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N O M U R A I N T E R N A T I O N A L ( H K ) L I M I T E D
A
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O
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Nomura Anchor Reports examine the key themes and value drivers that underpin oursector views and stock recommendations for the next 6 to 12 months.
Any authors named on this report are research analysts unless otherwise indicated.See the important disclosures and analyst certifications on pages 153 to 156.
Banks | C H I N A 2011 Outlook
Lucy Feng +852 2252 2165 [email protected]
Donger Wang +852 2252 1590 [email protected]
A leap of faith
We think the Year of the Rabbit will be favourable for early believers in China banks.We believe the market is undervaluing the near-term operational outlook, overplaying
regulatory risks and ignoring emerging growth. We look for NIMs to expand in the near
to medium term, and see the pace accelerating in 1Q11F and 2Q11F on the back of
the two rate hikes in late 2010. The fear factor has changed from LGFV exposure to
rate liberalisation, particularly deposit liberalisation, but this is likely to take a long time
in our view, and we do not expect significant margin erosion (50bps decline implied by
market valuations) in the next three years as Chinas inflation and benchmark rates are
on the rise while the PBoC addresses the issues of negative deposit rates and zero
real lending rates. We do acknowledge that the introduction of different RRRs changes
the playing field and this is an overhang on the stocks, but we believe we are the first
on the Street to analyse this in detail and conclude that what it really means is that thePBoC wants to align economic growth more closely with resource allocation. Therefore,
we believe banks with a rural focus such as ABC or an SME/retail focus such as CMB
are likely to benefit, and these are our top BUYs along with BOC (beneficiary of RMB
deregulation). That said, we believe BOCOMs growth profile will be compromised a
little by differential RRR and we downgrade to NEUTRAL.
Even more controlled lending to curb inflationary pressures
Implied sustainable ROEs already reflect bear case scenario
Stock picks: rural players immune to tighter new policies
BULLISH
Stocks for action
We remain positive on the sector, withCMB (SME focus), BOC (RMB
deregulation), ABC (rural financing) and
ICBC (defensive play) our top H-share
picks. Industrial Bank (mortgage
portfolio) is our A-share pick.
Stock RatingLocalprice
Pricetarget
ABC-H (1288 HK) BUY 3.99 4.80
ICBC-H (1398 HK) BUY 5.87 7.60
CCB-H (939 HK) BUY 7.06 8.60
BOC-H (3988 HK) BUY 4.14 5.20
BOCOM-H (3328 HK) NEUTRAL 8.03 9.00CMB-H (3968 HK) BUY 20.20 26.86
CITIC Bank-H (998 HK) BUY 5.22 6.30
Minsheng Bank-H (1988 HK) NEUTRAL 6.59 7.40
Downgrading from Buy; Raising PT; Cutting PTClosing prices as of 7 January 2011
Analysts
Lucy Feng
+852 2252 2165
Donger Wang
+852 2252 1590
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Banks | C H I N A 2011 Outlook
Lucy Feng +852 2252 2165 [email protected]
Donger Wang +852 2252 1590 [email protected]
Action
While we reiterate our fundamentally Bullish stance, we think 1Q11F monthly loan
figures will be subject to close scrutiny by the market as a barometer of things tocome under the new environment in 2011. We expect a more moderate pace of
rate hikes especially in 1H11F to cushion the impact of loan demand. Our top picks:
CMB, BOC, ABC and ICBC.
Catalysts
Strong 4Q10F and 1Q11F results may improve investment sentiment and provide
better earnings visibility for 2011.
Anchor themes
Margin expansion and front-loading new loans are the key themes investors will
look for in 1H11F, but negative sentiment from ongoing policy overhang still weighs
on valuation. We think that, with rate liberalization a medium-term theme, share
prices reflect a worst-case scenario on asset quality and margin deterioration.
A leap of faith
Even more controlled lending to curb inflationary pressures
In our view, the monthly monitoring of banks lending and different required reserve
rates (RRR) for different banks lets the Peoples Bank of China (PBoC) control
bank lending more closely using subjective measures. We believe the different
RRRs, if implemented strictly, are likely to affect the lending appetite of banks,
causing them to be more cautious with regard to the pace of lending as well as the
areas they lend to. The use of the anti-cyclical capital buffer is useful to absorb theimpact from excessive lending in the system. On the other hand, it is increasingly
apparent that liquidity is becoming tighter and it will be interesting to see whether
the continued pressure for funding will cause the erratic yield spikes at the end of
the month to persist. We understand that local bank branches have continued to be
active in selling short-term savings products to attract liquidity. We believe that
large-cap banks will dominate 2011 loan growth, given their lower LDR and larger
deposit base.
Implied sustainable ROEs already reflect bear case scenario
We estimate that under current valuations, Chinese banks have implied
sustainable ROEs of 13-14%. In our view, interest-rate deregulation remains a
medium-term target for the PBoC and it is likely to be a gradual process. The
China Banking Regulatory Commission (CBRC) is progressively helping Chinese
banks to be ready for Basel III through using related concepts as part of new
regulatory tools. We see no imminent credit risks or earnings downside, and
reiterate that the early believers will be rewarded.
Stock picks: rural players immune to tighter new policies
We maintain that the objective of the PBoC under the new different RRR system is
to align economic growth more closely with resource allocation. Therefore, we
believe banks with a rural focus such as ABC or an SME/retail focus such as CMB
are likely to benefit. Our sector top picks: CMB (SME focus), BOC (RMB
deregulation), ABC (rural financing is subject to more relaxed monetary policy) andICBC (defensive play).
BULLISH
N O M U R A I N T E R N A T I O N A L ( H K ) L I M I T E D
Stocks for action
We remain positive on the sector, with
CMB (SME focus), BOC (RMBderegulation), ABC (rural financing) and
ICBC (defensive play) our top H-share
picks. Industrial Bank (mortgage
portfolio) is our A-share pick.
Stock RatingLocalprice
Pricetarget
ABC-H (1288 HK) BUY 3.99 4.80
ICBC-H (1398 HK) BUY 5.87 7.60
CCB-H (939 HK) BUY 7.06 8.60
BOC-H (3988 HK) BUY 4.14 5.20
BOCOM-H (3328 HK) NEUTRAL 8.03 9.00
CMB-H (3968 HK) BUY 20.20 26.86
CITIC Bank-H (998 HK) BUY 5.22 6.30
Minsheng Bank-H (1988 HK) NEUTRAL 6.59 7.40
Downgrading from Buy; Raising PT; Cutting PTClosing prices as of 7 January 2011
Analysts
Lucy Feng
+852 2252 2165
Donger Wang
+852 2252 1590
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Contents
Executive summary 4
Five themes in 2011 6(1) Different RRR for different banks is a more micro approach and changes the
playing field 6(2) New rules help banks getting used to Basel III 7(3) The need to find loan supply to meet the demand 7(4) Seeking a solution to end-of-month pressure on yields 9(5) Rate deregulation remains a medium-term target 10Look for banks that have over-reacted on the news 111Q11 to provide a few clues to the riddle 11
Macro and monetary policy 13CPI inflation likely to stay on uptrend throughout 1H11F 13Two rate hikes in 2010, four more in 2011F 14Central Economic Work Conference laid positive foundation for banks in 2011F 15Overall loan and deposit growth trends in November 16
4Q10 preview and 2011 earnings forecasts 25Risks from LGFV loan default should remain remote 28County area banking in China 32
County areas in China 32County area banking in China 38
Rural banking industry analysis and case studies 45County area economy development under Chinas urbanisation 45Key provinces overview 50Jiangsu Zhangjiagang Rural Commercial Bank 55Jiangsu Xizhou Rural Commercial Bank 57Jiangsu Changshu Rural Commercial Bank 59Shanghai Rural Commercial Bank 61Zhuhai Rural Credit Cooperatives 63
Jiangsu Taicang Rural Commercial Bank 65Hefei Science & Technology Rural Commercial Bank 67Foshan Shunde Rural Commercial Bank 69Jilin Jiutai Rural Commercial Bank 71Jiangsu Jiangyin Rural Commercial Bank 72Jiangsu Wujiang Rural Commercial Bank 74Guangdong Rural Credit Union 77
Appendix 78PBoC benchmark rate 79Breakdown data by banks 80
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Regional banks valuation comparison 97Regional banks performance comparisons 99Latest company views
Agricultural Bank of China 101
ICBC 106
China Construction Bank-H 110
Bank of China (H-share) 114
Bank of Communications 118
China Merchants Bank 122
China CITIC Bank 127
China Minsheng Bank - H 131
Shanghai Pudong Development Bank 135
Shenzhen Development Bank 139
Industrial Bank 143
Huaxia Bank 147
Also see our Anchor Report: Asia PacificStrategy Deflation, inflation and the returnof the productive economy(6 December, 2010)
Also see our Anchor Report: China Strategy Higher ground(7 December, 2010)
http://www.nomura.com/research/GetPub.aspx?spid=7226http://www.nomura.com/research/GetPub.aspx?spid=7226http://www.nomura.com/research/GetPub.aspx?spid=7226http://www.nomura.com/research/GetPub.aspx?spid=7226http://www.nomura.com/research/GetPub.aspx?spid=7226http://www.nomura.com/research/GetPub.aspx?spid=7235http://www.nomura.com/research/GetPub.aspx?spid=7235http://www.nomura.com/research/GetPub.aspx?spid=7235http://www.nomura.com/research/GetPub.aspx?spid=7235http://www.nomura.com/research/GetPub.aspx?spid=7226http://www.nomura.com/research/GetPub.aspx?spid=72358/3/2019 Banks China Lucy Feng 2011
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Drilling down
Executive summaryThe best thing about the future is that it comes one day at a time Abraham
Lincoln
The year 2010 marks one of the worst years of performance for China banks on both
relative terms (they underperformed 10% versus the HSI and 4% versus the HSCEI)and absolute terms (-4% versus +15% on average in 2005-10). As the sector appears
inexpensive and stayed so in the past 12 months (7x to 8x P/E 2011F), we think
investors have come to the conclusions that (1) the sector is a valuation trap as the
trade was dominated by policies rather than fundamentals, and (2) the sector is cheap
for deep-rooted reasons/problems, which may cause a medium to long term de-rating.
