Retail vs. corporate banks – Another quarter of growing divergence

Deutsche Bank Markets Research Asia China Banking / Finance Banks Industry Chinese banks Date 29 October 2016 Results Retail vs. corporate banks – Another quarter of growing divergence Flat 3Q16 earnings; stick to retail banks for quality; top picks: CMB and ICBC ________________________________________________________________________________________________________________ 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) 057/04/2016. 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 Top picks ICBC (1398.HK),HKD4.69 Buy China Merchants Bank (3968.HK),HKD18.92 Buy Source: Deutsche Bank Companies Featured ICBC (1398.HK),HKD4.69 Buy China Construction Bank (0939.HK),HKD5.67 Buy Agri. Bank of China (1288.HK),HKD3.23 Hold Bank of China (3988.HK),HKD3.48 Buy Bank of Communications (3328.HK),HKD5.87 Hold China Merchants Bank (3968.HK),HKD18.92 Buy China CITIC Bank (0998.HK),HKD5.08 Hold China Minsheng Bank (1988.HK),HKD8.94 Hold CEB (6818.HK),HKD3.53 Hold Chongqing Rural Bank (3618.HK),HKD4.64 Hold Huishang Bank (3698.HK),HKD3.85 Sell Bank of Chongqing (1963.HK),HKD6.26 Sell Shanghai Pudong Bank (600000.SS),CNY16.20 Sell Industrial Bank (601166.SS),CNY16.20 Sell Ping An Bank (000001.SZ),CNY9.16 Hold Bank of Beijing (601169.SS),CNY9.33 Buy Bank of Nanjing (601009.SS),CNY10.43 Sell Bank of Ningbo (002142.SZ),CNY16.71 Sell Source: Deutsche Bank We value Chinese banks using a three-stage Gordon Growth Model (PV= (ROE-g)/(COE-g)), with target prices based on 2016E book values. Chinese banks reported 3Q16 net profit up 2.4% yoy. While it was in line with market expectations, this set of results continued to highlight challenging operating trends, with a modest decline in PPOP offset by lower credit cost. Amid profitability downtrends, retail banks (i.e. big-four and CMB) exhibited stronger operational quality than corporate banks (i.e. the rest), with higher ROA of 112bps in 3Q16 vs. 88bps for corporate banks. Retail banks’ defensive strengths are specifically demonstrated in lower cost of funds, less asset yield compression, less shadow banking exposure, and prudent expansion in broad credit. We continue to prefer retail banks while remaining cautious on others. Increasingly likely softening of provision coverage: positive for stable dividends Listed banks in 3Q16 reported lower provision coverage at 162%, down 3ppt qoq. Notably, CCB has joined ICBC to report a ratio lower than the 150% requirement (149%). For ICBC, it was the third consecutive quarter that the bank’s coverage ratio remained below the floor (at 136%). This may suggest a rising probability for the CBRC to soften the requirement. We view the potential relaxation positively, as it should help big-four banks achieve flattish earnings and hence a stable dividend payout in 2016-18. Otherwise, we see big-four banks as likely to report an earnings decline of 11-16% yoy in the coming two years (Figure 4), unless they “evergreen” problematic loans. Growing defensive strengths of retail banks Retail banks have demonstrated defensive strengths on two fronts. First, they continued to record lower cost of funds (Figure 5) and less asset yield compression (Figure 7) due to ample liquidity from low-cost retail deposits and hence generated higher, more sustained profitability than corporate banks (Figure 8). Second, they have less shadow banking exposure, with riskier receivable investment making up 4% of assets vs. 19% for corporate banks. Running 3Q16 numbers: weaker revenue offset by less NPL formation In 3Q16, the 15 A+H-listed Chinese banks under our coverage reported NPAT of Rmb328bn, up 2.4% yoy (Figure 1). The results were driven by a decline in PPOP by 0.2% yoy offset by lower credit cost of 96bps of average loans (3Q15: 110bps). NPL formation rate on average was stable in 3Q16 when compared with 2Q16. Capital ratios remained largely stable. CMB delivered the best results; sector risks China Merchants Bank (CMB) unveiled net profit in 3Q16 up 9% yoy and decent ROAA of 1.22% (up 3bps yoy). Despite weaker PPOP (down 6% yoy), we are still encouraged by its continued deleveraging of shadow banking exposure (down 7% qoq), strong retail banking revenue generation (50% of operating income), and strengthened capital.