Chinese banks?2016 outlook:Year of valuation normalization

Deutsche Bank Markets Research Asia China Banking / Finance Banks Industry Chinese banks − 2016 outlook Date 5 January 2016 Forecast Change Year of valuation normalization Stay positive on depressed valuation; Top picks: CCB and BOC ________________________________________________________________________________________________________________ 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. MCI (P) 124/04/2015. Hans Fan, CFA Research Analyst (+852) 2203 6353 hans.fan@db.com Vincent Gu Research Associate (+852) 2203 6185 vincent.gu@db.com Jacky Zuo Research Associate (+852) 2203 6255 jacky.zuo@db.com Key Changes Company Target Price Rating 1398.HK 6.90 to 6.13(HKD) - 0939.HK 7.90 to 7.12(HKD) - 1288.HK 4.61 to 4.14(HKD) - 3988.HK 5.40 to 4.76(HKD) - 3328.HK 8.49 to 7.47(HKD) - 3968.HK 24.83 to 23.49(HKD) - 1988.HK 11.60 to 10.51(HKD) - 3618.HK 6.94 to 6.27(HKD) - 3698.HK 3.42 to 3.74(HKD) - 1963.HK 6.36 to 6.78(HKD) - 600000.SS 17.75 to 17.13(CNY) - 601166.SS 15.63 to 17.46(CNY) - 601818.SS 4.96 to 4.74(CNY) - 000001.SZ 16.68 to 14.43(CNY) - 601169.SS 11.98 to 12.75(CNY) - 601009.SS 15.40 to 16.92(CNY) - 002142.SZ 12.70 to 13.81(CNY) - 601988.SS 4.67 to 4.11(CNY) - Source: Deutsche Bank Top picks China Construction Bank (0939.HK),HKD5.15 Buy Bank of China (3988.HK),HKD3.36 Buy Source: Deutsche Bank This report changes estimates and Target Prices for several companies under coverage. Please refer to figure 120 for a detailed summary. We maintain a positive view on Chinese banks, given our hopes for implementation of reform measures. While China’s de-capacity efforts may lead to more defaults, we expect the market ultimately to turn more sanguine about faster NPL recognition, as equity prices have already reflected a highly pessimistic outlook, with an implied NPL of 8%. In addition, we expect the re-introduction of NPL securitization to alleviate banks’ asset quality pressure. We continue to prefer the big-four banks, with the H-shares of CCB and BOC our top picks. Catalysts include NPL ABS issuance, mixed ownership reform, expedited universal banking and improving corporate debt serving. De-capacity to accelerate NPL recognition with manageable impact on banks China’s major overcapacity sectors boast Rmb8.3tr debt, on our estimates, or 5% of system credit. Our bottom-up studies identify c.30-45% of overcapacity sector credit posing higher risks, most of which have been granted to “zombie enterprises” that have been loss-making over three consecutive years. Given fewer ties with local governments and stricter risk controls, the listed banks are less exposed to overcapacity sectors (2% of total loan book). Assuming all higher-risk overcapacity credit turning into NPLs, we estimate the de-capacity process may boost listed banks’ NPL ratios by 52-83bps by 2017. Securitization of bad debts to alleviate asset quality pressure With the ABS balance more than doubling in 2015, we expect China to re-introduce the securitization of NPLs in 2016, which should improve banks’ efficiency and flexibility in disposing NPLs and increase their lending appetite to support the economy. In particular, the NPL ABS could improve banks’ provision coverage (183% as of 3Q15). Assuming China securitizes 10% of bad loans, similar US and Korea ratios, this would boost commercial banks’ provision coverage by 14ppts. In addition, more diversified investors (56% are non-bank institutions) are driving away risks from the banking system. Deleveraging is a long-term theme, but reform measures have taken effect It has not been easy to tackle China’s rapid build-up of credit leverage, with credit-to-GDP rising to 253% as of 3Q15 (2008: 140%). However, we believe easing and reform measures to address the “flow” of credit have already taken effect, resulting in a more sanguine profile for new credit and lower interest burdens. We expect the continued implementation of reforms to restructure the “stock” of credit in 2016, including de-capacity, SOE reform, asset securitization, local government debt swaps and capital market liberalization. Ongoing business transformations to mitigate challenges Operationally, we expect further monetary easing to trim banks’ NIM and a slowing economy to pose continued asset quality pressure. As such, we lower our 2016 earnings forecasts by 3.0% (excluding BOC’s one-off disposal gains) and cut our tar