While investors concern on the policy overhangs prevail, worry shifted from local
government funding vehicles (LGFV) to interest-rate liberalization, particularly the
pace and space, timetable, as well as the fundamental implications, for the sector.
Exhibit 1. Sector performance comparison
(50) 0 50 100 150
Technology
Power and Utilities
Property
Basic Materials
Financials
Conglomerates
Solar
China - Total
Telecoms
Consumer Related
Oil & Gas/Chemicals
Industrials
Transport/Logistics
Media & Internet
Health care & Pharm
Gaming, Hotels and Leisure
(%)
Source: Bloomberg, Nomura research
Exhibit 2. Historical share price performance
(%)2011
(YTD) 1H10 2H102010
(full year)
ICBC 1 (10) 1 (9)
CCB 1 (4) 10 6
BOC 1 (6) 3 (3)
BCOM 3 (3) (6) (9)
CMB 3 0 4 4
Citic 4 (23) 1 (22)
Minsheng (1) (8) (3) (10)
Sector 2 (7) 4 (4)
Hang Seng Index 3 (8) 14 6
HSCEI 2 (10) 11 0
MSCI Financials - World 1 (14) 17 0
MSCI Financials - Europe (1) (26) 15 (15)
MSCI Financials - US 2 (6) 16 10
Source: Bloomberg, Nomura research
It is our view that rate liberalization, particularly deposit liberalization, will take longer
than expected to implement. Initially the central bank probably will introduce pilot tests
for a few selected banks for a few selected products (such as large-size, long-maturity
term deposits). Thus, the impact for the sector should be limited and will be closely
monitored by the regulators. Significant margin erosion (50bps decline implied by the
market) is unlikely to happen in the next three years, in our view, as Chinas inflation
and benchmark rates are on the rise while the PBoC addresses the issues of negative
deposit rates and zero real lending rates.
Contrary to conventional wisdom, we believe that China banks NIM will expand in the
near to medium term, and that the pace will accelerate in 1Q11F and 2Q11F, with the
backdrop of two rate hikes in late 2010. Long term, we believe that now would be a
good time for regulators to introduce rate liberalization, as a rising rate environment
helps the banks absorb margin pressure from price competition. Hence, banks can
either re-orientate their lending business towards higher margin SMEs (though better
risk-pricing skills are required) or re-model their business model towards less capital-
consuming fee products. In Asia, the ASEAN banks have posted solid NIMs attributed
to rising interest rates and a profit-driven lending model.
Rate liberalization will take longer
than expected to implement
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Exhibit 3. NIM comparison of banks in regional
countries
0
2
4
6
8
Australia
China
Hong
Kong
India
Indonesia
Malaysia
Singapore
South
Korea
Taiwan
Thailand
(%) 2009 2010F
Source: Company data, Nomura estimates
Exhibit 4. Market implied margin erosion from
potential rate liberalisation
(0.8)
(0.6)
(0.4)
(0.2)
0.0
ABC
ICBC
CCB
BOC
BCOM
CMB
CITIC
Minsheng
(%)
Source: Bloomberg, Nomura estimates
While all trading patterns seem to call for an underweight stance on the sector, weremain positive for the aforementioned reasons. China banks have underperformed for
the past 15 months for the same reason policies and policy tightening. And
emotional markets tend to decline (or rally) much longer than is perceived possible.
Judging from the feedback of our past five weeks marketing, we conclude that most
investors do not expect further policy announcements to be worse than what they
already know. Even the bears do not expect rate liberalization to occur overnight and
cut sector NIMs by a quarter the level perceived by the market (13bps to 60bps
deterioration).
The fear or hope for a further correction is especially prevalent amongst investors
with a technical bent. This divergence between short-term and medium-term
perspectives reflects a difficult dilemma for investors, most of whom are equal to
underweight China banks, in our view.
Many expect a perfect storm in 1Q under an inflationary shock event, for bottom
fishing. Timing, as they say, is everything. We think that the much-speculated-about
pullback will not occur in 1Q, as we do not expect any inflationary shock in the next
few weeks. In the next section we summarize five themes we will look into in 2011and
we point out that most of the positive catalysts, which should drive a re-rating of the
sector, will occur in 1Q11F, in our view.
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2011 outlook
Five themes in 2011
(1) Different RRR for different banks is a more micro approachand changes the playing field
We think that from the beginning of 2011, the PBoC will start monitoring individual
banks on a monthly basis and issue different RRRs accordingly. Different RRRs are
likely to be applied to national financial institutions initially. We think that the PBoC will
allow a grace period of three quarters. We believe that the PBoC is considering
lowering the interest rate for required reserves to lower the banks own costs. We
believe that this system allows the PBoC to control bank lending more closely, in
addition to the loan quota, which at times to us appears inadequate in controlling
seasonal fluctuations and excessive lending by certain banks. Interestingly, this
appears to be moving in the opposite direction to the further deregulation of the
Chinese banking system.
We believe that the different RRRs, if implemented strictly, would be likely to affect the
lending appetite of banks, and that this could have implications for loan growth. The
market has been speculating that this could lead to more lending in early 2011, due to
the grace period in the first three quarters, which would effectively allow for a lower
level of different RRRs.
Exhibit 5. RRR versus banking sector PB
6
8
10
12
14
16
18
20
Jun-05
Oct-05
Mar-06
Jul-06
Nov-06
Apr-07
Aug-07
Jan-08
May-08
Oct-08
Feb-09
Jun-09
Nov-09
Mar-10
Jul-10
Dec-10
(%)
0.00.51.01.52.0
2.53.03.54.0
(x)
RRR - Large Depository Institution (LHS)
RRR - Small and Medium Depository Institution (LHS)
sector PB (RHS)
Source: Bloomberg, Nomura research
Exhibit 6. RRR versus banking sector PB (large cap
banks and small & medium banks)
6
8
10
12
14
16
18
20
Nov-05
Apr-06
Aug-06
Dec-06
May-07
Sep-07
Jan-08
Jun-08
Oct-08
Mar-09
Jul-09
Nov-09
Apr-10
Aug-10
Dec-10
(%)
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
(x)RRR - Large Depository Institution (LHS)RRR - Small and Medium Depository Institution (LHS)
Large cap banks PB (RHS)
Small & Medium banks PB (RHS)
Source: Bloomberg, Nomura research
Regulators becoming stricter to control lending
In setting its lending strategy, a bank must consider its deposit growth/LDR,
provisioning and capital. It appears to us that both the PBoC and CBRC now have a
tighter grip on each of these factors. We believe that through these measures the
regulatory authorities hope to make banks more cautious in their lending.
Interest rate paid for the different RRRs is not certain
The different RRRs will usually earn an interest rate on the reserve, which is now
1.62%. However, if a bank has been lending excessively or has been asked to have a
different RRR a number of times then the excess RRR interest rate (0.72%) might
apply or the PBoC might pay no interest.
Linking RRR with CAR
We understand that the PBoC is contemplating setting the different RRRs by applying
a factor of stability-adjustment specifics for the bank and multiplying this by the
difference between the required CAR and the actual CAR. We think the factor of
We think PBoC will start
monitoring banks through
issuance of different RRR
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stability adjustment will be set subjectively by the PBoC and is likely to be driven
mainly by 1) liquidity, leverage, provisioning levels, credit rating, and internal controls
of a bank; and 2) the actual lending by the bank including the sectors.
In our view, the goal of the PBoC under the new different RRR system is to align
economic growth more closely with loan allocation. Therefore, we believe that banks
with a rural focus, such as ABC, or an SME/retail focus, such as CMB, are likely to
benefit.
Exhibit 7. RRR versus loan and deposit growth
0
5
10
15
20
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
(%)
0
10
20
30
40
(%)
RRR - Large Depository Institution (LHS)
RRR - Small and Medium Depository Institution (LHS)
y-y loan growth (RHS)
y-y deposit growth (RHS)
Source: CEIC, Nomura research
Exhibit 8. RRR versus LDR
0
5
10
15
20
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
(%)
60
65
70
75
80
(%)
RRR - Large Depository Institution (LHS)
RRR - Small and Medium Depository Institution (LHS)
LDR (RHS)
Source: CEIC, Nomura research
(2) New rules help banks getting used to Basel III
The linking of the RRR to the capital-adequacy ratio (CAR) is a new concept. At the
moment the required CAR is the mean of the minimum CAR (8%), system important
excess capital, and anti-cyclical capital buffer. Both the system important excess
capital and anti-cyclical capital buffer are also new concepts introduced under Basel III,which, in our view, the CBRC is considering to use as a new regulatory tool. Therefore,
the implementation of a different RRR is also likely to help Chinese banks to be ready
for Basel III over time. For the system important excess capital, the PBoC would
consider a banks asset size, mix of counterparties and volume, market share and
client impact.
The PBoC stated that ABC, ICBC, CCB, BOC, and BCOM are systemically important
banks. For other smaller banks, BCOMs asset size relative to that bank could be used
as a factor to determine the system important excess capital.
For the anti-cyclical capital buffer, the PBoC calculates this as a banks contribution to
pro-cyclical lending multiplied by [bank lending growth minus (GDP target growth plusCPI target growth)]. For a banks contribution to pro-cyclical lending, there are two
references:
Total lending divided by GDP and its spread from the long-term mean;
A banks lending relative to the total. The PBoC stated that the anti-cyclical capital
buffer is useful to absorb the impact from excessive lending in the system.
