China banks:From bad to worse

More NPL to come; downgrade sector to UW

Chinese banks disappoint again in the latest interim with a worseningoutlook on asset quality. Coupled with NIM compression from anotherrate cut and deposit relaxation, we have to cut our already belowconsensus forecast once more and lower TP across the board. Poor macrodata and corporate results suggest more downside to NPL. We moveaway from the positive bias and downgrade the sector to UW; ABC andBOC to U-PF; Bocom to SELL.

Another result disappointment

Chinese banks interim provide no joy to investors – ABC, ICBC and BOC posted anEPS YoY decline in 2Q. Even the more aggressive CMB delivered only 1.6% growth.

Falling NIM and rising credit cost are the usual culprits. And still, not enoughprovision seems to be taken in order to avoid more damage to the bottomline.

Nobody is na?ve enough to have high expectations but the NPL pickup at ICBC isalarming. It set a full year target of 1.45% yet at half year it’s already 1.4%.

More risk of SOE default

While SMEs are still the primary stress point, we worry that the faster thanexpected NPL increase might imply more spillover risk to SOEs.

They certainly posted more profit decline in July than 1H15; performance ofindustrial companies and ex-financials A-shares has also weakened.

Our preference for large banks is led by safety of SOEs. If more of them start todefault, the valuation case could be broken.

Cutting earnings again

Asset quality aside, NIM is also suffering, from rate cut and deposit liberalisation.

Loan yield fell over 20bps HoH for our coverage while deposit cost only slid 2bps.

We now expect a bigger profit decline for 15CL, by 1-6% (except CMB up small).

For 16CL, the rebound will also be much milder as credit cost moves up a notch.

Our coverage won’t need fundraising in sensitivity if we can manage pace of NPLpickup, though ROE may plunge to low single digit and some won’t make any profit.

Becoming a value trap

Valuation isn’t demanding. But there’s a strong prospect of further credit worseningand earnings downside. It’s a risk that we can’t dismiss.

We lower the discount factor applied to fair value PB in recognition of the risk; cutTPs across the board and downgrade sector to UW from OW.

We downgrade ABC and BOC to U-PF from O-PF and BUY respectively; Bocom toSELL from U-PF. CCB and ICBC remain BUY on more resilience in credit quality.