China Banking Sector：2H15 outlook: reforms in place

www.dbsvickers.com ed-JS / sa- AL 2H15 outlook: reforms in place  Pullback creates a good entry opportunity  Asset quality and earnings growth to recove  Sector reforms are long-term drivers  Top picks BoCom-H & CITIC-H; ICBC-A & CMB-A Asset quality and earnings growth to recover. We do not expect much more pressure on NIM during the rate cut cycle (pg5), since China has largely completed its interest rate liberalization process. There is still a lot of room for RRR cuts to boost liquidity and loan growth. (pg4) Concerns on local government loans should be largely eased by local government’s debt swap program (pg8). With GDP growth to stabilise at c.7% in 2H15, which is the New Normal, China banks’ NPL formation ratio and credit cost should stablise (pg10), although overall NPL ratio will likely rise and top at 2% by 2017. As mentioned in our 1Q15 results recap, we believe 2015 will be the slowest year in recent history for banks’ earnings growth, but we expect earnings recovery in 2016-2017. Fuelled by sector reform. Mixed-ownership reform will make a difference as the better ownership structure will pave the road for a market-oriented compensation system, multi-divisional reforms (pg14) and potential subsidiary spinoffs, and the employee stock ownership plan (ESOP), should enhance banks’ efficiency in the long-run. Overseas markets can be a new growth driver as banks expand alongside clients due to China’s One-Belt-One-Road Plan. (pg15). In future, we also expect higher contribution from private banking and wealth management businesses in tandem with development of China’s capital markets. BoCom’s recent acquisition of Huaying Sec. signals the potential mixed-operation reform in the financial sector and the rise of universal banks. Entry opportunity for H-share banks; Top picks BoCom-H & CITIC-H; ICBC-A & CMB-A. After the pull-back in the past month, H-share China banks are trading at an attractive 0.9x FY15 P/BV on average, creating a good entry opportunity. We are looking for at least 20% upside for H-share China banks, and A-share banks should see a short-term boost driven by the market bailout plan (pg20). We like banks that will benefit from financial sector reforms and have strong innovative ability in developing new businesses, including internet financing (pg16). We revised up our mid-term growth assumption for BoCom to factor in impact from reforms (pg21) and slightly increased TP. HSI: 25,236 ANALYST Shujin CHEN CFA, + 852 2820 4920 shujin_chen@hk.dbsvickers.com Nicole WU +852 2820 4919 nicole_wu@hk.dbsvickers.com Top picks Closing FY15F Target Stock price PBV PER yield ROE Price rating (Lcl$) (X) (X) (%) (%) (Lcl$) A-share CMB (600036) 18.82 1.29 7.6 4.0 18.3 23.42 Buy ICBC (601398) 5.79 1.21 7.3 4.6 17.4 6.37 Buy H-share Citic Bank (998) 5.97 0.74 5.4 5.5 14.6 8.31 Buy BoCom (3328) 7.68 0.87 6.8 4.6 13.4 9.34 Buy Source: Bloomberg Finance L.P., DBS Vickers Based on closing prices on 6-Jul-15. Sector average P/BV 0.50.70.91.11.31.51.71.9Jan-11Jan-12Jan-13Jan-14Jan-15x 0.99 '13 trough =0.84'13 max =1.314 max = 0.9914 trough = 0.76 Source: Thomson Reuters, DBS Vickers DBS Group Research . Equity 7 July 2015 China / Hong Kong Industry Focus China Banking Sector Refer to important disclosures at the end of this report Industry Focus China Banking Sector Page 2 Table of Contents Macro: Still room to use monetary tools to boost economic growth 3 Local government's debt concerns now eased by debt swap programme 8 NPL trends up but to stabilise at 2% in 2016-2017 10 Long-term driver: Mixed-ownership reforms 12 Long-term driver: Potential overseas expansion boosted by One-Belt-One-Road Plan 15 Banks are well prepared for trend towards Internet financing 16 Concern on government’s bailout creates entry point for H-share China banks 20 Valuation and recommendation 21 Appendix – PB bands 24 Appendix – Financial summary 26 Industry FocusChina Banking Sector Page 3 Macro: Still room to use monetary tools to boost economic growth While US and Europe have run out of QE tools, China still has ample room to loosen its monetary and fiscal policies to support its economy. Benchmark rate at record low. PBOC cut its 1-year lending benchmark rate to a record low of 4.85% on 28-Jun-15, the fourth reduction since Nov-14, and 1-year deposit rate was cut to 2%. The rate cuts are aimed at reducing funding cost for the real economy and financial institutions, and to stabilise economic growth during economic restructuring. The move confirms that PBOC will continue to adopt a monetary loosening policy to support economic growth and the A-share market. According to PBOC, positive macroeconomic indicators in May imply that economic growth will bottom out in 3Q15. PBOC policy lending rates PBOC policy deposit rates 4.0 4.5 5.0 5.5 6.0 6.5 7.0 7.5 8.0 Dec‐06Jun‐