Results beat. China CITIC Bank reported 1Q19results on Thursday. Total loans as of 1Q19 grew 13% YoY andtotal deposits grew by 9%. NIM increased to 1.96% in 1Q19 from 1.79% in 2017 and 1.94% in 2018. Netinterest income reported 16%YoY growth, while non-interest income reported 25% YoY growth. Totalrevenue reached Rmb47.4bn, representing 19.6% YoY growth. Net profit arrived at Rmb13.2bn and basicEPS reached Rmb0.27, representing 8.6% YoY growth, 4% higher than our expectation. Its NPL ratio reached1.72% as compared to 1.68% in 2017 and 1.77% in 2018. Coverage ratio reached170% as compared to169%by end 2017 and 158% by end 2018.
Regaining confidence. We are turning more positive on the banking sector. There were three majorconcerns, including narrowing NIM, weakening asset quality and rising capital pressure, when wedowngraded the sector rating to Equalweight in last Dec, but now we notice three major marginalimprovements: （1） NIM: We notice preliminary signal of economic stabilization like improving infrastructureand property investment as well as stabilizing export and consumption growth in Mar 2019. This hasresulted in improving effective loans demand and rising risk appetite from banks. The proportion of midlongterm enterprise loans reached 41% in 1Q19 as compared to 36% in 2018, 46% in 2017 and 33% in 2016,which will lead to rising loans yield. Looking forward, with the deceleration of monetary loosening, the risinginterest rate curve in the interbank market and bond market will improve the pricing power of bank loansand relieve the NIM contraction pressure in 2019.（2） Asset quality: According to our bottom up analysis onthe solvency of listed companies, the potential default ratio increased from 3.43% in 2017 to3.69%in 2018,much lower than that of 11.5% in 2015 and 5.9% in 2016. Looking forward, the default ratio may start todecline amid economic stabilization and bank asset quality may improve if the government lower itsrequirement on banks’ loans offering toward private and small firms. Moreover, the CBIRC raised the NPLclassification criteria in 2018 that overdue loans with more than 90 days have to be identified as NPLs andbanks have to charge stricter provisions under IFRS9 implemented since 2018.Therefore, banks havebecome more prudent in their risk management.（3） Capital pressure. Thanks to the recovering earningsgrowth and various capital replenishment tools, the total CAR increased from 14.0% in 2017 to 14.6% in2018, and banks’ payout ratio increased from 27% in 2017 to 29% in 2018.This indicate fluent capitalreplenishment channels such has convertible bonds, perpetual securities, preferred shares and capitalbonds, which provides attractive safety margin for banks. Backed by these marginal improvements, we areregaining confidence on the sector.
Top picks. On retrospect of the investment clock of HK listed China banks, banks do enjoy absolute returnfrom improving fundamental and recovering valuation when the economy is stabilizing and rate curving isrising. Currently banks are trading at 0.65x 19E PB. Since we downgraded the sector, it only rallied by 6%,underperforming the HSCEI by 7ppts. Given the recent bottoming out of economic outlook, deceleration ofmonetary easing and laggard share performance, banks may also report relative returns. We favor those bigand medium sized banks with cheap valuation, SOE backgroud and laggard share performance in thepreliminary stage of economic stabilization in 2Q19,while investors could buy those small banks withaggressive asset portfolio if we see a comprehensive recovery of macro economy and rising interest ratecurve in 2H19.
Upgrade to Buy. We revise up our EPS forecasts toRmb0.97 in 19E （+9.5% YoY）， Rmb1.07（+10.8% YoY） in20E and Rmb1.19（+11.0% YoY） in 21E.Currently CITIC is trading at 0.46x 19E PB. Since year to date, it onlyrallied by 4%, as compared to the sector average rally of 6% and HSCEI increase of 13%. We maintain itstarget 19E PB at0.55x and revise up TP to HK$6.03. With 21% upside, we upgrade to Buy.