Chinese banks -2018Outlook:Positioning in policy tightening
Valuation gap to widen; earnings forecasts, valuation, catalysts and risks.
PBOC has hiked OMO rates 25bps in 2017; we expect another 20-45bps in2018, but liquidity vol. should stay ample, as we believe that, while tightening,PBOC also needs to prevent systemic risks. Indeed, in 2017, PBOC injectedRmb1.6tr liquidity mainly via MLF and PSL, equivalent in size to 100bps RRRcut or sufficient to fund 10% of banking asset expansion. Recent relaxation onautomated pledged financing suggests smaller banks in temporary liquiditytroubles should have access to bigger-amt funding provided by PBOC. Alsotemporary RRR cut during Chinese New Year may release Rmb1.5-2.0trliquidity for 1mo., which should smooth liquidity tightness by then. We expectrelatively remote likelihood of bank run in wholesale funding market.
PBOC has conducted special inspection on banks’ interbank operation for bothsettlement and investment & lending accounts during Sept 2016 to January2017, and released the results to banks in July 2017, reported by local media.
Financial deleveraging: market rate hikes, new committee, tighter regulations.
A summary of recent regulations and monetary policy measures
CBRC has approved Agricultural Bank of China’s (ABC) proposal to establishan asset management subsidiary with Rmb10bn registered capital, mainlyfocusing on market-oriented debt-to-equity swap (DES) business to supportcorporate deleveraging. Previously in July 20 this year, CCB was the first bankin China to be approved by CBRC to set up an AMC subsidiary. ABC AMC willbe a 100%-owned subsidiary under ABC, which is the largest one among allABC’s subsidiaries by registered capital. ABC has so far signed Rmb200bn DEScontracts, versus Rmb544.2bn for CCB (as of July 20). CCB earlier said it hadc.50% market share in terms of DES contract size on its website.
In the past year, China’s financial deleveraging campaign has made progress.
Implications for the system and individual banks
(DB view) Facing tighter regulation of shadow banking, we expect risingcapital pressure on smaller banks which may not be fully realized by themarket. Indeed, we have noted that 20 listed banks have announced capitalraising plans worth Rmb593bn, among which Rmb66bn will be issued viaprivate placements. In a bear case, we estimate that listed banks would haveto raise CET-1 capital of Rmb343bn, or 18% of their market cap. As tradingbelow book, listed smaller banks would probably have to slow asset growth,shift to lower-return assets and cut dividends in the near term. We prefer theBig Four and CMB, with much stronger capital bases.
China has made containing financial risks a top priority. Financial deleveragingmay last longer than expected, with higher market rates and more coordinatedbut tighter regulations. This may lead to moderate credit growth but slowerleverage build-up and hence, less financial stability risk. On the banks’ assetside, we expect supply-side reform will be strictly followed and SOE reformmay accelerate, leading to improving corporate financial health. Thus, we staypositive on the Chinese bank sector. We expect wider divergence betweenretail banks (big-4/CMB/CRCB) and the rest, as funding strength remains thekey differentiating factor; upgrading CRCB to Buy – top picks: BOC & ABC.
The pace of releasing new regulations has accelerated notably. Three ruleswere unveiled by CBRC over the weekend. The direction is clearly on thetightening side: cracking down on shadow banking and reducing wholesalefunding. On the other hand, to hold the bottom line of no systemic risks, thePBOC has increased liquidity injections (by Rmb1.6tr in 2017, equivalent to110bps RRR cuts) and announced a few pre-emptive measures, e.g. atemporary RRR cut and relaxation in the automated pledging financing facility.As such, we expect financial deleveraging to continue but the process is likelyto be orderly, given the low risk of an uncontrollable “liquidity event”.
Some banks’ local branches were also banned on interbank business for 3-6months, which can be resumed after the completion of internal risk-controlenhancement.
Supply-side and SOE reforms to relieve asset quality risks.
Monetary policy: higher rates but ample liquidity with pre-emptive measures
(DB view) We think this is part of the on-going regulation tightening andfinancial deleveraging. Nevertheless, CBRC loosened the tone in May 2017 togrant another 4-6 months phase-in period for banks to correct incomplianttransactions, and the tighter rules would be only imposed on incremental newbusinesses. We expect China’s financial deleveraging campaign to be orderlybefore the leadership transition. The campaign has already made progress bycutting off excess non-productive leverage, shortening the financing chains,and trimming shadow banking. We expect financial deleveraging to continue,resulting in elevated market rates and consistent regulatory tightening. Thisshould drive up NIM for big banks and boost loan growth for them, whilesmaller banks could be forced to slow down asset expansion due to capitaland regulatory pressure. Please refer to our report - Time to accumulate bigbanks and Financial deleveraging - slower pace, but unchanged direction.
Our proprietary study shows that c. 8-13% of China’s corporate debt wasevergreening, dropping from 9-14% in 2016 and likely to decline further.
Tighter regulations: closing loopholes, but being more coordinated
This inspection has been widely spread over 60,331 interbank accounts,including 30,421 settlement accounts of 2,664 banking branches, and 29,910investment & lending accounts of 2,310 banking branches. It is indicatedcity/rural commercial banks, village banks and rural credit cooperatives havemore irregular interbank activities due mainly to weaker risk awareness thanlarge banks, and the number of local banks’ violations accounted for41.2%/43% irregular cases in investment & lending / settlement accounts.
