1H16 profit growth was 33% y-o-y, up from 23% in 2H15 and above our full yearestimates. The strong 1H16 bottom line growth was mainly due to a 68% y-o-ydecline in impairment charges as PPOP grew by only 2%.
What we liked: (i) income from TDA (NPLs acquisition and disposal from financialinstitutions) rose by 195% y-o-y on a low base. The company further reduced itsaverage turnover period to only slightly above 1 month from 4 months in 1H15,according to our estimate. We continue to believe such flow-based TDA business, i.e.fast TDA turnover, is an appropriate strategy in an unfavourable macroeconomicenvironment. (ii) The calculated funding cost in 1H16 was 3.88%, down 79bps h-o-hon larger drop of borrowing cost.
What we disliked: (i) Impaired RDA (RDA are mainly lendings extended to nonfinancialenterprises with temporary cash flow issues) rose by 20% h-o-h, significantlyslower than the 49% growth of over 90-day overdue RDA; as a result, impaired RADrecognition ratio (impaired RDA / over 90-day overdue ) declined by 12ppt to 49%.Lower recognition may lead to more provision in 2H, in our view. (ii) Despitecontinuous worsening of RDA asset quality, the company had RMB733mn write-backof provision (vs. RMB8bn charges in 2015), a major driver for earnings growth.
Other points of interest: (i) The IRR of TDA declined to 16.2% in 1H16 (vs. 17.0%in 1H15 and 20.2% in 2015). (i) Total NPLs acquired from financial institutions rose138% y-o-y to RMB80bn, with those from large banks, join-stock banks and non-bankFIs growing by 142%, 550% and 65% respectively. (1) Income from DES fell 91% yo-y on unfavourable market conditions. (3) Capital ratio declined by 104bp h-o-h to13.7% as of 1H16.
Remain Hold on Huarong, raise target price raised 3% to HKD3.40 as we tune up2016-18e earnings by 7% on lower impairment charges. Our TP implies 10.7%upside and we rate the stock Hold: our investment thesis is that while Huarong hasexpanded its TDA business in the past two years, we expect it to continue to growthe RDA business faster than peers. In an economic down cycle, we believe thecredit risks associated with RDA business will be much higher than traditional lendinggiven the lower quality of borrowers. Huarong trades at 0.9x 2016e PB, which wethink is broadly fair value.