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Morningstar | ICBC Saw Strong Improvement in Credit Quality, Deposit Costs Advantage Remained Intact

Following Industrial and Commercial Bank of China's solid results including net profit increasing 4.1% from 2017, we retain our CNY 6.50 per share fair value estimate for the A-shares, and HKD 7.50 for H-shares as results were largely in line. Net profit growth came in slightly below our 5% expectation as a result of increased provision expenses, while growth in preoperating provision profits, or PPOP, remained steady at 9%. In our view, such high growth indicated ICBC’s strong top line growth and its superior operating efficiency. Despite hefty technology investment in line with large peers, ICBC was able to achieve continuous improvement in cost/income ratio by 55 basis points to 23.9%, the lowest level among Chinese banks. The results are reflective of its strong customer base in both retail and corporate banking business, as evidenced by better-than-peer deposit growth and modest increase in deposit cost. Furthermore, ICBC recorded strong improvement in credit quality, with both special-mentioned loans and overdue loans balance contracting from 2017. This was not an easy task under the backdrop of a slowing economy and financial deleveraging in 2018.

With H shares trading at 0.7 times 2019 price/book and a 23% discount to our fair value estimate, which implies 0.9 times forward P/B, the stock is undervalued and we believe it’s an attractive entry point for long-term investors. The past results reaffirmed our long-term thesis that ICBC’s strong customer base and leading position in wealth management enable it to stand out. ICBC is one of our top picks for Chinese banks and we expect the bank’s prudent management should translate to steady growth in shareholders’ equity in the long run.

Net interest income grew nearly 10% on 8% loan growth and an eight basis point expansion in net interest margin to 2.30%. The bank’s deposit growth and pricing trend bear testimony to its superior customer base. Retail deposit balance grew 10% from 2017, higher than 9% growth at CCB. Its 7.2% growth in corporate deposits further set the bank apart when compared with the 4% growth at CMB and a 0.4% decline in CCB. Average deposit costs merely climbed three basis points to 1.45%, compared with the six basis point increase for CCB and 16 basis point increase for CMB. We expect ICBC’s effective customer segmentation strategy will translate to a steady deposit growth.

The past results also confirmed our better-than-peer credit quality outlooks for ICBC. Credit quality saw solid improvement, with bad debt ratio falling three basis points to 1.52%. Bad debt formation rate was 0.97% versus 0.66% in 2017 on stricter bad debt classification. While growth in leading indicators including special-mentioned loan and overdue loan balance continued the downward trend since 2014. Special mentioned loan contracted by 20% and overdue loan contracted by 6% from 2017. Credit cost modestly increased to 1.19% from 1.1%, we expect credit costs will stay at current level in 2019.