(3) The need to find loan supply to meet the demand
2011 is the first year of the new 12th Five-year Plan, in which there is likely to be new
projects and strong loan demand. It will be intriguing to see how this will be affected by
what seems to be tightening liquidity and shrinking loan supply. We understand that
Chinese banks still have on hand a good amount of projects that require loans, so the
issue is whether banks have the capacity and willingness to lend.
Different RRRs are likely to help
Chinese banks ready themselves
for Basel III
The issue is whether banks have
the capacity and willingness to
lend
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For Chinese banks, we estimate that around RMB21.6-21.8tn of loans will mature
during 2011. Assuming 2011 sector new loans hit Rmb7-8tn, effectively a net number,
this means gross new loans are circa RMB28.6-29.8tn in our view.
Exhibit 9. Percentage of loans with maturity
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Exhibit 13. Net new loans/deposits breakdown in for Jan/Feb/Mar for past few years
2005 2006 2007 2008 2009
Jan Feb Mar Jan Feb Mar Jan Feb Mar Jan Feb Mar Jan Feb Mar
Loans
Monthly net new loans 288.5 95.9 341.9 483.9 149.0 537.4 568.4 413.8 441.7 800.5 247.0 283.4 1,652.7 1,071.6 1,891.7
As % of total new loans in the year 17.5 5.8 20.7 15.8 4.9 17.5 15.6 11.4 12.2 19.2 5.9 6.8 17.2 11.1 19.6
Deposits
Monthly net new deposits 394.4 338.3 682.1 427.4 623.5 786.1 467.8 530.7 880.4 218.0 1,337.6 1,076.6 1,538.9 1,650.8 2,451.8
As % of total new deposits in the year 8.6 7.4 14.9 8.8 12.9 16.3 8.7 9.8 16.3 2.8 17.4 14.0 11.7 12.6 18.6
Source: CEIC, Nomura Research
Given larger banks generally have a relatively lower LDR and also potentially higher
deposit growth, they are the ones with the capacity to lend in our view. At the same
time, the larger banks tend to be more cautious and strategic in their lending approach.
Finally, we think bills remain the key source of short-term funding for corporates. Under
a tighter liquidity environment, their flexibility could be used as a tool for banks to
manage liquidity.
Exhibit 14. Discounted bills as percentage to totalloans
0
2
4
6
8
10
12
Jan-07
May-07
Sep-07
Jan-08
May-08
Sep-08
Jan-09
May-09
Sep-09
Jan-10
May-10
Sep-10
(%)
3.29% at end-Nov, 2010
Source: CEIC, Nomura research
Exhibit 15. Yield on discounted bills (with maturity of6 months)
01
2
3
4
5
6
7
Jan-10
Feb-10
Mar-10
Apr-10
May-10
Jun-10
Jul-10
Aug-10
Sep-10
Oct-10
Nov-10
Dec-10
Jan-11
(%) 4.6% as of 7 Jan, 2010
Source: www.zgpj.net
(4) Seeking a solution to end-of-month pressure on yields
It is increasingly apparent that liquidity is becoming tighter and it will be interesting to
see whether the continued month-end pressure on yields will cause the erratic spikes
during month-end to persist.
We understand post speaking with bank branch management that large-cap bankshave continued to be active in selling short-term (meaning single-digit days) savings
(or what they package as investments) products to attract liquidity (or in fact deposits).
Meanwhile, large-cap banks seem to fund medium to smaller banks through inter-bank
activities which could generate handsome income, given the ongoing spike in short-
term inter-bank rates.
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Exhibit 16. Historical SHIBOR yields
0
2
4
6
8
10
12
Oct-06
Apr-07
Oct-07
Apr-08
Oct-08
Apr-09
Oct-09
Apr-10
Oct-10
(%) Overnight
1 week
1 month
3 month
6 month1 year
Source: CEIC, Nomura research
Exhibit 17. SHIBOR yield curve
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
Overnight 1 week 1 month 3 month
(%)Today 3 months ago 1 year ago
Source: CEIC, Nomura research
Exhibit 18. RRR versus SHIBOR
0
5
10
15
20
Oct-06
Feb-07
Jun-07
Nov-07
Mar-08
Jul-08
Dec-08
Apr-09
Aug-09
Dec-09
May-10
Sep-10
(%)
0.0
1.0
2.0
3.0
4.0
5.0
(%)
RRR - Large (LHS)
RRR - Small and Medium (LHS)
SHIBOR- 1 month (RHS)
SHIBOR- 3 month (RHS)SHIBOR - 1 year (RHS)
Note: Large=Large Depository Institution; Small and medium= Small and mediumDepository Institution
Source: CEIC, Nomura research
Exhibit 19. RRR versus 7-day repo rate
0
5
10
15
20
Mar-06
Jul-06
Nov-06
Apr-07
Aug-07
Dec-07
May-08
Sep-08
Jan-09
Jun-09
Oct-09
Feb-10
Jun-10
Nov-10
(%)
0
2
4
6
8
10
12
(%)
RRR - Large (LHS)
RRR - Small and Medium (LHS)
7d repo rate (RHS)
Note: Large=Large Depository Institution; Small and medium= Small and mediumDepository Institution
Source: CEIC, Nomura research
(5) Rate deregulation remains a medium-term target
A recent article published on the PBoC website regarding the potential acceleration of
interest-rate deregulation prompted discussion in the market and created an overhang
for bank shares, in our view. The article suggested deregulation of the lending market
and allowing a higher cap for deposit rates. The article mentioned that deregulation
can happen by steps through initially longer-term and larger deposits and moving toshorter-term and smaller deposits.
We assume the PBoC hopes to maintain price stability and enhance efficient resource
allocation through interest-rate deregulation, because expectations of rate change
would be the key driver for market rates after the deregulation. We continue to believe
that interest-rate deregulation remains more of a medium-term theme for Chinese
banks. Moreover, we highlight that discounted bills and bond yields are already subject
to market-determined rates so, in a way, over a quarter of Chinese banks assets
already have liberalised interest rates.
The sector is at an FY11F PB of 1.2-2.1x with an implied sustainable ROE range of
13.0-15.5%. Assuming long-term gross NPL formation is around 100bps (50bps higher
than our forecast for 2011F and 2012F), 5% to 8% loan growth, cost/income ratio (CIR)of 40% and fee income of 15% to 20%, we derive a long-term NIM of 2% to 2.2% on
average for the sector. This implies another 30bps to 50bps erosion from the current
level, and is lower than for most other banks in Asia particularly for the countries
Interest-rate deregulation remains
to be a medium-term theme
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experiencing rising inflation and interest rates, such as India, Indonesia, Malaysia, and
Thailand. We note that China is officially on a rising rate cycle since the PBoC
announced a prudent monetary policy for 2011.
Exhibit 20. Current PB implied LT ROE by banks
12
13
14
15
16
ABC
ICBC
CCB
BOC
BO
COM
CMB
C
ITIC
Mins
heng
(%)
Note: Closing prices as of 7 Jan, 2011
Source: Bloomberg, Nomura estimates
Exhibit 21. FY11F ROE erosion (difference between
FY11F ROE and implied LT ROE)
(10)
(8)
(6)
(4)
(2)
0
ABC
ICBC
CCB
BOC
BO
COM
CMB
C
ITIC
Mins
heng
(%)
Source: Bloomberg, Nomura estimates
Look for banks that have over-reacted on the news
As a result of the above policy speculation, certain banks under our coverage have, in
our view, again become easy targets by the markets use of certain assumptions for
risk exposures and the consequent capital, liquidity, and provisioning required. We
point out that:
The regulator has not yet confirmed such news on liquidity (dynamic RRRs), capital
or provisioning requirements;
We believe that the recent subdued share-price performance of Chinese banks
already more than accounts for the worst-case scenario of any of these changes.
Therefore, we would recommend that investors accumulate Chinese banks that have
over-reacted on this news flow as we believe that their fundamental story remains
intact. Our top picks are CMB (key beneficiary for rate hike, SME-oriented business),
BOC (RMB liberalization), ABC (county area exposure which is subject to more
relaxed monetary policy) and ICBC (defensive play).
1Q11 to provide a few clues to the riddle
We understand the markets concern over policy risks and sense that investors aremore frustrated about the continued underperformance of China banks. Yet discounted
bill yields have been falling since the beginning of the year (dropped to 4.6% on 7
January 2011 from 6.5% in December 2010), which coincided with their outstanding
balance as a percentage of total loans reaching a low level (3.3% as at the end of
November 2010). We expect that this may cause monthly new loans to surprise on the
upside for 1Q11F, which could shift sentiment as the market gauges how the recent
lending rate hikes have affected loan demand.
SHIBOR yields have been moving up (one-year SHIBOR rose to 3.6620% on 7
January 2011 from 3.1103% on 1 December 2010), which we attribute to the recent
hikes in RRR and the subsequent tighter liquidity. We expect this to support bargaining
power for banks with more liquidity but, at the same time, it naturally seems better forthe ones more exposed to the SMEs, or subject to more relaxed monetary polices
(such as rural financial institutions).
