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Morningstar | CMB’s NIM Remained Strong at Industry-Leading Level, Fee Income Growth Was a bit Disappointing

Following narrow-moat China Merchants Bank's, or CMB's, first-quarter results, which continued to report industry-leading net profit growth of 11.3% from the year-ago quarter, we increased our fair value estimate to CNY 30 from CNY 28 for China A-shares, and HKD 36 from HKD 32 for H-shares to reflect our modestly higher net interest margin, or NIM, assumption in 2019 and time value of money since our last update. With revenue and preprovision operating profits growing at 12% and 13%, respectively, from the year-ago period, the results highlighted CMB's deposit advantage remained largely intact, translating to a 17 basis point increase in NIM to the industry-highest level at 2.72% from the year-ago period. This was attributable to the PBOC’s RRR cut in January and CMB’s continuous expansion in loan share to 60% of total interest-earning assets. Book value per share grew strongly at 5% over 2018 to CNY 21.09, thanks to strong industry-leading ROE at 19.5% in the past quarter. 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. 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.

While NIM growth was strong at 14.3% as CMB sped up lending to retail loans in the first quarter, NIM remained steady at high levels. Contrary to large banks’ higher lending to corporate loans in infrastructure and public service sectors, CMB’s first-quarter new lending still tilted toward retail loans. The latter represented 55%, up 3 percentage points in 2018. Fee income growth was a bit disappointing at 1.3% versus 3.9% in 2018. We believe this was largely due to a high contribution from asset management-related services, which accounted for half of its total income, but the business is still under restructuring. Furthermore, unlike most banks seeing negative growth in related service income in 2018, growth in asset management service at CMB remained resilient at 2%. This translated to a higher base for CMB in the first quarter. We expect fee income growth will pick up in the following quarter, given the diminishing impact of high base.

Credit quality was steady. Bad debt ratio fell one basis point to 1.35% from 2018, while growth in bad debt balance slightly rebounded by 4% to CNY 55.6 billion. Unlike other banks, CMB increased credit costs to 1.67%, up five basis points from 2018’s level. Provision coverage further improved to 363%, the highest among listed Chinese banks. The only drawback is an increase in bad debt formation rate to 0.87% from 0.44%. We suspect CMB has further strengthened its bad debt classification in response to high economic uncertainty and the regulator’s call for more stringent bad debt rules to improve asset quality transparency in 2019.