Chinese Banks - 2014 outlook ：It is time to re-rate

Deutsche Bank Markets Research Asia China Banking / Finance Banks Industry Chinese Banks -2014 outlook Date 8 January 2014 Forecast Change It is time to re-rate Stay positive on low valuation; top picks: BOC and ABC ________________________________________________________________________________________________________________Deutsche Bank AG/Hong Kong Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MICA(P) 054/04/2013. Tracy Yu Research Analyst (+852) 2203 6191 tracy.yu@db.com Hans Fan, CFA Research Analyst (+852) 2203 6353hans.fan@db.com Sukrit Khatri Research Associate (+852) 2203 5927 sukrit.khatri@db.com Michael Zhang, CFA Research Associate michael.zhang@db.com Top picks Bank of China (3988.HK),HKD3.47 BuyAgri. Bank of China (1288.HK),HKD3.60 BuySource: Deutsche Bank Companies Featured ICBC (1398.HK),HKD5.04 BuyChina Construction Bank (0939.HK),HKD5.64 BuyAgri. Bank of China (1288.HK),HKD3.60 BuyBank of China (3988.HK),HKD3.47 BuyBank of Communications (3328.HK),HKD5.21 BuyChina Merchants Bank (3968.HK),HKD15.28 BuyChina CITIC Bank (0998.HK),HKD4.04 HoldChina Minsheng Bank (1988.HK),HKD8.21 HoldChongqing Rural Bank (3618.HK),HKD3.62 BuyShanghai Pudong Bank (600000.SS),CNY9.20 HoldIndustrial Bank (601166.SS),CNY9.69 HoldChina Everbright Bank (601818.SS),CNY2.57 BuyPing An Bank (000001.SZ),CNY11.76 BuyBank of Beijing (601169.SS),CNY7.21 BuyBank of Nanjing (601009.SS),CNY7.91 HoldBank of Ningbo (002142.SZ),CNY9.17 BuySource: Deutsche Bank We upgrade FY13 and FY14 NPAT forecasts for the H-share banks by 4% and 17% to Rmb981bn and Rmb1.05tr respectively to reflect a higher NIM of 2.51% (3Q13: 2.57%) and lower credit costs of 59bps. On our estimates, the H-share banks are trading at 1x 2013E P/B and 4.8x 2014E P/E (ROAE: 18.6%) with a dividend yield of 6.5%. This distressed valuation reflects a highly pessimistic outlook and is at odds with the strong capital inflows into China (11M2013: Rmb2.5tr) that have historically been a leading indicator for GDP growth. We believe the government's commitment to maintain stable GDP growth despite reform pressure would be key to a sector re-rating. Event headline FY13-14 NPAT forecasts upgrade - Hard to get cheaper than current levels For 2014, we expect NPAT growth of 7.4% yoy for the 16 listed Chinese banks, with NIM of 2.47% (down 6bps yoy), net fee income growth of 14.4% yoy, a flat CIR of 39.8% and credit costs of 59bps. Despite our expectation of an increase in NPL ratio to 1.03% (2013: 0.97%) to reflect the change in loan mix in favor of small and micro companies, the buffer of excess provisions (1.2% of loans) will help the banks maintain relatively stable credit costs by lowering the NPL coverage ratio (2014: 269%, down from 279% in 2013) and deliver profit growth. In this report, we also introduce our 2015 forecasts – we expect NPAT growth of 8.3% yoy. Tighter regulations on shadow banking system to control risks We believe the introduction of circular 107 will lead to deleveraging of the weaker and risky part of the shadow banking system, leading to a shift in credit demand towards the banks, the bond markets and the more developed part of the financial system. As a result, we see lower systemic risks in the long run, but tighter regulations on banks’ exposure to inter-bank assets and WMPs that might pressurize earnings growth of the share-holding banks in the short term, particularly affecting CNCB, MSB and Industrial bank, which have been lending actively to the shadow banking system through the inter-bank markets. Internet financing to reduce operating costs and foster product innovation While the unchartered growth of Yu’E Bao (an MMF launched by Alibaba and Tianhong Asset Management) has raised questions on the likely threat to banks’ profitability, our analysis shows that Chinese banks are proficient in electronic banking, as evidenced by the high counter substitution rate of 75%. With the cost of electronic banking being one-fifth that of counter services, we see internet financing as a catalyst for product innovation and a means to reduce operating costs (equivalent to 2-3% of NPAT). Valuation offsets risks: Top picks: BOC and ABC We maintain our target prices, which offer potential upside of 30%, unchanged as the earnings upgrade leads to an increase of just 1.6% in book value with no change in terminal growth from 2016. On our estimates, the H