Company Reports

We maintain our fair value estimates for the state-owned enterprise banks in our coverage except for Agricultural Bank of China, which is seeing higher-than-expected net interest margins. We now increase ABC’s NIM assumption by 5 and 2 basis points in 2024 and 2025, respectively, which leads to a rise in fair value estimate to HKD 3.80 from HKD 3.50. Overall, there are no changes to our outlook for the other SOE banks.

The country's third-largest bank by assets, Agricultural Bank of China boasts a dominant position in county areas and sector-leading network scale that reward it with enviably low funding costs and a narrow economic moat.

Driven by improved investor sentiment for China banks with stable dividend payments and a historic property rescue package introduced in May, the Hang Seng Mainland Banks Index rallied over 20% in the second quarter. But it pulled back sharply on profit-taking and investors’ concerns that the easing measures were not sufficient to turn around struggling property sales. H-shares of most China banks remain undervalued, with 2024 price/book modestly increasing to 0.2-0.5 times. Dividend yields remain attractive at 6%-8%. With A-share counterparts trading at a 35% premium to H-shares on average, we expect the regulators’ push for higher and more regular dividend payouts, as well as the expansion of eligible exchange-traded funds on Stock Connect, should gradually narrow the valuation gap for Chinese dual-listed banks. Amid sluggish economic growth in China with no major recovery in property sales and consumer spending anticipated in 2024, we prefer defensive state-owned banks, including China Construction Bank, or CCB, and Industrial and Commercial Bank of China, or ICBC, and leading retail-focused bank China Merchants Bank for stable dividends, strong capital returns, and better earnings visibility.

As expected, China’s state-owned enterprise banks—Industrial and Commercial Bank of China, China Construction Bank, Agricultural Bank of China, Bank of China, and Postal Savings Bank of China—reported a year-on-year revenue decline of 2% on average in the first quarter, versus 0.6% growth in 2023. Though the contraction in net profit appeared weaker than expected when compared with the 2% growth in 2023, we expect revenue headwinds to gradually abate. Banks are on track to meet our full-year net profit growth forecast of 0.5%. We retain our fair value estimates of HKD 5 per H share for ICBC, HKD 6.20 per H share for CCB, HKD 3.50 per H share for ABC, HKD 3.50 per H share for BOC, and HKD 6.50 per H share for PSBC.

We maintain fair value estimates on the H-shares of Industrial and Commercial Bank of China, or ICBC, at HKD 5, China Construction Bank, or CCB, at HKD 6.2, Agricultural Bank of China, or ABC, at HKD 3.5 per, Bank of China, or BOC, at HKD 3.5, and Bank of Communications, or BoCom, at HKD 6 as results were largely in line and we leave our key assumptions unchanged. H-share prices are undemanding for all SOE banks, but our preferred picks are CCB, ICBC, and CMB on their strong capital position, above-peer return on risk weighted assets, and steady dividends.

The China banks’ cumulative, nine-month net profit growth was largely in line with our expectations, with decent loan growth partly offsetting declining net interest margin and soft fee income. Industrial and Commercial Bank, Bank of Communications, China Merchants Bank, and Postal Savings Bank, saw 0.8%, 1.9%, 6.5%, and 2.4% growth in net profit, respectively, year on year. Agricultural Bank of China reported higher profit growth at 5%, but the improvement was mainly driven by a lower tax rate on higher investment in government bonds. Among the China banks that reported results, Agricultural Bank and China Construction Bank reported steadier net profit growth at 3.1% and 5%, versus 3.4% and 3.5% in the first half, thanks to their resilient loan and fee income growth.

The country's third-largest bank by assets, Agricultural Bank of China boasts a dominant position in county areas and sector-leading network scale that reward it with enviably low funding costs and a narrow economic moat.

Our valuations for Agricultural Bank of China, Bank of China, Industrial and Commercial Bank of China, and Postal Savings Bank of China are unchanged following interim results that are largely in line with our expectations. We expect Postal Savings Bank and Bank of Communications to deliver 2023 stronger-than-peer earnings growth. All state-owned-enterprise banks, including China Construction Bank, which reported results earlier, are undervalued, trading at a historic trough of 0.3-0.4 times 2023 price/book ratio and about a 9% dividend yield, except for Postal Savings of about 7%. Postal Savings shows better growth momentum, but Agricultural Bank and China Construction are our top picks given above-peer provision coverage, stable credit quality, lower exposure to retail banking—which faces near-term challenges—and high return on equity. These factors should mean resilient growth in net profit and book value. We are confident these well-capitalized banks can deliver stable dividend income during an economic downturn.

Large Chinese banks will release 2023 interim results in late August. We expect that stabilized loan yields after the first-quarter loan repricing, mild consumption recovery, a favorable base effect, and a generally benign credit quality outlook supported by government policies will translate to improved second-quarter growth in both revenue and net profits compared with the first quarter. We expect second-quarter net profit growth to increase by 2 or 5 percentage points to 4% to 9% for six state-owned enterprises from the first quarter’s level, primarily driven by higher revenue growth and lower credit costs.

