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Morningstar | BOCOM Posted Strong Rebound in Fee Income and Net Interest Income Growth in 3Q

No-moat Bank of Communications, or Bocom, posted a solid third-quarter results, highlighted an accelerating growth in total revenue. Third-quarter total revenue and net profits growth picked up to 21% and 7.1%, respectively, versus a 1.8% decline and 4.6% growth in the revenue and net profits in the first half. The strong rebound was primarily driven by robust year-on-year growth in net interest income (at 9.3%) and investment income (at 118%), while fee income remained relatively steady, contrary to significant declines for most peers. Fee income grew 9.2%, boosted by a rapid growth in credit card and cash settlement-related incomes. Bocom’s credit card business became the spotlight of recent results, issuing over 70 million cards and total spending growing 40% to over CNY 2 trillion, ranking only second to China Merchants Bank in terms of credit card spending. Representing 78% of our full-year net profit forecast of CNY 73.8 billion, the first three-quarter results were large in line with our expectation. We retained our fair value estimate at CNY 5.90 per share for A shares and HKD 6.60 for H shares. Trading at 0.6 times 2018 price/book and 14% discount to our fair value estimate, H shares are slightly undervalued, but we believe the discount is not enough to compensate for the risks. Though the market was disappointed by its slow restructuring progress, we believe quarter-on-quarter rebound in core revenue growth has been encouraging. We expect the restructuring will speed up after the new management is on board in mid-2018. The bank's elevated efforts in credit card and asset management business in the following quarters should support its continuing mild improvement in fee income.

Net interest margin further expanded to 1.47% from 1.41% in the first half, indicating a 9-basis point increase in the past quarter. The improvement was higher than peers, thanks to its increased allocation into bank loans and local government bonds, and relatively steady funding costs. Leveraging the capital released by recent RRR cuts, the bank expects to increase CNY 50 billion for new loans in the second half, resulting in a 8.5% full-year loan growth versus 11.6% in 2017. The increased local government bond investments also boosted NIM, of which aftertax yield already trading at 40 basis points above central government bonds. On the liability front, the benefits of a 12-basis point decline in interbank funding costs to 3.15% was largely offset by increased deposit costs while deposit balance remained flat over the quarter. Looking forward, management expect NIM will remain steady, given resilient demand for bank loans due to ongoing shadow banking credit contraction. While we suspect longer-term NIM will face rising downward pressure as funding costs are likely to climb at a faster pace.

Credit quality in the past quarter remained steady, with bad debt ratio was flat at 1.49% from mid-2018. The bank increased credit costs by three percentage points to 1.12%, doubling from the year-ago period. Retail loans accounted for about two third of total new loans over the quarter as credit quality in corporate sector is still concerning. Management noted that both overdue loan balance and percentage of total loans continued to decline. Proportion of loans overdue more than 90 days has dropped to 1.35%, indicating prudent bad debt classification. Bad debts remained concentrated in manufacturing and wholesale sectors in Shangdong, Yunnan and Sichuan provinces. The bank spotted a rising trend in zombie firms from Northeastern area. Though the impact of worsening trade tension has yet been felt for banks, management noted slowing economic activities in areas including Shanghai, Jiangsu and Guangdong. Despite slowing bad debt formation rate, we expect credit costs will remain high at current level.