The other smaller banks will experience ongoing funding and capital pressure.
Longer term, we see most deleveraging measures as necessary to strengthenChina’s financial stability, generating net positive to financial system and realeconomy. Near term, for financial system, we expect slower banking assetgrowth, modest yield curve steepening & lower actual risk-free rate. For realeconomy, we forecast moderate credit growth with shrinking shadow bankingand hence, slower economic growth. Yet, it should come with benefit ofslower build-up in leverage & better transparency. Retail banks (big4/CMB/CRCB) should benefit from higher rates & yield curve steepening due tosolid deposit franchises. Other smaller banks will experience ongoing fundingand capital pressure. Our order remains BOC/ABC/CCB/ICBC/CRCB/BoCom.Catalysts: better results, introduction of CCyB and D-SIB, apt. of governor ofnew committee and Southbound inflow.
Bank of Nanjing (BONJ) announced that it will issue 1.70bn shares to 5targeted investors including Nanjing Zijin Investment Holding (181.7mnshares), Nanjing Gaoke (72.7mn), Jiangsu Communication Holding (647.7mn),Taiping Life Insurance (458.0mn) and Jiangsu Phoenix Publishing & MediaGroup (335.9mn) with capital raised up to Rmb14bn, implying a maximumsubscription price of Rmb8.25, 3% above the last closing price or 1.17x 2017P/B. The five targeted investors commit a 3-year lock-up period post thesubscription. Among the five investors, Taiping Life is controlled by MOF andthe rest four investors are all local SOEs. Nanjing Zijin and Nanjing Gaoke arethe existing shareholders which held 23.1% stake in BOBJ before the deal;Taiping Life also held 0.17% stake. We estimate the private placement wouldboost CET-1 ratio by 2.1ppt to 10.25% based on 1Q17 RWA number. BONJCET-1 ratio was only 8.14%, the lowest among listed Chinese banks.
China has pledged to deepen supply side reform. Our recent field trips showedthat local governments are rigorously carrying out de-capacity efforts thatrebalance supply-demand dynamics. SOE reform has also been accelerating,with a rising number of mixed-ownership pilot runs and notable progress inremoving social responsibilities. As a result, the improvement in corporatefinancial health, especially for industrial enterprises (22% of China’s debt) andSOEs (35%), will probably be sustained in the coming quarters (note), albeitwith slower net profit growth. This should lead to less NPLs, rising provisionwrite-backs and reduced asset yield pressure given fewer “evergreening” loans.
Since the first meeting of the Financial Stability and Development Committeeon 8Nov 2017–the “super-regulator” coordinating financial regulators–thepace of releasing new regulations has accelerated notably (Fig. 2). Thisweekend, the CBRC released 3regulations targeting entrusted loans, banks’concentration risks and shareholding management. These regulations, ingeneral, target a crack down on shadow banking by closing loopholes andreducing regulatory arbitrage. What makes this round of tightening differentfrom the past is that with the new committee leading, the regulations are morecoordinated and most have considerable grace periods. Starting with TheAsset Management Guideline (note), an overall guideline, the regulations aretargeting particular sub-markets/sectors one-by-one and step-by-step.
PBOC also highlighted in the report, asking 40 financial institutions (includinglocal branches) to strengthen up internal risk control, including ABC, MSB,CCB, BOC, CMB, PAB, ICBC, Heng Feng Bank, BONJ, Hua Xia Bank, CEB.
In 2017, retail banks (big-4/CMB/CRCB) have outperformed other banks by28ppt. We re-rate further on stabilizing ROE. We forecast 6.5%/8.5% yoygrowth in 2018/19 vs. 4.3% yoy in 2017E. Reflecting the rollover of book valueinto 2018E and exchange-rate adjustment, we lift TPs by 15%/8% for H/Asharebanks. We upgrade CRCB to Buy and CEB-H and BOCQ to Hold. Ourpecking order is: BOC/ABC/CCB/ICBC/CRCB. Catalysts include results: introductionof CCyB and D-SIB and Southbound inflow. For smaller banks, wemight turn positive if the PBOC starts loosening. Upside risks: removal orsoftened GDP target and more aggressive SOE reforms. Downside risks:disorderly deleveraging and property price correction.
Yet we are probably still in the first half of the process, as M2/GDP and creditto-deposit ratios remain elevated. We expect monetary policy and macroprudentialpolicy to stay on the tightening side. Our rates strategist expects ahike total of 20-45bps in OMO rates until 2018 (note). New regulations on assetmanagement (note) and liquidity risks (note) will be phased in. With theFinancial Stability and Development Committee – the new committeecoordinating financial regulators – leading, more regulations are likely to befollowed. System wise, we expect slower credit growth, shrinking shadowbanking and less reliance on wholesale funding. Retail banks should benefitfrom higher rates and yield curve steepening due to solid deposit franchises.
Another year of divergence among banks; still prefer retail-oriented banks.
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