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Morningstar | CMB’s 2018 Results Showed Strong Improvement in NIM and Loan Quality

Narrow-moat China Merchants Bank's, or CMB's, 2018 results were in line with its preliminary announcement, with net profits increasing 14.8% from 2017. We retain our CNY 28 fair value estimate for A-shares and HKD 32 for H-shares. The results highlight CMB's deposit advantage remained largely intact and pace of new customer acquisition showed signs of acceleration, fueled by increasing technology adoption. Net interest margin, or NIM, saw strong improvement by 14 basis points, leading to a 11% growth in net interest income. CMB's ROE and ROA have steadily improved since mid-2017. ROE and ROA have expanded to industry-leading levels of 16.57% and 1.24%, respectively. Its H-shares are fairly valued and CMB has been trading at valuation premium against large banks including ICBC and CCB, thanks to its faster-than-peer growth in shareholders' equity. Increasing 13% from 2017, growth in book value per share was in line with expectation.

Leveraging its premium customer base, CMB will continue to lead the industry in asset quality improvement and transformation in retail banking but we believe the upsides are largely factored in. Improved credit quality and increased bad debt provision were also bright spots of the results, with bad debt ratio significantly declining 25 basis points to 1.36%. Bad debt formation rate fell to 0.44% from 0.48%. Leading indicators including special-mentioned loan and overdue loan balances contracted by 2% and 2.4% from 2017. Provision coverage expanded to industry-leading level of 326% from 262%. Bad debts are concentrated in mining, manufacturing and wholesale industries, with bad debt ratio ranging from 4% to 8%. Positively, bad debt ratios of most loan categories remained low at 0.4% to 1.4%.

CMB also achieve strong growth in customer acquisition thanks to rising popularity of its mobile platform. CMB’s two mobile platforms CMB APP and CMB Life APP became leading mobile banking applications in China, with total users growing 43% to 148 million, and monthly active users reaching over 81 million in 2018. These platforms have enhanced customer stickiness with the bank, as nonbanking services contributed about 27% and 44% of user traffic. As a result, number of retail customers grew 17.6% to 125 million, driving retail AUM up by 10.4% to CNY 6.8 trillion. Its VIP customers which represented only 2% of total retail customers but contributed about 80% of total retail AUM, continued a steady growth of 11% to 2.36 million. Its premium customer base translated to leading market positions in bank WMP and private bank business. Bank WMPs grew 4.6% to CNY 1.96 trillion in contrary to decline for most peers. Private bank AUM increased 7% to CNY 2 trillion, solidifying its position as the largest private bank in China. Number of CMB’s retail saving accounts also surpassed 100 million in January 2019. This was a significant achievement when considering the bank only has 1800 offline outlets in China.

As a result of increased technology investment to beef up their mobile platform and improve operating efficiency. CMB spent CNY 6.5 billion or 2.8% of total revenue in 2018. This resulted in a 0.8 percentage point increase in cost to income ratio to 31% in 2018. Excluding such impact, we expect cost to income ratio would have improved by 2 percentage points thanks to growing scale and better cost management. The company has proposed to set aside no less than 3.5% of total revenue as technology development fund in coming years. The plan is currently pending for shareholders’ approval. Management believe this is a long-term guideline and they’re confident to keep future cost to income ratio at reasonable level.