Despite recent earnings fluctuation due to policy intervention, China banks’ mid-to-long term profitability would not deviate much from macro trend, which is on a clear recovering path. As credit cost peaks out on easing NPL formation and window guidance effect abates, we could see an inflection point in 3Q20 earnings growth (narrower profit decline vs 2Q20).
- NIM pressure should ease as market rates normalize. LPR has stayed unchanged since May, and interbank rates/ bond yields rose notably from Apr trough. On liability side, the pullback in structure deposits will help to lower funding cost. PBoC’s remark over the weekend on avoiding excess easing also pointed to less margin pressure for banks. Therefore, we expect a milder NIM contraction of 4bp in 2H20, vs 9bp in 1H20.
- Topline growth to remain solid. Based on the central bank’s guidance of RMB 20tn full-year system new loans, we estimate banking sector/ banks under coverage to post 13.1%/10.5% YoY FY20 loan growth, largely stable vs 1H20. Reviving production and consumption activities are likely to spur fee income growth. As such, we anticipate FY20 revenue/ PPoP growth of 4.6%/4.2% YoY.
- Asset quality outlook improves with macro recovery and front-loading of NPL. Latest economic indicators, such as PMI/ Industrial production/ retail sales, have been rebounding from the COVID-19 shock, suggesting the worst might be behind us in terms of NPL formation. Aggressive provision charge and NPL recognition in 2Q20 created buffer for banks to lower credit cost in future. We noted that banks’ NPL/overdue loan ratio reached 99% as of 2Q20, close to 2009 peak.
- Repeat of 2016-2017 re-rating cycle? After 8.9%/18.4% YTD plunge, A/H-share China banks trade at 0.7x/0.5x FY20E P/B, near historical valuation bottom in early 2016. In the last round of bull market, A/H-share banks advanced 63%/96% from Feb 2016 to Jan 2018, outperforming CSI 300/HSI by 15ppt/24ppt. With stronger provision coverage and more thorough NPL exposure as of 2Q20 (vs end-2015), the sector is poised for a re-rating cycle once earnings downside and policy risks are fully priced in. We prefer retail-oriented JSBs. Top picks are PAB (000001 CH) and CEB (6818 HK).
