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Morningstar | CCB Delivers Steady Net Profit Growth in 2018; Inclusive Finance Becomes a Key Strategy

Narrow-moat China Construction Bank posted good 2018 results, featuring steady 6% growth in revenue. Net profit growth slowed to 5.1% from 6.4% in the first three quarters. The slowing growth was primarily attributable to increased provision expense in the fourth quarter, while growth in preprovision operating profits stayed steady at 8%. Given the result is largely in line, we retain our fair value estimates of CNY 7.20 for the A shares and HKD 8.20 for the H shares. Trading at a 17% discount to our fair value estimate and 0.7 times 2019 price/book assuming 10% growth in book value per share (versus an 11% compound annual growth rate over the past three years), the H shares appear undervalued, in our view, as the market is overly concerned about CCB’s credit quality, given the weakening economy. While CCB has one of the lowest-risk loan portfolios among Chinese banks, government-led infrastructure loans and home mortgage loans accounted for 25% and 34% of total loans, respectively. Bad-debt ratios of such loans are low at 0.92% and 0.24%. We believe large banks including CCB have among the strongest customer bases, low shadow bank exposure, and industry-leading capital strength and profitability, which should enable them to better steer through challenges.

The 7.5% growth in net interest income was a bit slower than peers including ICBC and CMB. Fourth-quarter net interest income fell 4.5% from the previous quarter on zero growth in loan and interest-earning assets and an estimated 12-basis-point decline in net interest margin over the quarter. Management explained the decline was a result of rising deposit costs and lower loan pricing related to inclusive finance credits. Looking into 2019, we expect a slight decline in NIM given ongoing deposit competition and a falling rate environment.

CCB is the largest inclusive finance lender in China, with its loan balance growing over 50% to CNY 631 billion, or 4.5% of total loans in 2018. Average loan pricing for new inclusive loans granted in the past quarter has declined 1 percentage point to 5.29% from the first quarter of 2018. The bank looks to ramp up the business with via digitalization in five key work processes: mass customer acquisition, customer persona mapping, automatic approvals, AI-based risk management, and comprehensive services. With the help of technology, the bad-debt ratio for new loans granted in 2018 stood below 0.4%, much lower than the 8% in the past, according to management. We have observed a trend that leading Chinese banks including CCB and ICBC and fintech companies are increasing their focus on inclusive finance. Though we believe these large players are best positioned to meet the underserved market needs, we remain skeptical about the robustness of their newly built risk management system. However, the prudent management culture and strict capital requirement given us confidence that CCB will not advance rashly into this untested territory in the near term.

Credit quality has stabilized, with bad-debt ratio slid 1 basis point to 1.46%. The bad-debt formation rate rose to 1.02% from 0.69% in 2017 on stricter bad-debt recognition. CCB increased credit costs to 1.36% from 0.84%, lifting provision coverage ratio to 208% of bad debts, one the highest levels among Chinese banks. Both overdue loans and special-mentioned loans grew 6% from 2017. We expect credit costs will stay at the current level in 2019.