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Morningstar | Ping An Bank Revenue Growth Accelerated in 2018, Increase FVE on Improved Asset Management Outlooks. See Updated Analyst Note from 11 Mar 2019

Following no-moat Ping An Bank’s, or PAB's, release of 2018 results and investor conference on the same day, we lift our fair value estimate to CNY 13.5 from CNY 12 per share. The increase was attributable to improved expectation for near-term fee income growth, boosted by better-than-expected progress in the merger with Ping An Trust, or PAT, and time value of money. Shares are fairly valued, trading at 9% discount to our fair value and 0.9 times 2019 forward P/B.

PAT is the country’s second-largest trust company in terms of revenue and net profits, with revenue reaching CNY 5 billion in 2018, or 16% of PAB’s fee income. It managed nearly CNY 580 billion assets for 75,000 wealthy customers. The merger is likely to substantially boost PAB’s retail AUM and number of high net-worth individuals, by doubling PAB private bank’s current size of CNY 400 billion AUM and 30,000 customers. We expect the merger will offer better customer experience and increase cross sales for PAB’s existing and new customers via one integrated platform. Thanks to strong management execution, over 90% of trust employees has been transferred to PAB within two months and private bank business has seen rapid growth for first two months of 2019. This is the first within-the-group consolidation after PAB’s chairman Xie Yonglin was named as co-CEO of Ping An Group. We don’t preclude the possibility PAB will merge with other financial subsidiaries such as Ping An Securities, given PAB is now positioned as a leading portal for the group’s wealth management and asset management business.

Our near-term outlooks for PAB are also boosted by recent completion of CNY 26 billion convertible bond issuance which is expected to lift tier ! ratio to 10.5% from 9.39% in 2018. We expect the conversion will complete in 2019 at the price of CNY 11.77 per share, at 8% discount to its 2018 book value. We expect the merger with PAT will more than offset the dilution from the conversion of those bonds in 2019.

Year-on-year growth in 2018 net profits accelerated to 7%, helped by pickup in fourth-quarter net interest income to 9% versus a disappointing 1.7% decline for the first three quarters thanks to lower wholesale funding costs as result of monetary loosening in the second half of 2018. PAB’s full-year net interest income and NIM performance looked a bit disappointing at merely 1% growth and 3 basis point contraction to 2.35% from 2017. However, we believe this was mostly attributable to the reclassification of fair value change for trading financial assets into investment return under the new accounting rules, rather than interest income as before. We estimate net interest income would have grown 9.7% following the old accounting rules. In 2018, Loan mix shift toward retail and increase in loan pricing has supported PAB’s NIM. Retail loan shares have expanded to 58% of total loans in 2018, versus 36% in 2015, close to reaching management’s 60% long-term target. For the second half of 2018, average retail loan rate increased 88 basis points to 8.29%, and average corporate loan rate slightly higher by one basis point to 4.76%. We estimate the significant increase in retail loan pricing was due to the reclassification of credit card service fee for installments into interest income in 2018. As average loan pricing stands above 8% and credit card fee has slowed to 35% from 80% in the first half, we expect retail loan optimization will have very limited room for further NIM expansion.

Overall deposit growth remained slow at 6% hampered by zero growths in corporate deposits in both 2017 and 2018, while growth in retail deposits further increased to 35% from 27% in 2017. Management hinted that they will see gradual recovery in corporate loan growth in 2019 given retail loan shares reaching its 60% long-term target (by total loans?). PAB’s corporate business will become more focused in 10 selective industries, following the capital-light and asset-light strategy. Leveraging its technology advantage and customer pool of its parent, we expect the modest recovery in corporate loan growth will benefit overall deposit growth and NIM in 2019.

The bank still see pressure in credit quality despite a slow improvement, with bad debt ratio slightly increased to 1.75% from 1.68% in mid-2018 on stricter loan classification. Bad debt formation rate declined to 2.6% from 2.9% in 2017. Leading indicators such as special-mentioned loans and overdue loans dropped 13% and 16% respectively. PAB recognized 103% loans overdue more than 90 days as bad debts, up from 70% in 2017, indicating significant improvement in bad debt classification standards. However, provision coverage remained low at 155% of bad debts, versus 151% in 2017. Credit costs slightly dropped to 2.6% from 2.7% in 2017. We expect PAB will increase credit costs in the near term given the need to improve provision coverage and prepare for uncertainties in the corporate sector,