The Hang Seng Mainland Banks Index has declined 11% from its recent peak in early May. We attribute the decline to increasing concerns about downward pressure on banks’ net interest margins, or NIMs, and growing risks related to debts of local government financing vehicles, or LGFVs, amid a weak economic recovery and struggling land sales. We believe SOE banks have smaller exposures to LGFV debt and that their credit quality is better than peers given strong bargaining power to implement prudent borrower selection. Monetary and fiscal easing and the government’s strong support for troubled regional banks also limit systemic risks, in our view. That said, we believe the ongoing LGFV loan restructuring is likely to weigh on banks’ NIMs and the classification of restructured loans as special-mentioned loans will also increase provision expenses for banks. We maintain our fair value estimates for Chinese banks as we already factored in a NIM reduction of 10-25 basis points this year and expect credit costs to trend in line with our existing forecasts.

Agricultural Bank of China’s first-quarter results were largely within our expectation. We continue to like ABC and China Construction Bank among the state-owned banks, and are heartened that loans and fee income growth remain relatively robust for these two banks while net interest margin trend is in line with peers. ABC’s total loans increased 7% from end-2022, outpacing the 3%-6% growths of its peers in our coverage. We keep our fair value estimate at CNY 3.30 per A-share and HKD 3.50 per H-share. The stock is undervalued, trading at a historically low 0.4 times 2023 price/book value and an over 8% dividend yield. Notably, NIM contracted 39 basis points year on year but only dropped 3 basis points quarter on quarter. We expect pressure on ABC's NIM to subside as the base gets lower in the remaining quarters of 2023. This should help boost its profitability in the second half.

Agricultural Bank of China, or ABC, posted the strongest growth, at 7.4%, in full-year 2022 net profits among the big four SOE banks, supported by robust loan growth and resilient fee income. In contrast to the year-on-year decline in revenue for ICBC and CCB, ABC’s revenue edged up 0.7% on the 2.1% and 1.2% respective growths in net interest income and fee income. Loans grew at a faster-than-peer pace of 15% in 2022 from the 2021 level, underscoring its inherent advantage in rural financing and policy tailwinds brought by the government's rural revitalization initiative.

The large Chinese banks will release 2022 results in late March and first-quarter 2023 results in late April. Pressures on net interest margin are likely to rise in the first quarter. However, the accelerating recovery in China’s economy since reopening reaffirms our expectation for asset risks to be contained. This allows banks some flexibility in their already-high provision levels, which should enable them to smooth net profit growth despite significant revenue pressures. But we do see a wider divergence in profitability in 2023 as slowing revenue growth results in less leeway to manage earnings growth. Those banks that can benefit from a rebound in retail lending and wealth-management services, which we expect in mid-2023, should present buying opportunities along with stronger earnings performance.

The largest five SOE banks: Industrial and Commercial Bank of China, or ICBC; China Construction Bank, or CCB; Agricultural Bank of China, or ABC; Bank of China, or BOC; and Bank of Communications, or Bocom; released third-quarter results end of October. The mixed results reflected mounting challenges to top line growth given the dim consumer outlook, heightened capital market volatilities, and exchange losses related to banks’ overseas assets. We expect headwinds to continue in the first half of 2023.

The country's third-largest bank by assets, Agricultural Bank of China boasts a dominant position in county areas and sector-leading network scale that reward it with enviably low funding costs and a narrow economic moat.

The country's third-largest bank by assets, Agricultural Bank of China boasts a dominant position in county areas and sector-leading network scale that reward it with enviably low funding costs and a narrow economic moat.

Narrow-moat Agricultural Bank of China's, or ABC’s, second-quarter results showed a steady growth in net interest income despite a sharp deterioration in net interest margin, or NIM, thanks to a strong loan growth benefiting from policy tailwinds. In our view, this reflects ABC’s strength in the underserved rural banking market. First-half total revenue and net profits grew 5.9% and 5.5%, respectively, year on year. Revenue growth was largely flat from 2021, while net profit growth slowed to 5.5% from 7.4% year on year. ABC’s loans have grown at an industry-leading pace since 2020. Rural loans contributed over 44% of the total increase in new loans during the past six months, with loan balance growing 11.5% from 2021 and outpacing the 9.5% growth in total loans. Such outperformance was attributable to its inherent advantage in rural financing and policy tailwinds from the government's rural revitalization initiative. Six-month year-on-year growth in fee income was resilient compared with joint-stock bank peers, despite a 1.5-percentage-point decline from the first quarter’s level to 2.8%. This growth was driven by the 12% increase in bank card-related fees, indicating ABC’s credit card customers are more diversified and their consumption behavior was less affected by the economic downturn and COVID-19 lockdowns in major cities in the first half.

The country's third-largest bank by assets, Agricultural Bank of China boasts a dominant position in county areas and sector-leading network scale that reward it with enviably low funding costs and a narrow economic moat.

The country's third-largest bank by assets, Agricultural Bank of China boasts a dominant position in county areas and sector-leading network scale that reward it with enviably low funding costs and a narrow economic moat.

We maintain our fair value estimates for the majority of our Chinese bank coverage after the media reported an increasing number of homebuyers across China are refusing to repay mortgage loans for delayed projects. While we expect the imminent impact on banks' credit quality is small, the news reflects challenging liquidity conditions for private developers and weak consumer confidence. We believe this may lead to a weak recovery of the wealth management business—especially for private bank business—as investors are likely to have little mood for financial products linked to the property sector. Hence, we modestly lower fair value estimates for the two retail-oriented banks China Merchants Bank, or CMB, to HKD 68 from HKD 70 per share; and Ping An Bank, or PAB, to CNY 24 from CNY 26 per share, to factor in lower wealth-management-related income growth in 2022.