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Morningstar | CMB's 1H Preliminary Results Showed Strong Fee Income Rebound. See Updated Analyst Note from 26 Jul 2018

Following narrow-moat China Merchants Bank's, or CMB's, preliminary results, we increase the bank's fair value estimate to CNY 26 from CNY 24, or to HKD 31 from HKD 29 to reflect our more optimistic assumption for future fee income growth. The results saw a 11.5% growth in revenue and 14.6% growth in net profit for the first half of 2018, steadily improving from the 7.2% and 14.8% respective growths in the first quarter. A strong rebound in fee income growth in the past second quarter was an upside surprise to the market, leading to a 17.6% year-on-year growth in the first half, versus a 1.5% growth in the first quarter. Given the lack of disclosure, we suspect the strong recovery was driven by credit card installment fees, which represented about 28% of total credit card-related income in 2016, according to China Union. Thanks to rapid growth of e-commerce and changing payment behaviors, installment purchase become increasingly popular in China. CMB's leading position in the booming credit card market was attributable to its large customer base given its status of the third-largest card issuers in China, and its popular mobile application with monthly active users over 30 million, far exceeding joint-stock bank peers. We also expect the regulator's recent easing of bank wealth management product control will benefit large banks with high exposure to asset management business such as CMB. The stock is fairly valued, trading at a 2% discount to our new fair value. CMB has been trading at valuation premium against large banks including ICBC and CCB, as CMB lead the industry in asset quality improvement and retail banking transformation.

Another revenue driver, net interest income saw slight decline in growth at 6.9% over the second quarter, versus 8.7% in the first quarter. We suspect it was driven by slight decline in net interest margin, or NIM, given mounting competitive pressure for deposits. CMB's loan growth accelerated to 4.4% from 3.1% in the year-ago period, while deposits growth fell to 2.8% from 6.9% in 2017. We expect CMB will achieve steady NIM level in 2018, as deposit competition should gradually ease off in the coming quarters given tighter financial regulation in place and the economic growth slowdown.

Strong improvement in credit quality during the past quarter was another positive of the results. Bad debt ratio further declined by five basis points to 1.43% by end of June, after a 13 basis point decline in the first quarter. The improving trend is likely to indicate loan quality of leading banks has yet to be negatively impacted by rising bond defaults due to tighter shadow banking controls.