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Morningstar | China Citic Bank Records Strong Net Interest Margin Expansion, Weakened Loan Quality in 2018

No-moat China Citic Bank’s 2018 results were largely in line with our expectation, with growth in total revenue steady at 5.2% and net profit growth narrowing to 4.6% versus 5.9% for the first three quarters. The deceleration in net profit growth was primarily attributable to increased provision expense in the fourth quarter. We retain our fair value estimates of CNY 4.80 for the A shares and HKD 5.40 for the H shares. Trading at 0.5 times forward price/book value for H shares, the low end of the peer valuation range, the stock appears slightly undervalued at a 7% discount to our fair value estimate. However, we believe such a margin of safety is not enough to compensate for Citic's higher-than-peer uncertainties, given its weak credit quality and high interbank funding reliance.

As its corporate banking restructuring is coming to an end, Citic will put more effort into its retail banking transformation. Retail banking performance in 2018 was a bit disappointing. Despite 5% revenue growth, net profit from this segment dropped 22% on increased provision expenses. The share of retail banking profit declined to 29% from 39% of the bank’s total profits in 2017, while revenue contribution remained steady at 35%. There are early signs of worsening quality of retail loans, as credit card loans saw the bad-debt ratio increasing 61 basis points to 1.85% in 2018. The overdue rate climbed 84 basis points to 3.59% in 2018. This category has grown at a 35% compound annual growth rate over the past three years and represented 12% of total loans. We also estimate the bad-debt ratio of other non-home-mortgage personal loans stands above 1.5%. Accounting for 23% of total loans, inclusive finance, credit card, and other personal loans will remain growth drivers for the bank’s loan portfolio, in our view. However, we lack confidence in the quality of such loans, given their fast expansion pace in the past.

The results highlighted a 15-basis-point expansion in net interest margin to 1.94% from 2017. Benefiting from lower wholesale funding costs after the central bank’s liquidity injection in the second half of 2018, Citic saw its NIM expand quarter by quarter in 2018. The bank also increased its loan portfolio by 11% by scaling back lower-yield bond investment and other financial investment; as a result, average return on interest-earning assets rose 25 basis points to 4.86%. Deposit growth recovered to 7% in 2018 versus a 6% decline in 2017. This was driven by 8% growth in corporate deposits while retail deposits remained flat and represented just 15% of total deposits. We expect increasing pressure on Citic’s NIM level in 2019, given weakening corporate credit demand amid a falling interest rate environment and weak retail deposit base.

The bad-debt ratio rose 9 basis points to 1.77% from 1.68% in 2017. In response to the regulator’s call for stricter bad-debt recognition, Citic started to recognize 100% of loans overdue more than 90 days as bad debt. The provision coverage ratio improved to 161% from mid-2018 as credit costs increased while remaining below last year’s level at 169%. Such provision coverage ratio remained low compared with peers. The bad-debt ratio of corporate loans climbed to 2.61% from 2.27%, with the Bohai Rim region and northeastern region contributing the largest amount of new bad debts in 2018. Balances of special-mentioned loans and overdue loans grew 24% and 6% from 2017, versus a 10% and 2% respective decline in 2017, indicating weaker trend of its loan quality than peers. We expect increasing provision pressure for the banks in the coming quarters.