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Morningstar | CCB’s First-Half Results Stronger on Larger-Than-Peer NIM Expansion and Fee-Income Growth. See Updated Analyst Note from 30 Aug 2018

Narrow-moat China Construction Bank, or CCB, posted solid first-quarter results featuring 6.1% growth in revenue and 7% growth in net profit. The result was largely in line with our expectations, and the firm is well on track to deliver our forecast of 8% growth in 2018. The results highlighted strong net interest margin, or NIM, expansion; healthy recovery in fee income; and leading capital efficiency. However, the trend of improving credit quality showed signs of a turning point, given the challenging market conditions. We retain our CNY 7.20 per share fair value estimate for the A shares but lower our fair value estimate for the H shares to HKD 8.20 from HKD 8.80 per share, as we assume a lower exchange rate. Trading at a 15% discount to our fair value estimate and 0.8 times 2018 price/book, the H shares appear undervalued in our view, as the market is overly concerned about CCB’s credit quality, given the weakening economy. We believe large banks including CCB have among the strongest customer bases, low shadow-bank exposure, and industry-leading profitability, which should enable them to better navigate challenges. Capital ratios were largely flat from 2017, with the core Tier 1 and capital adequacy ratio standing at 13.08% and 15.64%, respectively. Return on equity fell slightly by 40 basis points to 16% due to issuance of preferred shares, while return on assets slightly rose to 1.31%, indicating industry-leading profitability and capital position.

The results included a strong recovery in fee-income growth to 6% in the second quarter from a 2% decline in the prior quarter, driven by robust growth in bank cards, electronic banking, and custody-service-related income. These three categories represented 54% of total fee income. While the bank is facing pressure from new asset management rules and regulations on short-term savings-type insurance products, fee income from bank wealth management products, or WMPs, and agent sales dropped 47% and 10%, respectively, in the first half. CCB’s WMPs outstanding shrank 6.6% to CNY 1.96 trillion. We think fee income growth is likely to pick up from the current 1.4% level in the second half, boosted by a lower base for agent sales in the second half of 2017 and recent modest relaxation in bank WMP rules.

A 20-basis-point expansion in CCB’s NIM to 2.34% also outperformed peers including ABC and BOC, which recorded respective NIM expansion of 11 basis points and 4 basis points in the first half. This, together with steady asset growth, translated to a 10% increase in net interest income. CCB increased asset allocations to higher-yield retail loans, including credit card and home mortgage loans, while NIM shrank slightly in the second quarter due to rising deposit costs. The bank's deposit base remained strong, growing 3.2% from 2017, faster than the 2% growth in interest-earning assets. The proportion of demand deposits remained steady at 54%, leading to roughly flattish deposit costs at 1.34%, despite rising deposit competition.

The trend of improving credit quality since mid-2016 has showed signs of weakening, given the challenging market conditions. The bad-debt ratio fell slightly by 1 basis point to 1.48%, with the bad-debt formation rate falling 3 basis points to 1.48% from the year-ago period. The provision level has further strengthened to cover 193% of total bad debts. Special-mention loans grew 4% from 2017, lower than the 13% and 5% respective growth rates in first-half 2016 and 2017. However, overdue loans, which served as a leading indicator, saw a significant rebound to 14% (for loans overdue within 90 days) and 16% (for loans overdue more than 90 days). We expect a slight increase in credit costs in 2018 to counter these risks.