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Exhibit 22. Price targets, ratings and key forecasts
ABC ICBC CCB BOC BCOM CMB CITIC Minsheng SPDB Industrial SZDB Huaxia
Rating BUY BUY BUY BUY NEUTRAL BUY BUY NEUTRAL NEUTRAL BUY NEUTRAL REDUCE
TP HK$4.80 HK$7.60 HK$8.60 HK$5.20 HK$9.00 HK$26.86 HK$6.30 HK$7.40 RMB14.65 RMB33.00 RMB16.64 RMB8.71
Target P/BV (x) 2.0 2.2 2.1 1.7 1.7 2.8 1.5 1.5 1.4 1.7 1.5 1.0
2010F
NIM (%) 2.59 2.41 2.48 2.12 2.42 2.69 2.68 2.91 2.60 2.69 2.62 2.22Loan growth (%) 19 18 17 17 20 19 22 22 19 19 25 19
Credit cost (%) 0.78 0.30 0.43 0.46 0.60 0.50 0.55 0.35 0.37 0.13 0.47 0.97
NPL ratio (%) 2.06 1.27 1.30 1.43 0.20 0.68 0.85 0.96 0.77 0.46 0.63 1.50
Coverage ratio (%) 155 182 184 156 161 310 152 226 261 271 192 164
Y-Y NPAT growth (%) 44 31 29 19 32 50 33 33 48 46 31 42
EPS (RMB) 0.32 0.49 0.57 0.35 0.76 1.26 0.50 0.62 1.43 3.61 1.97 0.90
BVPS (RMB) 1.64 2.39 2.88 2.24 3.90 6.31 3.00 3.67 9.20 16.44 9.41 7.88
2011F
NIM (%) 2.76 2.54 2.61 2.23 2.64 2.96 2.76 3.03 2.73 2.81 2.68 2.33
Loan growth (%) 20 17 17 18 23 19 22 23 19 20 20 18
Credit cost (%) 0.69 0.40 0.50 0.58 0.65 0.58 0.70 0.40 0.47 0.18 0.40 1.01
NPL ratio (%) 1.79 1.20 1.40 1.44 0.15 0.73 0.81 1.10 0.78 0.58 0.71 1.50
Coverage ratio (%) 179 191 164 156 163 305 177 216 270 204 186 164
Y-Y NPAT growth (%) 34 16 18 18 24 34 22 25 23 19 27 20
EPS (RMB) 0.39 0.56 0.65 0.41 0.88 1.70 0.55 0.64 1.75 4.03 2.32 0.94
BVPS (RMB) 1.96 2.74 3.28 2.46 4.39 7.66 3.33 4.02 10.81 20.13 11.00 8.72
2012F
NIM (%) 2.87 2.63 2.72 2.36 2.74 3.22 2.73 3.09 2.86 2.87 2.67 2.44
Loan growth (%) 22 18 18 19 23 20 20 23 19 20 20 19
Credit cost (%) 0.69 0.40 0.50 0.62 0.60 0.61 0.70 0.40 0.76 0.21 0.40 1.07
NPL ratio (%) 1.82 1.12 1.52 1.48 0.15 0.76 0.77 1.21 0.89 0.68 0.80 1.54
Coverage ratio (%) 175 201 155 155 161 304 203 204 278 170 176 163
Y-Y NPAT growth (%) 24 17 22 22 18 29 22 22 14 17 19 20
EPS (RMB) 0.48 0.65 0.79 0.50 1.04 2.18 0.60 0.78 1.99 4.72 2.77 1.12
BVPS (RMB) 2.27 3.14 3.78 2.74 4.99 9.37 3.73 4.32 10.64 24.44 13.02 9.70Source: Nomura estimates
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Macro and monetary policy
Macro and monetary policy
CPI inflation likely to stay on uptrend throughout 1H11F
Chinas CPI inflation surged to 5.1% y-y in November, the fifth consecutive rise since
June 2010, and the highest reading in 28 months (source: CEIC data). This triggered
renewed market concern about further rate hikes in the coming months in order to rein
in inflation and anchor inflation expectations.
In our view, Chinas CPI inflation should continue its uptrend, albeit in a milder way, in
the coming months, and it is unlikely to peak in January 2011. Our economics team
expects CPI inflation to reach 4.1% y-y and 4.5% y-y, respectively, in 1Q11 and 2Q11.
We believe this is because, although food prices started easing since late November
due to the central governments policy measures to control food prices (eg, wholesale
prices of vegetables in 36 cities in China have been falling for four weeks in a row as
of 5 December 2010; source: CEIC), non-food prices have been steadily rising in
recent months and we expect this to continue in the near future. But we do not think
that Chinas inflation will get out of control.
Exhibit 23. Chinas CPI inflation
(10)
(5)
0
5
10
15
20
25
Jan-07
Jul-07
Jan-08
Jul-08
Jan-09
Jul-09
Jan-10
Jul-10
(% y-y)Headline CPI
CPI: Food
CPI: Non food
Source: CEIC, Nomura research
Exhibit 24. Chinas CPI inflation vs Hang Seng index
10,000
15,000
20,000
25,000
30,000
35,000
Jan-05
Jul-05
Jan-06
Jul-06
Jan-07
Jul-07
Jan-08
Jul-08
Jan-09
Jul-09
Jan-10
Jul-10
(Index)
(4)
(2)
0
2
4
6
8
10
(% y-y)HSI index (LHS)
China CPI inflation (RHS)
Source: CEIC, Bloomberg and Nomura research
Nomuras economics team believes that the rise in non-food prices is mainly driven by
rising input costs (raw materials and wages), excess liquidity and reduced overcapacity
in the manufacturing sector. Given an average of above-20% minimum wage hikes
implemented in 29 of 31 provinces in 2010, we expect growth in labour costs to
continue climbing in the quarters ahead, pushing input costs higher. Moreover, given aweakening US dollar and high liquidity due to the US QE2 exercise totalling
US$600bn, global commodity prices are set to rise firmly in the first half of 2011,
contributing to higher inflation in China, in our view.
As we think Chinas CPI inflation should be on a steady but milder rising trend in the
first few months and is unlikely to peak in January 2011, there is a possibility that the
PBoC might disappoint the market with no rate hikes in January or February 2011. We
think the stock market has fallen such that there is little chance of a new low before
2Q11F, as we believe there will be no new policy measures to dampen the market to a
new low until then. As such, we think it is time for investors to accumulate China banks
stocks.
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Two rate hikes in 2010, four more in 2011F
The PBoC has recently raised interest rates twice: once in October, once in December
2010. Both were asymmetrical, hiking longer maturity (>1 year) time deposit rates by a
greater magnitude than lending rates with the same maturity.
Exhibit 25. Recent two hikes of PBoC's benchmark interest rates
Before 20 Oct, 2010 Since 20 Oct, 2010 Change (bps) Since 26 Dec, 2010 Change (bps)
Deposit rate (%)
Demand 0.36 0.36 0 0.36 0
Time
- 3 months 1.71 1.91 20 2.25 34
- 6 months 1.98 2.20 22 2.50 30
- 1 year 2.25 2.50 25 2.75 25
- 2 years 2.79 3.25 46 3.55 30
- 3 years 3.33 3.85 52 4.15 30
- 5 years 3.60 4.20 60 4.55 35
Lending rate (%)
- 6 months 4.86 5.10 24 5.35 25
- 6-12 months 5.31 5.56 25 5.81 25- 1-3 years 5.40 5.60 20 5.85 25
- 3-5 years 5.76 5.96 20 6.22 26
- >5 years 5.94 6.14 20 6.40 26
Source: PBoC, Nomura research
We see the PBoCs recent rate hikes as moves to narrow the deeper negative real
deposit rate and anchor inflation expectations. The 1-year real deposit rate has
remained in negative territory since February and dipped much deeper in recent
months, with November CPI climbing to 5.1% y-y and the 1-year deposit rate
remaining at 2.50% in the same month. We believe the prolonged negative deposit
rate heightens expectations of higher inflation.
Exhibit 26. China's 1-year deposit rate and CPI
inflation
(2)
0
2
4
6
8
10
Nov-03
Nov-04
Nov-05
Nov-06
Nov-07
Nov-08
Nov-09
Nov-10
(%) CPI, % y-o-y
Saving deposit rate: 1 year
Source: CEIC, Nomura research
Exhibit 27. Breakdown of loans by maturity (as of
June 30, 2010)
0
1,0002,000
3,000
4,000
5,000
6,000
7,000
ABC
ICBC
CCB
BOC
BOCOM
CMB
Citic
Minsheng
(RMBbn) Loans mature in more than 1 year
Loans mature in 1 year
Source: Company Data, Nomura research
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Central Economic Work Conference laid positive foundation forbanks in 2011F
Chinas 2010 Central Economic Work Conference (CEWC) closed on 12 December in
Beijing, having set the tone for economic policymaking in 2011F. While it did not
release specific targets for GDP growth, CPI inflation and new loan growth in 2011F, it
did set forth the main tasks for the governments economic work in the coming year:
Strengthen and improve macro control to maintain stable economic growth;
Promote the development of modern agriculture to guarantee the efficient supply of
agricultural products;
Accelerate the strategic adjustment of economic structure to improve the harmony
and competitiveness of economic development;
Improve basic public service and encourage innovation in the mechanisms of social
management;
Enhance the reform, and promote transformation, of the economic growth model;
Continue to open up and promote global cooperation.
More importantly, in our view, the meeting highlighted that Chinas monetary policy will
officially shift from relatively loose to prudent in 2011F in an effort to control excess
liquidity in the economy. It put a high priority on stabilising prices in the year 2011. As
such, we believe the market is now expecting a RMB7trn new loan quota and multiple
rate hikes in 2011F. Post our conversation with regulators, we believe new loan targets
in 2011F should be slightly lower than those for 2010. We see rigid credit control in
1H11F, given that CPI inflation is likely to remain elevated before mid-year. However,
we believe monetary policy will be reviewed in 2H11 when inflation moderates, and
thus the loan target is likely to be revised up.
Moderate loan quota plus rate hikes should help expand NIM
In our view, tighter new loan quota and multiple rate hikes should be positive for China
banks earnings outlook in 2011F. This is because banks earnings are more sensitive
to changes in margin than to new loan volume, in our view.
On the one hand, tightening of new loans should mean that banks can be more
selective of their customers and thus should enjoy more pricing power while
undertaking new lending. For instance, during its January 2011 analyst briefing
Minsheng stated that it sees much-improved pricing power in January 2011 compared
with the same period in 2010. As a result, the price of its SME product Shang Dai
Tong has climbed to 10% pa, according to comments by Minsheng management.
