EUR 850.00 For Business Accounts Only

Morningstar | BOC’s 2018 Growth Weaker than Peers on Rising Deposit Costs, Credit Quality Stable

Following narrow-moat Bank of China’s, or BOC’s, 2018 results, we retained our fair value estimate of CNY 4.0 for A-shares and HKD 4.40 for H-shares as results were largely in line. Revenue growth accelerated to 4.3% from 3.3% in the first three quarters, while net profit growth slid to 4.5% from 5.3% on increased provision expenses in the fourth quarter. Trading at 19% discount to our fair value estimate, H-shares remain undervalued as current stock prices merely imply a 0.6 forward price/book value, or around 14% implied bad debt ratio. Despite a weaker 2018 growth compared with big four peers, we believe its solid deposit base, leading position in the cross-border banking and first-mover advantage in international platform, should bode well for the long run. In particular, we expect the bank will become one of the largest beneficiaries from rising integration of Guangdong-Hong Kong-Macao Greater Bay Area, thanks to its leading position in Hong Kong and Macao. The market seemed overly concerned with its credit quality and ongoing business restructuring. Its solid fundamentals should support our five-year ROE forecast at an average of 12% and such strong profitability is able to absorb loan risks gradually.

Compared with large peers, BOC posted weaker topline growth and slower improvement in operating efficiency. The 6% growth in net interest income was lower than the 7% to 10% of peers. Fee income contracted by 1.7%, while its peers posted growth at 4% to 7%. BOC recorded 25 basis point improvement in operating efficiency, but such improvement pales when compared with the 50-170 basis point increase of peers. Thanks to continuous expansion in net interest margin, or NIM, quarter by quarter, growth in preprovision operating profits, or PPOP, picked up to 5.6%. However, it remained lower than the 8% to 16% range of big four peers. The past results reflected BOC was more negatively impacted by intensifying deposit competition and shadow bank deleveraging in 2018.

NIM increased 6 basis points to 1.90% from 2017 on a group level and NIM for mainland Chinese business climbed seven basis points to 2.11%. The pace of expansion was at par with peers while the absolute level was lower than peers of over 2.30%. We believe this was attributable to higher deposit pressure for BOC. The 10% deposit growth was impressive among large peers; however, we suspect the growth was partly via the issuance of high-cost structure deposits and certificate of deposits, which saw its proportion increased to 7.5% of total deposits versus 5.9% in 2017. As a result, average deposit costs climbed 11 basis points to 1.63%, versus a low-single-digit increase for most peers. Looking into 2019, we expect a slight decline in NIM. We see no signs of easing competition among banks for low-rate deposits as these banks are increasingly focusing on enhanced customer experience via digital investment. BOC’s significant exposure to overseas markets should partly offset such pressure.

Credit quality was stable, with bad debt ratio dropping 3 basis points to 1.42% and bad debt balance grew 5% to CNY 167 billion mostly on worsening credit quality in manufacturing and wholesale sectors. Bad debt formation ratio rebounded slightly to 0.91% versus 0.86% in 2017 on stricter bad debt classification. While growth in leading indicators including special-mentioned loans and overdue loans rebounded to 8.0% and 8.4%, versus a 2% increase and a 5% decline, respectively, in 2017, as impacted by slowing economy and rising uncertainties in international trade. Credit costs improved four basis points to 0.88% and provision coverage rose to 182%. Bad debt classification is prudent as evidenced by the bad debt to loans overdue more than 90 days ratio, which is standing at 217%. We expect credit costs will remained at current high level for the next three years.