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Morningstar | Bocom's 1H Saw Quarter-on-Quarter Improvement in Fee Income and NIM

No-moat Bank of Communications', or Bocom's, first-half results remained lackluster, with net profits increasing 4.5% from the year-ago period and representing 55% of our full-year forecast. The growth was mainly driven by decrease in tax expense as the bank increased investment in local government bonds, which are tax-exempt. Excluding this, operating profits were flattish from the year-ago period. Given results were largely in line, we retained our CNY 5.90 per share fair value estimate for A shares, and lower H-share fair value estimate to 6.60 per share to reflect the latest Chinese yuan/Hong Kong dollar exchange rate. Trading at 0.6 times 2018 price/book and 17% discount to our new fair value estimate, H shares are undervalued as the market was disappointed by its slow restructuring progress. However, we expect this should speed up as new management was 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.

Second-quarter revenue growth picked up quarter to quarter to 8% from a negative 11% in the first quarter, boosted by a 3.6% fee income growth versus a negative 4% on a 20% growth in credit card-related fee income. Fueled by fast-growing mobile payment, credit card consumption grew 44% and credit card loans increased 25%. As a result, shares of credit card fees expanded to 41% of total fee income, from 25% by mid-2016. Growth in net interest income saw mild pickup from the first quarter on stabilizing net interest margin, while the NIM trend remained weaker than peers as the bank was relatively slow in restructuring its loan mix and deposit growth. Hampered by slow revenue growth and increased employee compensation as part of mixed-ownership reform and technology investment, operating efficiency deteriorated as the cost/income ratio rose to 29% from 27% in the year-ago period.

Bocom's credit quality has stabilized with bad debt ratio declining to 1.49% from 1.5% in 2017. But the bank's quarter-by-quarter improvement was at a pace slower than peers. Bad debt ratio remained flattish at 1.50% from 2017. With credit costs improved to 0.82% in the second quarter, provision coverage grew to 171%. In response to the regulator's call for stringent bad debt recognition, Bocom's bad debt balance now covered 98% of loans overdue more than 90 days, versus 89% in 2017. Management also hinted that Bocom's off-balance-sheet shadow banking exposure was less than 13% of total bank WMP outstanding and 2% of total assets, well below the 35% and 4% regulatory ceilings, indicating limited pressure regarding the implementation of new asset management rules.