The current rate hike cycle should have helped China banks margin expansion, given
the rate for demand for deposits was unchanged. As the next Exhibit shows, by end1H10, over 50% of China banks deposits were demand deposits, most notably at ABC
(55.7%), ICBC (50.8%), CCB (53.5%) and CMB (56.2%). This indicates that more than
half of banks deposits would not be subject to higher rates, thus adding nil in extra
funding costs for China banks. Further, 45.5%, on average, of banks loans have a
maturity of less than one year; we believe these loans would be subject to re-pricing
within one year if the PBoC announces additional rate hikes, which would in turn
expand banks NIMs.
Exhibit 28. % shares of demand deposits and short-term loans of China banks
1H10 (%) ABC ICBC CCB BOC BOCOM CMB CITIC Minsheng
% share of demand deposits in total deposits 55.7 50.8 53.5 42.9 49.3 56.2 47.2 47.8% share of short-term loan in total loans 39.7 34.2 38.0 40.3 48.4 53.5 57.3 52.9
Source: Company data, Nomura research
Banks will be more selective oftheir customers, allowing for
better pricing
Current rate hike cycle should
have helped banks NIM
expansion
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What could go wrong in our bullish forecast?
We expect 6-27bps margin expansion in 2011F, based on the following factors:
Mortgage rate will be re-priced in January 2011 for all existing mortgages; hence, a
narrowing discount rate will be applied for new home buyers, in our view.
Front-loaded new loans new loans will be lent out at a higher benchmark rate and
more than 35% of the new loans quota will be used in 1Q11F. More rate hikes in early 2011F.
Still, since PBoC governor Zhou Xiaochuan views the current round of inflation as
liquidity-driven, there exists the risk of the central bank using more of a quantitative
monetary policy, rather than price monetary policy, to absorb excess liquidity from the
economy to ease rising inflation. If this proves to be the case, the PBoC will probably
hike rates by less than the market is expecting, which brings downside risk to our
forecast for NIM expansion in 2011F.
Exhibit 29. Yield on discounted bills (with maturity of 6 months)
0
1
2
3
4
5
6
7
1/4/2010
2/4/2010
3/4/2010
4/4/2010
5/4/2010
6/4/2010
7/4/2010
8/4/2010
9/4/2010
10/4/2010
11/4/2010
12/4/2010
1/4/2011
(%) 4.6% as of 7 Jan, 2010
Source: www.zgpj.net
Overall loan and deposit growth trends in November
Under the PBoCs lower loan quota introduced in January 2010 (RMB7.5tn in 2010
versus RMB9tn in 2009), new loans made by banks moderated when compared with
2009. Although new loans rebounded strongly recently (RMB600bn in September,
RMB588bn in October and RMB564bn in November, compared with RMB545bn in
August), outstanding loan growth dropped to 20% y-y in November 2010, from 34% a
year ago. However, in 2010 total new loans to November amounted to RMB7.47tn,
almost reaching the official target of RMB7.5tn. We expect loan growth in 2010 will be
down significantly but total new loans in 2010 will probably exceed the official target.
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Exhibit 30. Monthly new loans
0
200
400
600
800
1,000
1,200
1,400
1,600
1,800
2,000
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
(RMBbn) 2009 2010
Source: CEIC, Nomura research
Exhibit 31. Loans and deposits: y-y growth
0
5
10
15
20
25
30
35
40
Dec-98
Dec-99
Dec-00
Dec-01
Dec-02
Dec-03
Dec-04
Dec-05
Dec-06
Dec-07
Dec-08
Dec-09
Dec-10
(%) Loan Deposit
Source: CEIC, Nomura research
On the other hand, new deposits in November rebounded to RMB592bn after a
significant drop in October (from RMB1,456bn in September to RMB177bn in October),with deposit growth remaining stable at 20% y-y in October. Given that new loans
continued to surge, LDR (rolling 6 months) on incremental loans over deposit was
further boosted to 149% in November from 143% in October, while outstanding LDR
rebounded to 66.9% in November from 66.7% in October. The level remained stable
throughout 2010. A closer look at banks LDRs reveals that the high ratios (and
leverage) are more of a problem for small and medium-sized banks than large banks.
The loan-to-deposit ratio of large banks stayed at 65% in November; however, the
loan-to-deposit ratio of small and medium-sized banks was 84% in November, much
higher than the regulators requirement of 75%.
Exhibit 32. Monthly new deposits
0
500
1,000
1,500
2,000
2,500
3,000
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
(RMBbn)2009 2010
Source: CEIC, Nomura research
Exhibit 33. Monthly new loans and deposits
0
200
400
600
800
1,000
1,200
1,400
1,600
1,800
Jan-10
Feb-10
Mar-10
Apr-10
May-10
Jun-10
Jul-10
Aug-10
Sep-10
Oct-10
Nov-10
(RMBbn) Loan Deposits
Source: CEIC, Nomura research
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Exhibit 34. Loan-to-deposit ratio: outstanding and
rolling new loans and deposits
60
65
70
75
80
85
90
95
Jan-98
Mar-99
May-00
Jul-01
Sep-02
Nov-03
Jan-05
Mar-06
May-07
Jul-08
Sep-09
Nov-10
(%)
(1.5)
(1.0)
(0.5)
0.0
0.5
1.0
1.5
2.0
(%)LDR (LHS)
New LDR (rolling 6 months) (RHS)
Source: CEIC, Nomura research
Exhibit 35. Loan-to-deposit ratio by bank type
63% 63% 62% 63% 64% 63% 65% 65% 64% 65% 65%
84% 85% 83% 82% 84% 84%86%86%88%90%90%
15
25
35
45
55
65
75
85
95
Jan-10
Feb-10
Mar-10
Apr-10
May-10
Jun-10
Jul-10
Aug-10
Sep-10
Oct-10
Nov-10
(%) Large banks Small & Medium banks
Source: CEIC, Nomura research
In terms of total loans, the percentage share of corporate loans has been falling since
April 2009, to the current level of 76.5%, while that of household loans has been
consistently rising, to 23.4% as of November 2010. Households are increasingly
becoming loan growth drivers, especially in long-term household loans, which account
for 69% of total outstanding household loans and are continuing to rise at a steady
pace.
Exhibit 36. Percentage of total outstanding loans
15
16
17
18
19
20
21
22
23
24
Dec-04
Mar-06
Feb-07
Jul-07
Dec-07
May-08
Oct-08
Mar-09
Aug-09
Jan-10
Jun-10
Nov-10
(%)
72
74
76
78
80
82
84
86
(%)Household (LHS)
Corporate (RHS)
Source: CEIC, Nomura research
Exhibit 37. Percentage of total new loans
0
17
34
51
68
85
Feb-07
Jul-07
Dec-07
May-08
Oct-08
Mar-09
Aug-09
Jan-10
Jun-10
Nov-10
(%)
0
20
40
60
80
100
(%)Household (LHS)
Corporate (RHS)
Source: CEIC, Nomura research
Among corporate loans too, long-term loans have continued to account for a higher
percentage of total loans, while short-term loans (for working capital) have continuedto fall. Meanwhile, the percentage share of discounted bills remained at a historically
low level in November. We believe the higher proportion of long-term household and
corporate loans should benefit banks in the form of higher loan yields over the long
term.
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Exhibit 38. Household loan breakdown: as % of total
outstanding loans
4
6
8
10
12
14
16
18
Dec-04
Mar-06
Feb-07
Jul-07
Dec-07
May-08
Oct-08
Mar-09
Aug-09
Jan-10
Jun-10
Nov-10
(%) Household - short term (LHS)
Household - long term (LHS)
Source: CEIC, Nomura research
Exhibit 39. Corporate loan breakdown: as % of total
outstanding loans
3
4
5
6
7
89
10
11
Dec-04
Mar-06
Feb-07
Jul-07
Dec-07
May-08
Oct-08
Mar-09
Aug-09
Jan-10
Jun-10
Nov-10
(%)
25
30
35
40
45
50
(%)Discounted Bills (LHS)
Corporate - short term (RHS)
Corporate - long term (RHS)
Source: CEIC, Nomura research
In terms of total deposits, while deposit growth was relatively strong in the first elevenmonths of 2010, it was driven by strong enterprise deposit growth, which we think is
probably a result of improving corporate profits since the turn of 2010. According to the
PBoC, enterprise deposit increased by RMB574bn (accounting for 97% of total new
deposits) in November, while household deposits grew by RMB133bn. If this trend
continues, it could weigh on Chinese banks deposit costs as corporate (wholesale)
deposits are generally more expensive than household (retail) deposits. The PBoC
said it is concerned about household deposits moving away from the system due to
high inflation expectations, and has hiked interest rates twice by 25bps each time in
late October and December in order to address the situation.
Separately, the proportions of time and demand deposits remained relatively stable in
November, suggesting stable funding costs for Chinese banks.
