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Morningstar | Citic’s fee income continued to contract amidst signs of worsening credit quality. See Updated Analyst Note from 02 Sep 2018

The lackluster growth of no-moat China Citic Bank’s first-half results reflected the bank facing rising difficulties in rebalancing its asset and liability mix amid stricter regulation and slowing economy in China. Its credit quality seemed to suffer larger than peer impacts during the period, given ongoing shadow bank contraction and the regulator’s stricter rules to recognize and dispose bad debts. Growth in total revenue and net profits slightly picked up to 5.9% and 7.1%, respectively, from the year-ago period. Net profits were well on track to deliver our forecast CNY 45 billion or 5.7% year-on-year growth in 2018.

Following the results, the valuation benefits of our increased NIM forecast was offset by increased credit costs projection in our DCF model, leading to our unchanged A-share fair value estimate at CNY 4.80 per share, but we lower our H-share fair value estimate to HKD 5.40 from HKD 5.90 per share to reflect the latest CNY/HKD exchange rate. Trading at the low end of valuation range of peers, the stock is slightly undervalued. However, we believe such safety margin is not enough to cover its higher-than-peer uncertainties given its weak credit quality and high interbank funding reliance.

Unlike most peers seeing a strong rebound in fee income and first-half growth turned positive, Citic's fee income growth dropped 3.9% as the bank saw income contraction was more broad-based when compared with peers. Hurt by the new asset management rules, agent sales and custody related fee income dropped 3% and 43%, respectively, these two items accounted for 22% of total fees. Financial consulting and settlement services also dropped 22% and 13% respectively, and representing 13% and 3% of total income. We believe this indicate weakening corporate customer base of the bank. The 16% growth in Citic's bank card service fee was lower than peers and was not enough to turn overall fee income growth into positive territory.

Our credit quality outlooks were overshadowed by the significant increase in special-mentioned loans and lower provision level. Bad debt ratio rose 12 basis points to 1.8% from 2017, with bad debt balance growing 13% to CNY 60.9 billion. Driven by weakening economy and the regulator's stricter rules in bad debt recognition, special-mentioned loans surged 25% from 2017, in sharp contrast to a 7% decline in the year-ago period. Though overdue loan balance remained flat, loans overdue within 90 days rose 5%. This indicated rising risks of weakening credit quality in our view. The bank’s bad debt classification became stricter, with bad debts now covering 106% of loans overdue more than 90 days. The 1.59% credit costs was lower than the 2017’s level at 1.84%. We see higher-than-peer provision pressure for the bank as provision coverage fell to 151% from 169% in 2017.