shrinkage, asset growth slowdown and less asset qualityimprovement (PAB is an example, see our 2Q17 note: Fundamental recoverytakes time). As a result, smaller banks may report a decline in PPoP (down3.5% yoy) and then have to lower loan-loss provision charges (down 21% yoy).

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