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Exhibit 40. Deposit breakdown as % of total
deposits: household and enterprise
30
35
40
45
50
55
Feb-07
Jul-07
Dec-07
May-08
Oct-08
Mar-09
Aug-09
Jan-10
Jun-10
Nov-10
(%)Household Saving Enterprise
Source: CEIC, Nomura research
Exhibit 41. Deposit breakdown as % of total
deposits: demand and time
30
35
40
45
50
55
Feb-07
Jul-07
Dec-07
May-08
Oct-08
Mar-09
Aug-09
Jan-10
Jun-10
Nov-10
(%) Total Demand Total Time
Source: CEIC, Nomura research
Exhibit 42. As % of total household saving deposits
30
35
40
45
50
55
60
65
70
Feb-07
Jul-07
Dec-07
May-08
Oct-08
Mar-09
Aug-09
Jan-10
Jun-10
Nov-10
(%) Demand Time
Source: CEIC, Nomura research
Exhibit 43. As % of total enterprise deposit
30
35
40
45
50
55
60
65
Feb-07
Jul-07
Dec-07
May-08
Oct-08
Mar-09
Aug-09
Jan-10
Jun-10
Nov-10
(%) Demand Time
Source: CEIC, Nomura research
Loan/deposit growth trends by bank size
At large banks in China, household deposits made up over half of total deposits while
enterprise deposits accounted for around a third based on our analysis of the 3Q10
financial statements of China banks. In contrast, household deposits only accounted
for 20% or so at small and medium-sized banks, while enterprise deposits accounted
for 54% of the total deposit base. In general, enterprise (wholesale) deposits are more
expensive than household (retail) deposits; as a result, small and medium-sized banksare bearing much more of the higher funding cost than large banks. In addition, as
they attract the majority of household deposits, we believe large banks would benefit
more from the growth in household deposits as the PBoC has reversed its monetary
policy and raising deposit rates will be the tool to address inflation.
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Exhibit 44. Large banks: deposits as % of total
51%52% 51% 51% 50% 51% 51% 51% 51% 50% 50%
32% 31% 32% 32% 32% 32% 32% 31% 31% 32% 32%
15
20
25
30
35
40
45
50
55
Jan-10
Feb-10
Mar-10
Apr-10
May-10
Jun-10
Jul-10
Aug-10
Sep-10
Oct-10
Nov-10
(%)Household Saving Enterprise
Source: CEIC, Nomura research
Exhibit 45. Small and medium-sized banks: deposits
as % of total
19% 21% 20% 20% 20% 20% 20% 19% 20% 19% 19%
56% 55% 55% 55% 55% 55% 54% 54% 53% 54% 54%
15
20
25
30
35
40
45
50
55
60
Jan-10
Feb-10
Mar-10
Apr-10
May-10
Jun-10
Jul-10
Aug-10
Sep-10
Oct-10
Nov-10
(%)Household Saving Enterprise
Source: CEIC, Nomura research
Again, the proportions of demand and time deposits at large banks were stable in 2010,with the former accounting for 43% and the latter 38% by end-November based on the
disclosures by large banks. For small and medium-sized banks, the proportion of
demand deposits and time deposits was stable at 39% and 34% as of end-November.
We think some corporates entered into a negotiated deposit rate with small and
medium-sized banks, categorised as other deposits. Small and medium-sized banks
have a higher percentage share of such other deposits, which usually carry higher
interest rates than demand deposits. This again points to higher funding costs for small
and medium-sized banks in China.
Exhibit 46. Large banks deposits as % of total
43% 42% 43% 42% 43% 43% 43% 43% 42% 43% 43%
40% 39% 39% 39% 38%40% 40%40%40%40%41%
15
20
25
30
35
40
45
Jan-10
Feb-10
Mar-10
Apr-10
May-10
Jun-10
Jul-10
Aug-10
Sep-10
Oct-10
Nov-10
(%)
Total Demand Total Time
Source: CEIC, Nomura research
Exhibit 47. Small and medium-sized banks deposits
as % of total
41% 40% 40% 40% 40% 41% 40% 39%38% 39%
39%
34%35% 34% 35% 34% 34% 34% 34% 34% 34%36%
15
20
25
30
35
40
45
Jan-10
Feb-10
Mar-10
Apr-10
May-10
Jun-10
Jul-10
Aug-10
Sep-10
Oct-10
Nov-10
(%)
Total Demand Total Time
Source: CEIC, Nomura research
Most household deposits tend to be in time deposits (for saving), both for large banks
and small and medium-sized banks, while most enterprise deposits are in demand (for
working capital). In particular, enterprises hold a higher proportion in time deposits at
small and medium-sized banks than in large banks, according to our analysis.
This was particularly the case in 1H10, when smaller banks aggressively took deposit
market share from large peers in order to deleverage their balance sheet and meet the
75% LDR requirement, according to a report by the 21st Century Business Herald inJune 2010. The price war not only pushed up deposit costs for small and medium-
sized banks, but resulted in added operational costs allocated to account managers for
their marketing expenses and the gifts they offered new depositors. Given the three-
time 50bps RRR hikes in November and December, we expect competition for
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deposits will still be keen till end-2011. We saw this trend of keen competition for
deposits resume in 4Q10. Given that tighter liquidity pushed interbank rates higher, we
think Chinese banks were promoting more short-term structured financial products at
higher yields. For instance, CCB offered a 3.9% pa rate for 3-day and 7-day deposit
products on 29, 30, and 31 December 2010.
Exhibit 48. Large banks: as % of total householdsavings
40% 40% 40% 40% 40% 41% 41% 41%42% 41% 42%
60% 60% 60% 60% 60% 59% 59% 59% 58% 59% 58%
15
20
25
30
35
40
45
50
55
60
65
Jan-10
Feb-10
Mar-10
Apr-10
May-10
Jun-10
Jul-10
Aug-10
Sep-10
Oct-10
Nov-10
(%) Demand Time
Source: CEIC, Nomura research
Exhibit 49. Small and medium-sized banks: as % oftotal household savings
36% 36% 37% 37% 36% 38% 36% 37% 37% 37% 37%
64% 64% 63% 63% 64% 62% 64% 63% 63% 63% 63%
15
25
35
45
55
65
75
Jan-10
Feb-10
Mar-10
Apr-10
May-10
Jun-10
Jul-10
Aug-10
Sep-10
Oct-10
Nov-10
(%) Demand Time
Source: CEIC, Nomura research
Exhibit 50. Large banks: as % of total enterprise
deposits
71% 69% 69% 69% 70% 70% 70% 70% 67%70% 71%
29% 31% 31% 31% 30% 30% 30% 30%33%
30% 29%
15
25
35
45
55
65
75
Jan-10
Feb-10
Mar-10
Apr-10
May-10
Jun-10
Jul-10
Aug-10
Sep-10
Oct-10
Nov-10
(%) Demand Time
Source: CEIC, Nomura research
Exhibit 51. Small and medium-sized banks: as % of
total enterprise deposits
59% 60% 60% 60% 60% 60% 59%57%
59% 60%
39%41% 40% 40% 40% 40% 40% 41%
43%41% 40%
61%
15
20
25
30
35
40
45
5055
60
65
Jan-10
Feb-10
Mar-10
Apr-10
May-10
Jun-10
Jul-10
Aug-10
Sep-10
Oct-10
Nov-10
(%) Demand Time
Source: CEIC, Nomura research
On the assets front, medium- to long-term loans account for a major chunk of total
loans of large banks, accounting for 73% of their total loans in November 2010 based
on our analysis of their financial statements. On the other hand, medium- to long-term
loans only made up 52% of total loans for small and medium-sized banks and short-
term loans accounted for 45% in November 2010. We think that this is likely because
large banks have more SOE borrowers who need more long-term loans for fixed-asset
investment and infrastructure construction projects. In contrast, small and medium-
sized banks have 40-80% of SME corporate clients who are more in need of short-
term working capital loans.
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Exhibit 52. Large banks: as % of total loans
24% 24% 24% 24% 24% 24% 24% 24% 24% 24% 24%
71% 71% 72% 72% 72% 73% 73% 73% 73% 73% 73%
5% 4% 3% 4% 4% 3% 3% 3% 3% 2% 2%
0
10
20
30
40
5060
70
80
Jan-10
Feb-10
Mar-10
Apr-10
May-10
Jun-10
Jul-10
Aug-10
Sep-10
Oct-10
Nov-10
(%) Short-term Medium-Long term Bill financing
Source: CEIC, Nomura research
Exhibit 53. Small and medium-sized banks: as % of
total loans
46% 45% 44% 44% 44% 44% 44% 44% 44% 45%
51% 51% 51% 52% 52% 52% 52% 52% 52%
5% 4% 4% 4% 4% 4% 4% 4% 3% 3% 3%
46%
49% 50%
0
10
20
30
40
50
60
Jan-10
Feb-10
Mar-10
Apr-10
May-10
Jun-10
Jul-10
Aug-10
Sep-10
Oct-10
Nov-10
(%) Short-term Medium-Long term Bill f inancing
Source: CEIC, Nomura research
Deposit growth still holds the key
Generally, LDRs of Chinese banks declined slightly over the first three quarters of
2010, with most banks under our coverage meeting the 75% LDR requirement. That
said, we reckon deposit costs would have continued to rise for the rest of 2010 as
banks continued to compete for deposits, given the importance of maintaining deposit
growth. In our view, banks should try to avoid the vicious cycle where slower deposit
growth leads to slower loan growth, which, in turn, results in slower deposit growth.
In addition, we reckon that banks with lower LDRs and capacity to lend will continue to
enjoy better loan-deposit spreads, and thus would be more selective in choosing
customers.
Exhibit 54. LDR (1Q10 3Q10)
0
10
20
30
40
50
60
70
80
90
ABC
ICBC
CCB
BOC
BOCOM
CMB
CITIC
Minsheng
SPDB
Industria
l
SZDB
Huaxia
(%) 1Q10 2H10 3Q10
Note: Huaxia did not disclose LDR in 1Q10 and 3Q10 results announcement
Source: CEIC, Nomura research
The PBoC raised RRR twice in November and once more in December to absorb
excess liquidity in the market. Based on our estimates, banks will have to park an
additional RMB1,050bn of their deposits at the central bank. As a result, banks are
under more pressure to compete for deposits in order to meet the regulatory LDR of
75% by the year end. In our view, the impact will be less significant for large-cap banks
which generally have a lower LDR and wider deposit base. We expect to see risingfunding costs as banks compete to attract more deposits, especially as we expect the
RRR to continue its upward trend in 2011.
