Quality banks to re-rate on better results and fund inflows

Deutsche Bank Markets Research Asia China Banking / Finance Banks Industry Chinese Banks Date 23 October 2017 Results Quality banks to re-rate on better results and fund inflows What is in this report? ________________________________________________________________________________________________________________ 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) 083/04/2017. THE CONTENT MAY NOT BE DISTRIBUTED IN THE PEOPLE’S REPUBLIC OF CHINA (“THE PRC”) (EXCEPT IN COMPLIANCE WITH THE APPLICABLE LAWS AND REGULATIONS OF PRC), EXCLUDING SPECIAL ADMINISTRATIVE REGIONS OF HONG KONG AND MACAU Hans Fan, CFA Research Analyst (+852 ) 2203 6353 hans.fan@db.com Jacky Zuo Research Analyst (+852 ) 2203 6255 jacky.zuo@db.com Edward Du Research Associate (+852 ) 2203 6185 edward.du@db.com Stephen Andrews, CFA Research Analyst (+852 ) - 2203 6191 stephen-a.andrews@db.com Top picks Bank of China (3988.HK),HKD4.04 Buy Agri. Bank of China (1288.HK),HKD3.65 Buy China Construction Bank (0939.HK),HKD6.93 Buy Source: Deutsche Bank Companies Featured ICBC (1398.HK),HKD6.30 Buy China Construction Bank (0939.HK),HKD6.93 Buy Agri. Bank of China (1288.HK),HKD3.65 Buy Bank of China (3988.HK),HKD4.04 Buy Bank of Communications (3328.HK),HKD6.03 Buy China Merchants Bank (3968.HK),HKD30.40 Hold China CITIC Bank (0998.HK),HKD5.13 Hold China Minsheng Bank (1988.HK),HKD7.42 Hold CEB (6818.HK),HKD3.81 Sell Chongqing Rural Bank (3618.HK),HKD5.19 Hold Huishang Bank (3698.HK),HKD3.88 Sell Bank of Chongqing (1963.HK),HKD6.44 Sell Shanghai Pudong Bank (600000.SS),CNY13.02 Hold Industrial Bank (601166.SS),CNY17.89 Sell Ping An Bank (000001.SZ),CNY11.48 Hold Bank of Beijing (601169.SS),CNY7.40 Buy Bank of Nanjing (601009.SS),CNY7.94 Sell Bank of Ningbo (002142.SZ),CNY16.42 Sell Source: Deutsche Bank We value Chinese banks using a three-stage GGM (PV= (ROE-g)/(COE-g)), with target prices based on 2017E book values. Downside risks: large-scale DES, over-tightening and property price correction. Upside risks: SOE reforms and removal or softening of GDP targeting. See p.9. We discuss three things in this report: 1) we provide a preview of 3Q17 results to be released by the end of this month, which may continue to show a notable divergence between retail- and wholesale-funded banks; big banks may report gradual improvements in NIM and asset quality; 2) we update funding inflows and particularly expect Southbound buyers to add positions in quality H-share Chinese banks on wider A-H premiums; 3) we switch our top picks from ICBC/BOC to BOC/ABC/CCB on the recent outperformance of ICBC (by 20ppt YTD vs. peers). We stay positive on the sector with a preference for big banks. 3Q17 – expecting NPAT growth of 5.7% yoy with better quality by big banks We expect the 17 listed banks under our coverage to report NPAT growth of 5.7% yoy in 3Q17 vs. 4.9% in 2Q17 (excluding BOC’s one-off gains). Nonetheless, the quality difference between bigger and smaller banks remains notable. The big banks may continue to report NIM expansion (up 2bps qoq), with decent PPoP growth of 9% (vs. 8% in 2Q17) and a stronger coverage ratio (up 3ppt qoq to 164%). Deposit franchise is the key. In 3Q17, more than 60% of the new liabilities at the big banks were low-cost demand deposits, while the small banks relied more on high-cost time deposits and interbank CDs. At smaller banks specifically, reflecting modestly higher interbank rates in 3Q17 and tighter regulations, joint-stock banks (JSBs) are likely to have remained subjected to funding pressure and capital pressure, which may have led to a decline in net interest income (down 3% yoy), muted PPoP growth and lower provision charges (down 8% yoy). What may surprise the market on the downside is that many smaller banks may continue to report declines in net interest income, driven by either higher funding cost or balance sheet shrinkage (depending on the individual bank strategies). Funding flow analysis – southbound inflow may have been stronger Southbound buyers have accumulated Chinese banks’ H-shares since July 2017 after some selling in June, driven mainly by wider A-H premiums. Noticeably, Ping An Life Insurance recently offloaded a portion of holdings in ICBC-A and switched to ICBC-H to capture the price difference (at one point as high as c.20%), according to ICBC’s 1H17 report and the Hong Kong stock exchange. Looking ahead, we expect the southbound