【Sector Research】China Banking Sector – Earnings negative mostly priced in, turning point looms

The overhang risk on China banks’ earnings has largely materialized after CBIRC reported 9.4% YoY decline in the sector’s 1H20 net profit. We expect earnings growth to bottom out in 2Q20, on the back of stabilizing NIM and easing credit cost.

 

  • CBIRC reported 9.4% YoY net profit decline in 1H20 for China banks, implying a sharp contraction of 24% YoY in 2Q20, vs 5% YoY growth in 1Q20. We see earnings drag mainly from counter-cyclical provisions. Topline growth should remain solid, as evidenced by moderate NIM shrink (-1bp QoQ), healthy asset expansion (+10.8% YoY), and lower cost-income ratio (-0.6ppt YoY). Meanwhile, lower fee rate as part of the profit concession measures and possible bond trading loss from yield hike might result in softer non-interest income. We believe China banks also intended for kitchen-sinking amid COVID-19 shock and disappointing results for major US and European banks.   

 

  • Better-than-expected asset quality despite prudent provision. During the mid-year work conference, CBIRC urged banks to plan ahead for asset quality deterioration, with stricter NPL recognition and more proactive impairment charge. In 2Q20, sector’s NPL ratio rose 3bp to 1.94%, but SML ratio retreated notably by 21bp to 2.75%, suggesting underlying asset quality stays benign. In particular, joint-stock banks and city commercial banks saw -1bp and -15bp QoQ decline in NPL ratio. Most banks joined our corporate day in mid-Jul anticipated that retail NPL formation will peak in 2Q20, and corporate side should face more pressure onwards.

 

  • Earnings growth is poised to rebound from 2Q20 trough. Given the lackluster bottomline growth revealed by CBIRC, we believe investors will focus more on China banks’ PPoP, NIM, and asset quality indicators in the upcoming 2Q20 results. Looking into 2H20, we expect relatively stable NIM trend on normalizing monetary policy and sequential decline in credit cost due to strengthened provision buffer. As illustrated in Figure 6, banks’ profit growth is highly correlated with GDP growth. Therefore, earnings should return to expansion along with economic recovery in coming quarters.

 

  • Retail banks on favorable spot. We continue to prefer retail-focused banks, including PAB, PSBC, and CEB, given faster asset quality recovery thus more resilient earnings.
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