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Exhibit 55. Impact of recent three-time RRR hikes on Chinese banks LDR
LDR (%) LDR after three-time RRR hike (%) Impact on LDR (pct)
ABC 55.15 55.99 0.84
ICBC 58.24 59.13 0.88
CCB 61.34 62.27 0.93
BOC 74.68 75.81 1.13
BOCOM 77.44 78.61 1.17CMB 73.71 74.82 1.12
CITIC 73.29 74.40 1.11
Minsheng 72.28 73.38 1.10
SPDB 70.37 71.44 1.07
Industrial 76.31 77.47 1.16
SZDB 74.23 75.35 1.12
Huaxia 72.79 73.89 1.10
Note: LDRs as of 30 September 2010, except Huaxia (30 June 2010)
Source: Company data, Nomura research
We think the three-time 50bps RRR hikes have lifted the sector's LDR by 0.84-1.17%,
which, we believe, is one of the reasons the PBoC slowed new-loan growth inNovember and December 2010. Based on our analysis, most large-cap banks are
immune to the hikes because their LDR ratios are much lower than 75% LDR ratios
of ABC (55.15%), ICBC (58.24%) and CCB (61.34%) would be well below the
requirement and because they have plenty of excess reserves. However, there
would have been more pressure on other peers to meet the 75% requirement as the
year-end checks approached. We believe this will restrain those banks with higher
LDR ratios from expanding their loans substantially. Moreover, we see greater
pressure on joint-stock banks not to raise funding costs in the course of attracting
more deposits in an effort to bring down their LDR ratios.
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A preview of the new environment in 2011: different RRR, loan supply and yields
4Q10 preview and 2011 earnings
forecastsWe believe the upcoming 2010 annual results should record solid operating trends for
Chinese banks, with their earnings growing at 19.7-49.8% y-y for the full year. We
expect NIM to have expanded by 8-32bps to reach 2.12-2.91% for 2010F, helped byimproving pricing power resulting from both recent rate hikes and tighter liquidity,
especially in 4Q10. While interest income continues to grow steadily, we estimate fee
income growth should reach 22.1-41.5% y-y, further underpinning the earnings growth
in 2010.
Looking forward, we remain positive on China banks earnings growth in 2011F. We
forecast 16.2-34.1% y-y NPAT growth for China banks under our coverage based on
our assumption of bullish NIM expansion of 6-27bps in 2011F, given our economics
teams expectation of four rounds of 25bps rate hikes, one in each quarter of the year.
We think banks with more exposure to SMEs will be able to enjoy better pricing power
and thus higher NIM expansion in 2011F. In particular, we believe CMBs FY11F NIM
should expand by 27bps, CCBs by 13bps and Citics by 8bps. On the balance sheetside, we think new loan growth is likely to reach RMB7.2-7.5trn, translating into
estimated growth of 15-16% y-y in 2011F. Meanwhile, as regulators may adopt
monthly monitoring and different RRR for individual banks, we see joint-stock banks
facing more intense competition in attracting deposits for the purpose of bringing down
their LDR ratios to meet the 75% requirement in each month/quarter. However, we
reckon that credit costs should largely stay steady at 50bps, on average, in 2011F.
Rate hike sensitivity test for 2011F
We believe the recent rate hikes by the PBoC should benefit China banks as they
should boost NIMs in 2011F. Given that the demand deposit rate remains unchanged
and, as of 1H10, about half of the total deposits of H-share banks are demanddeposits ABC (55.7%), ICBC (50.8%), CCB (53.5%), BOC (42.9%), BOCOM
(49.3%), CMB (56.2%), Citic (47.2%) and Minsheng (47.8%) while around 58.5%,
on average, of these banks loans will be re-priced within one year, we believe the last
two rounds of rate hikes should be largely positive for China banks as their NIMs
should be boosted by 3.7-11.7bps and net profits by 1.4-6.8% in 2011F.
Exhibit 56. Time deposits vs demand deposits (as of
June 30, 2010)
0
2,000
4,000
6,000
8,000
10,000
12,000
ABC
ICBC
CCB
BOC
BOCOM
CMB
Citic
Minsheng
(RMBbn) Time deposits Demand deposits
Source: Company data, Nomura research
Exhibit 57. Personal deposits vs corporate deposits
(as of 30 June, 2010)
0
2,000
4,000
6,000
8,000
10,000
12,000
ABC
ICBC
CCB
BOC
BOCOM
CMB
CITIC
Minsheng
(RMBbn) Personal deposits Corporate deposits
Source: Company data, Nomura research
We expect NIM to expand by 8-32
bps to reach 2.12-2.91% in 2010
We expect NIM to expand 6-27bps
in 2011
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Exhibit 58. Deposits breakdown (as of 30 June, 2010)
(RMBmn) ABC ICBC CCB BOC BOCOM CMB CITIC Minsheng
Demand deposit 4,651,708 5,503,161 4,702,362 3,337,253 1,332,932 985,467 768,661 630,278
- Corporate deposits 2,434,994 3,448,278 3,137,269 2,055,842 991,074 603,281 689,544 564,740
- Personal deposits 2,216,714 2,054,883 1,565,093 1,281,411 341,858 382,186 79,117 65,538
Time deposit 3,445,418 4,952,712 3,786,779 3,420,745 1,365,527 766,933 860,641 686,611
- Corporate deposits 858,867 1,914,605 1,463,682 1,281,571 840,919 473,956 659,964 535,570- Personal deposits 2,586,551 3,038,107 2,323,097 2,139,174 524,608 292,977 200,677 151,041
Subtotal: corporate deposits 3,293,861 5,362,883 4,600,951 3,337,413 1,831,993 1,077,237 1,349,508 1,100,310
Subtotal: personal deposits 4,803,265 5,092,990 3,888,190 3,420,585 866,466 675,163 279,794 216,579
Other Deposits 235,712 155,325 461,336 4,472 2,671
Overseas Deposit 15,982 221,591 102,560
Total 8,348,820 10,832,789 8,591,701 7,219,334 2,702,931 1,752,400 1,629,302 1,319,560
Source: Company data, Nomura research
Exhibit 59. Cumulative impact of the two interest-rate hikes in 2010
ABC ICBC CCB BOC BOCOM CMB CITIC Minsheng
Impact on FY11F NIM (bp) 5.7 3.7 4.0 6.3 8.8 9.6 8.6 11.7
Impact on FY11F net profit (%) 3.1 1.4 1.6 4.0 4.7 4.4 4.6 6.8
Impact on FY12F NIM (bp) 7.1 3.6 4.2 6.7 9.4 9.1 8.6 12.1
Impact on FY12F net profit (%) 3.6 1.3 1.5 3.8 4.9 3.9 4.5 6.5
Source: Nomura estimates
Our economics team continues to see a higher CPI inflation of 4.5% in 2011F. They
believe the PBoC needs to quicken the process of interest-rate normalization, hence
the expectation of a 25bp rate hike in each quarter of 2011F.
If this proves to be true, we believe it should serve as a positive catalyst for Chinese
banks earnings growth in 2011F. Assuming 25bp symmetrical rate hikes in each
quarter of 2011, which is our baseline forecast, Chinese banks NIM should expand by9-17bp and net profit should grow by 2.7-9.7% in 2011F.
Exhibit 60. Chinese banks NIM expansion and earning growth in 2011F (baseline scenario)
ABC ICBC CCB BOC BOCOM CMB CITIC Minsheng
Impact on FY11F NIM (bp) 9.4 6.2 7.1 9.6 12.8 14.1 13.0 16.5
Impact on FY11F net profit (%) 5.4 2.7 3.1 6.0 7.0 6.7 7.4 9.7
Impact on FY12F NIM (bp) 11.2 6.2 7.2 10.1 13.5 13.6 13.0 16.9
Impact on FY12F net profit (%) 5.8 2.5 2.9 5.8 7.1 5.9 7.2 9.3
Source: Nomura research
That said, we see a chance of fewer rate hikes in 2011F. If the PBoC turns out to
announce only one round of 25bp symmetrical rate hikes, based on our estimates, itwould boost banks NIM by only 2.5-6.6bp and earnings by 1.1-3.9% in 2011F. If there
are two rounds of 25bp symmetrical rate hikes, we expect FY11F NIM to expand by
4.4-11.6bp and net profits to increase by 1.9-6.8%. Three rounds of 25bp symmetrical
rate hikes should boost NIM by 5.6-14.9bp and earnings growth by 2.4-8.8% in 2011F,
by our estimates.
Exhibit 61. NIM expansion and earning growth provided one 25bp symmetrical rate hike in 2011F
ABC ICBC CCB BOC BOCOM CMB CITIC Minsheng
Impact on FY11F NIM (bp) 3.7 2.5 2.8 3.8 5.1 5.6 5.2 6.6
Impact on FY11F net profit (%) 2.2 1.1 1.2 2.4 2.8 2.7 2.9 3.9
Impact on FY12F NIM (bp) 4.5 2.5 2.9 4.0 5.4 5.4 5.2 6.8
Impact on FY12F net profit (%) 2.3 1.0 1.2 2.3 2.9 2.4 2.9 3.7
Source: Nomura research
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Exhibit 62. NIM expansion and earning growth provided two 25bp symmetrical rate hikes in 2011F
ABC ICBC CCB BOC BOCOM CMB CITIC Minsheng
Impact on FY11F NIM (bp) 6.5 4.4 4.9 6.7 9.0 9.8 9.1 11.6
Impact on FY11F net profit (%) 3.8 1.9 2.2 4.2 4.9 4.7 5.2 6.8
Impact on FY12F NIM (bp) 7.8 4.4 5.1 7.1 9.4 9.5 9.1 11.9
Impact on FY12F net profit (%) 4.1 1.8 2.0 4.0 5.0 4.1 5.0 6.5
Source: Nomura research
Exhibit 63. NIM expansion and earning growth provided three 25bp symmetrical rate hikes in 2011F
ABC ICBC CCB BOC BOCOM CMB CITIC Minsheng
Impact on FY11F NIM (bp) 8.4 5.6 6.4 8.6 11.5 12.7 11.7 14.9
Impact on FY11F net profit (%) 4.8 2.4 2.8 5.4 6.3 6.0 6.6 8.8
Impact on FY12F NIM (bp) 10.1 5.6 6.5 9.1 12.2 12.2 11.7 15.2
Impact on FY12F net profit (%) 5.2 2.3 2.6 5.2 6.4 5.3 6.5 8.4
Source: Nomura research
However, if the expected rate hike turns out to be asymmetrical, we believe it would
have a negative impact on Chinese banks and reduce their NIMs by 7.8-11.7bp and
earnings growth by 5.2-8.1%, assuming 25bp rate hike on deposit rate while the
lending rate remains unchanged. Having said that, we think there is a small chance the
PBoC will take such action. As such, we remain positive on the China banks sector in
2011F.
