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Morningstar | Agricultural Bank of China's 1Q Saw Rising NIM Pressure; Fee Income Growth Strongly Rebounded

As expected, first-quarter results of narrow-moat Agricultural Bank of China's indicated rising pressure on net interest margin, or NIM, for the large Chinese banks as the impact of monetary easing has gradually translated to lower margins for its bank lending business, since the fourth quarter of 2018. Though, the slowdown in net interest income (at 1.4% versus 14% in the year-ago period) came in a bit lower than our expectation, its strong fee income recovery at 25% resulted in the total revenue growth of 11%, which is in line with our expectation. Net profit growth slightly slowed to 4.3% from 5.4% on higher credit costs, but remains on track to deliver our 7% expected full-year growth. We believe such revenue fluctuations are short-term in nature and won’t change our medium-term assumptions for the bank. As such, we retain our fair value estimates at CNY 4.20 for the A shares and HKD 4.80 for the H shares given its strong fundamentals are intact. H shares appear undervalued, trading at a 23% discount to our fair value estimate and 0.6 times 2019 price/book. We believe the market has overlooked Agricultural Bank of China's strong improvement in operating efficiency and enviable funding cost advantage.

As major short-term liquidity lenders, large banks’ NIM pressure was exacerbated by a sharp decline in interbank rates and bank bills discount rates over the quarter. They had little benefit from falling interbank funding costs as their funding is primarily customer deposits, and competition remains fierce. As a result, growth in Agricultural Bank of China’s first-quarter net interest income slowed to 1.4% from 14% in the year-ago period. NIM fell by 10 basis points to 2.10% from the fourth quarter of 2018, according to our estimate. Average asset yield dropped 3 basis points and average funding costs climbed 7 basis points as shares of fixed-term deposits increased. On the bright side, fee income growth saw a strong rebound at 25% versus an 8% decline a year ago. We suspect rapid growth in bank card business and online banking transactions primarily boosted this. Agent sales of mutual funds and insurance products are likely to see strong year-on-year recovery given the favorable base effect and strong A stock market rally in the past quarter. Looking forward, we expect NIM pressure will ease off in the second half, due to limited downside in average loan pricing as the PBOC’s policy stance becomes less accommodative.

Credit quality looked stable; the bad debt ratio dropped 6 basis points to 1.53% from 2018. Bad debt balance slightly increased 1.4% to CNY 192.7 billion. The bank increased provision expenses and accelerated bad debt disposal over the quarter. Credit costs increased to 1.38% versus 1.21% in 2018. Provision coverage slightly dropped to 239% from 252%, remaining at the high end of listed banks. In light of seasonal patterns, we expect Agricultural Bank of China’s credit costs to decline slightly in the coming quarters, with full-year credit costs standing slightly above 2018's level.