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Morningstar | PSBC’s First Half Posted Strong Growth Momentum Amid Weakening Credit Quality

With a 25% increase in revenue and growth of 22% in net profit, no-moat Postal Savings Bank of China’s first-half results posted accelerated growth compared with the first quarter, which already exhibited the strongest growth among listed Chinese banks we cover. The results are in line with our expectations, with net profit reaching CNY 32.5 billion, which contributed 56% of our forecast full-year net profit of CNY 57.9 billion and is well on track to deliver our projected 22% growth. We retain our major assumptions while lowering our fair value estimate to HKD 5.50 from HKD 6.00 per share to reflect the latest Chinese yuan/Hong Kong dollar exchange rate. The stock is trading at a 16% discount to our fair value estimate and 0.78 times 2018 price/book, assuming 11% growth in book value per share. We believe the bank is undervalued, given our fair price/book ratio of 0.9 times. We believe its strong growth momentum deserves a better-than-peer valuation. Though we’re a bit disappointed to see signs of weakening credit quality due to stricter regulatory requirement and rising macroeconomic uncertainty, we acknowledge that PSBC’s credit quality remains stronger than peers. The results confirmed our long-term thesis that PSBC will continue to stand out, thanks to its strong deposit base and low loan/deposit ratio; these support faster-than-peer loan growth and NIM expansion, which were also evident in its past results. The fast-growing scale also translates to continuous improvement in operating efficiency.

PSBC also witnessed strong improvement in return on equity and capital position, with ROE rising 1.4 percentage points to 16.3%, and its core Tier 1 ratio improving to 9% from 8.6% in 2017, without external capital injection. This ROE level is on par with the Big Four banks; this was partly attributable to its weaker capital position when compared with the 11%-13% range of core Tier 1 ratios for those banks. We expect the upcoming A-share IPO will dilute its ROE in the short term, while this should better support its future fast growth and boost investor sentiments.

Net interest margin rose 33 basis points to 2.64%, the strongest expansion among peers. Though growth in deposit was not strong, the bank further lowered average funding costs by achieving flat deposit costs and increasing financing from lower-yield interbank financing. Benefiting from reserve requirement ratio, or RRR, cuts, PSBC increased asset allocations to bank loans and interbank assets, which represent 44% and 10% of total interest-earning assets respectively. The proportion of bond investments contracted by 3 percentage points to 31% of total assets, hurt by tightening shadow-banking rules. As a result, average asset yield expanded 26 basis points while average funding cost declined 1 basis point.

Credit quality showed signs of weakening as judged by financial data, with the bad-debt ratio rising 12 basis points to 0.82 from the first quarter and reversing the downward trend since late 2016. We believe this was driven by rising defaults for certain peer-to-peer platforms when regulations tightened and stricter bad-debt recognition as required by the regulators. As a result, bad debts increased in corporate loans in the finance, trade, manufacturing, and transportation sectors. Credit quality in retail consumption loans, personal operating loans, and small business loans also weakened. Credit costs increased to 1.45%, double 2017’s 0.78% level. Despite less optimistic trends, PSBC’s credit quality remained much better than peers, with the bad-debt ratio and special-mention loan ratio staying at about 50% and less than 30% of the industry average, respectively, and its provision level 100 basis points higher than the industry average.