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Morningstar | China Citic Bank Recorded Strong Revenue Rebound, Raised FVE on Higher Fee Income Growth Expectation. See Updated Analyst Note from 28 Apr 2019

While no-moat China Citic Bank, or Citic’s, 8.6% net profit growth in the first quarter were on track to meet our expectation for a 6.6% growth for the full year of 2019, we’re surprised by the strong 20% year-on-year growth in total revenue and 48% growth in fee income, significantly up from the 5% growth and the 3.6% decline, respectively, in 2018. Core earnings as measured by preprovision operating profits, or PPOP surged 24% versus 4% in 2018, the fastest growth since 2016. We believe this was attributable to its rapidly-growing credit card business which represented over half of total fee income and rising net interest margin, or NIM, compared with the year-ago period. Its asset management business, which represented about 12% of total fee income, also saw recovery on low base. Besides, operating efficiency saw solid improvement with operating expense merely increasing 8% versus the 20% revenue growth.

We increase our fair value estimate for Citic to CNY 5 from CNY 4.80 for A shares and HKD 5.80 from 5.40 for H shares to reflect our expectation for higher fee income growth. Trading at 0.5 times forward price/book value for H shares, the low end of the peer valuation range, the stock appears undervalued at a 13% discount to our fair value estimate. However, we believe such a margin of safety is not enough to compensate for its higher-than-peer uncertainty, given its weak deposit base and high interbank funding reliance. Looking forward, we expect both revenue and PPOP growth will remain strong in the next one to two quarters thanks to low base in both fee income and net interest income. However, the growth is likely to taper off in the fourth quarter as a result of diminishing base effect and climbing NIM pressure.

Net interest income grew 16%, versus a 3.6% decline in the year-ago period. First-quarter NIM climbed 9 basis points to 1.96% on a year-on-year basis, while it started to fall by 4 basis points in the first quarter according to our estimate. We suspect this was attributable to rising deposit costs via the issuance of structured deposit products and lower average asset yield as the bank increased local government bond investment. Despite downward pressure on NIM, the tax-exemption feature of government bond investment resulted in lower tax rate thus benefit net profit growth. Another negative of the result is the high loan/deposit ratio, remaining at 98%, up from 95% in the year-ago period, indicating little improvement in deposit base.

Credit quality looked stable, with bad debt ratio declining 5 basis point to 1.72% from 2018. Bad debt balance remained flat at CNY 64 billion. While bad debt formation rate rose to 2.1% versus 1.8% in 2018. Credit costs surged to 2.09% versus 1.86% to accelerate bad debt disposal and improve provision coverage. As a result, provision coverage increased to 170% from 161% in 2018. We expect higher credit costs in 2019 given signs of weakening in its retail credit quality hurt by surging default risks in P2P lending platforms.