China/Hong Kong China Banking Please read the analyst certification and other important disclosures on last page China Banking Update 16 November 2010 The path to Mount Hua’s peak (II) China banks rebounded strongly partly on QEII in October 2010, but began to tumble on China’s monetary tightening coming into November 2010. In our view, China’s monetary effort to drain extra liquidity from the economy will help banks expand their margins faster than expected. Meanwhile, solid domestic economic growth will sustain stable credit quality despite monetary tightening. Once the five re-rating catalysts we have identified begin to take hold, China banks will have the potential to be re-rated. ICBC (1398 HK) remains our TOP PICK; CITIC (998 HK) upgraded to Outperform; Remove BoCom (3328 HK) from our top-call list with its rating downgraded to Neutral; Maintain Outperform on Minsheng (1988 HK); Remain Neutral on ABC (1288 HK) and CMB (3968 HK). Analysts Sophie Jiang (8610) 6652 3726 jiangli@ccbintl.com Terry Sun (852) 2532 2560 terrysun@ccbintl.com China Banking Update 16 November 2010 2 Table of Contents The path to Mount Hua’s peak (II) – Buy on dips ......................................................................... 3 Executive summary...................................................................................................................... 4 2011 monetary policy: Tightening! Tightening!! Tightening!!! ........................................................ 6 Tools to drain extra liquidity: PBOC notes .................................................................................... 8 Tools to drain extra liquidity: RRR ................................................................................................ 9 Tools to drain extra liquidity: Loan quota control ........................................................................ 12 Tools to drain extra liquidity: Interest rate hikes ......................................................................... 14 LGFP: A non-event in 2011 ........................................................................................................ 20 Basel III and the second round of recapitalization...................................................................... 23 Turning point of China’s NPL trend: 4Q10.................................................................................. 26 Property and banks: decoupling in 2011 .................................................................................... 31 Agricultural Bank of China (1288 HK) ........................................................................................ 37 Industrial & Commercial Bank of China (1398 HK) .................................................................... 42 Bank of Communications (3328 HK) .......................................................................................... 47 China Merchants Bank (3968 HK).............................................................................................. 53 China CITIC Bank (998 HK)....................................................................................................... 58 China Minsheng Banking Corp. (1988 HK) ................................................................................ 63 China Banking Update 16 November 2010 3 China Banking Update The path to Mount Hua’s peak (II) – Buy on dips Sector Rating: Overweight (maintained) Highlights:
In October 2010, shortly after we published our last sector report, The path to Mount Hua’s peak, on 8 September 2010, the China banks experienced a rally partly on the second round of quantity easing (QEII) in the US. Afterwards, the market began to tumble on China’s liquidity tightening in November 2010.
In our view, the China banks have the potential to be re-rated in this tightening cycle. China’s monetary effort to drain extra liquidity from the economy will help its banks expand their margins faster than expected. Meanwhile, solid domestic economic growth will sustain stable credit quality despite monetary tightening. Once the five re-rating catalysts we have identified begin to take hold, the China banks have the potential to be re-rated.
Five re-rating catalysts: (1) better margin expansion and stronger fee income growth; (2) one-off removal of the local government financing platform (LGFP) overhang; (3) stable credit quality in the tightening cycle; (4) clarification of new regulatory requirements on provision and capital ratios; and (5) completion of “The Great Recapitalization” in 2010.
Buy on major dips. Our November China Credit Monitor (CCM) suggests that drastic liquidity tightening may take place in November and December 2010, putting a damper on the stock markets. We recommend buying China banks on ma