China Banks: Earnings Should Improve, but Net Interest Margins Are Key Concern for Second Half

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 2-5 percentage points to 4%-9% for six state-owned enterprises from the first quarter’s level, primarily driven by higher revenue growth and lower credit costs.

As the spread between new loan yields and matured loan yields remained high and migration to time deposits continued in the second quarter, we expect a 1- to 5-basis-point decline in the six-month net interest margin for banks compared with the first quarter. We expect a cut in the June loan prime rate as well as restructuring of local government debt and potential repricing of existing mortgages to drive similar pace of quarter-on-quarter decline in banks’ third-quarter NIM. As such, we see a delayed turning point in NIM likely to be in the fourth quarter as consumer credit demand recovers.

Despite improved earnings growth and recent launch of pro-growth policies, market sentiment on Chinese banks remains muted given growing NIM pressures in the second half. Chinese banks remain undervalued, trading at a historical low of 0.2-0.5 times 2023 price/book ratio and a 7%-10% dividend yield. Our top picks are Agricultural Bank of China 601288 for SOE banks and China Merchants Bank 600036 for joint-stock banks. We like ABC’s high dividend yield, improved asset quality, high nonperforming loan coverage ratio, and above-peer growth potential in rural areas. We expect CMB to benefit from the consumer recovery in late 2023 as we’ve seen mild recoveries continue in consumer activities, including auto sales, credit card transactions, and issuance of bank wealth-management products.