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Morningstar | First-Half Growth for ICBC Was Strong and Credit Quality Trend Was Better Than Peers'

With growth in revenue and net profit accelerating to 7% and 4.9%, respectively, from the year-ago period, narrow-moat Industrial and Commercial Bank of China delivered another set of strong results in the first half. With the results representing 52% of our projected full-year net profit, ICBC is well on track to deliver our forecast 5% net profit growth in 2018. Though bottom-line growth seemed unimpressive, growth in core revenue including net interest income and fee income were both at the high end among ICBC's Big Four peers, boosted by its steady net interest margin expansion and fast-growing fee income from credit card and settlement services as the high-quality customer base continued to grow. ICBC saw lower-than-peer impact from the new asset-management rules, as evidenced by its outstanding balance of bank wealth management products growing over CNY 300 billion to CNY 3.37 trillion while related fee income declined 13%, versus large contractions in both metrics for peers.

We retain our CNY 6.50 per share fair value estimate for the A shares, but lower our H share valuation to HKD 7.50 from HKD 8 per share to reflect the latest CNY/HKD exchange rate. With H shares trading at 0.8 times 2018 price/book and a 20% discount to our fair value estimate, which implies 1 time forward P/B, the stock is undervalued on the market’s renewed concerns about banks’ credit quality as economic reform deepens amid escalated trade war tension. We believe ICBC has better-than-peer credit quality. It has been focusing in loan mix optimization since 2013, and the bad-debt formation rate has slowed consistently. New loans granted since 2013 represented over 70% of total loans and the bad-debt ratio was low at 0.88%. ICBC has also disposed of nonperforming loans, which represented about 6% of total loans since 2014, and current provisions cover nearly 3% of loans. This, plus the bank’s strong profitability, makes us confident that credit risks for ICBC should be manageable.

Net interest income grew 10.6% on a 14-basis-point increase in NIM. ICBC’s strong deposit costs were again illustrated by higher-than-peer deposit growth at 6% from 2017 and its ability to maintain flat deposit costs, which was difficult to achieve amid intensifying competition for a bank with the largest market share. Similar to large peers, ICBC saw slowing loan growth when compared with the previous two years, with an increase of 5% from 2017. Average loan yield rose 20 basis points, in line with industry trends. Retail loans accounted for about 50% of new loans in the first half, with home mortgage and credit card being the primary drivers. In light of climbing risks in personal consumption loans as defaults in peer-to-peer platforms continued, ICBC also scaled back this loan category by CNY 30 billion.

Credit quality showed better trend than peers, with the bad-debt ratio continuing its downward trend since late 2016, falling 1 basis point to 1.54% from 2017. Provision coverage further strengthened to 173% of bad debts. Contrary to some banks seeing a rebound in special-mention loans and overdue loans, these two indicators both declined 14% and 6% from 2017. The bad-debt ratio of retail loans fell 10 basis points to 0.8%, while that for corporate loans rose 2 basis points to 2% on a weakening economy. Management was confident about ICBC’s credit quality outlook, given that lower-risk retail loans now represent over 35% of total loans, and the spread between loans overdue more than 90 days over bad debts has declined to CNY 39.6 billion from the peak of CNY 190 billion in February 2016. Credit costs rose to 1.14% from 0.94% in 2017, and we expect full-year credit costs to reach a similar level.