Exhibit 64. Impact of asymmetrical rate hikes: 25bps rate hike on deposit rate, lending rate unchanged
ABC ICBC CCB BOC BOCOM CMB CITIC Minsheng
Impact on FY11F NIM (bp) (9.3) (10.3) (9.7) (7.8) (8.9) (9.5) (11.7) (9.7)
Impact on FY11F net profit (%) (6.0) (5.9) (5.2) (4.9) (5.5) (5.2) (8.1) (6.5)
Impact on FY12F NIM (bp) (9.5) (10.7) (9.5) (8.2) (8.8) (9.6) (11.8) (9.4)
Impact on FY12F net profit (%) (5.4) (6.0) (4.7) (4.7) (5.2) (4.9) (8.1) (6.0)
Source: Nomura research
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Risks from LGFV loans
Risks from LGFV loan default should
remain remoteAlthough we believe monetary policy will shift to being prudent and thus new loan
growth is likely to slow only slightly, in our view in 2011F, there is only a small
chance of a high default ratio for LGFV loans. We understand from management ofChina banks that most LGFV loans are concentrated in eastern coastal areas where
local governments have plenty of fiscal firepower to provide support to these LGFV
loans. For example, 25.9% of ICBCs total LGFV loans were lent to Shanghai, 11.4%
to Shandong province, 10.9% to Tianjin, 10.4% to Guangdong province, 7.7% to Hebei
province and 4% to Beijing, accounting for 61.3% of its total LGFV loans.
Local government fiscal revenue has grown steadily, at a CAGR of 19% from 1999 to
2009 (data for 2010 are not yet available), and we believe the trend should continue in
2010. Revenue from land use accounted for 2.8-2.9% of total fiscal revenue in 2008
and 2009, according to NBSC. With rising land prices in 2010, we expect a higher
percentage of revenue from land use in 2010. As China will continue to carry out
proactive fiscal policy in 2011F, in our view, we reckon that local-governmentsponsored projects will obtain more financing via fiscal channels to ensure
continuation of these projects. Thus, we do not think there should be a significant
increase in LGFV loan defaults just because of slower new loan growth in 2011F.
Exhibit 65. Local government revenue
0
1
2
3
4
5
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
(% share)
0
700
1,400
2,100
2,800
3,500
(RMBbn)
Total local governmentrevenue (RHS)
% share from use of land(LHS)
Source: CEIC, Nomura research
Exhibit 66. Land price
2,000
2,200
2,400
2,600
2,800
3,000
Mar-08
Jun-08
Sep-08
Dec-08
Mar-09
Jun-09
Sep-09
Dec-09
Mar-10
Jun-10
Sep-10
(RMB/sqm)
Source: CEIC, Nomura research
Moreover, LGFV loans accounted for only what we consider to be a reasonable
proportion of 7.8-19.2% of total loans for China banks under our coverage, according
to disclosures by banks. And, as reported in the 21st Century Business Herald, 24% of
all the LFGV loans are with full coverage and 50% with basic or partial coverage, if
classified by the new method of four categories based on their risks. As a result, we
are not concerned about any significant rise in NPLs of LGFV loans in 2011F.
Exhibit 67. LGFV loans of China banks
ABC ICBC CCB BOC BOCOM CMB CITIC Minsheng Countrytotal
1Q10 3Q10 3Q10 1H10 1H10 3Q10 3Q10 3Q10 1H10
Total LGFV loans (RMBmn) 530,000 830,000 718,600 419,700 139,000 130,000 220,000 190,500 7,660,000
% of total loans (%) 11.9 12.0 13.1 7.8 8.0 10.0 18.3 19.2 17.2
Source: Company data, Nomura research
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Latest measures on LGFV loans
Recently the 21st Century Business Heraldreported that the regulator will introduce a
more stringent loan classification method and risk-weighted measurement standards
for LGFV loans, according to a 22 December 2010 article, China Sets New Rules on
Financing to Local Governments.
Exhibit 68. LGFV details of China banks
(RMBmn, except %) ABC ICBC CCB BOC BCOM CMB Citic Minsheng Country total
2010 As of 30 Nov As of 30 Sep As of 30 Sep As of 30 Jun As of 30 Jun As of 30 Sep As of 30 Sep As of 30 Sep As of 30 Jun
Full 389,400 622,500 406,300 209,850 na 116,142 218,680 133,350 1,838,400
Basic 20,750 na 11,258 32,385
Partial50,364
na 2,1323,830,000
No
270,600186,750
312,300
159,486 na 468
1,32024,765
1,991,600
Total 660,000 830,000 718,600 419,700 139,000 130,000 220,000 190,500 7,660,000
% of total loans 11.9 12.0 13.1 7.8 8.0 10.0 18.3 19.2 17.2
NPL ratio 0.58 0.02 na 0.07 na na na 0 na
NPL balance 3,828 166 na 301 na na na 0 na
Source: Company Data, Nomura Research
LGFV loans re-classified into five categories
As stated in the news article, the CBRC may require lenders to classify LGFV loans
into five categories 1) pass, 2) special mention, 3) substandard, 4) doubtful and 5)
loss. Loans are classified based on the sufficiency of a borrowers cash flow, the
amount of the guarantee and the realized value of collateral of the related projects.
According to the article, in order for loans to be classified as pass or special
mention, the total value of cash flow, guarantee and collateral should be over 120% of
the loan amount. Those below 120% should be classified as non-performing loans,
whereby the ratio of substandard loans must be above 80%.
Risk weighting for LGFV loans
Moreover, the article also disclosed that the regulator may assign higher risk weights
to LGFV loans, with 100% risk weightings on loans fully covered by the borrowers
cash flow, 140% on loans with cash flow coverage of 70-100%, 250% on loans with
cash flow coverage of 30-70%, and as much as 300% on loans for which the cash flow
coverage is lower than 30%.
Exhibit 69. Classification and risk weighting of LGFV loans
Coverage Classification method Treatments % of Total Risk weight (%)
FULL Ratio is 100% or above borrower's cash flow is sufficient
Will be reclassified as corporate loan if the requirementsfor categorising into corporate loan can be fulfilled.
24 100
BASIC Ratio is between 70% and 100%and a portion of the loan requiresfiscal guarantee
140
PARTIAL Ratio is between 30% and 70% andrequires partial fiscal guarantee
Can be classified as corporate loan after going throughproject stripping, restructuring and adding in newborrowers and guarantors. For loans that are mainlyguaranteed or repayment sources are local fiscalincome, given that the original repayment relationship ofthe loan remains unchanged, certain features such asguarantee principal, land, high quality enterprise shares,effective income rights and other legal equitant collateralcan be added to reduce risks.
50
250
NO Ratio is below 30% and majority ofthe loan requires fiscal guarantee
There will be attempts to recover or exit from the loan. 26 300
Source: 21st Century Business Herald, Nomura research
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Manageable impact on capital adequacy and earnings
It is still difficult to verify the accuracy of the news report or if the CBRC would
implement this measure this year. However, assuming the regulator does implement
this measure, we believe Chinese banks' capital adequacy levels and earnings will be
affected.
According to our sensitivity analysis, the new measures, if they had been implemented,
would have decreased China banks CAR by 0.52-1.48pct in 2010 and 0.42-1.23pct in2011F and Tier 1 CAR by 0.39-1.13pct and 0.33-0.95pct, respectively, in 2010F and
2011F. Among all the China banks under our coverage, we see ABC as the most
affected while CMB would be the most resilient.
We believe the regulator will introduce the new measures with a phase-in period of 2-3
years, and we do not expect another round of capital raising in the near term.
Exhibit 70. Impact of new risk weighting of LGFV loans on FY10F CAR and T1 CAR
FY10F ABC ICBC CCB BOC BCOM CMB Citic Minsheng
CAR (%) 12.89 12.90 12.27 12.40 13.62 11.26 10.15 11.33
T1 CAR (%) 9.70 9.95 9.42 9.57 9.48 8.36 8.23 8.09
Impact on CAR (pct) (1.48) (1.22) (1.26) (1.09) (1.17) (0.52) (0.74) (1.27)
Impact on T1 CAR (pct) (1.12) (0.94) (0.96) (0.84) (0.81) (0.39) (0.60) (0.91)
Note: assume the current risk weight of LGFV loans to be 50%. As some of the banks did not disclose the detailed proportion under different coverage ratio, we couldonly estimate based on the data available and assume the same proportion as the nationwide results as of 30 June 2010
Source: Nomura Research estimates
Exhibit 71. Impact of new risk weighting of LGFV loans on FY11F CAR and T1 CAR
FY11F ABC ICBC CCB BOC BCOM CMB Citic Minsheng
CAR (%) 12.58 11.96 11.31 11.69 13.42 10.88 10.99 10.88
T1 CAR (%) 9.73 9.37 8.94 9.08 9.44 8.48 9.14 7.76
Impact on CAR (pct) (1.23) (0.94) (0.97) (0.90) (1.02) (0.42) (0.67) (1.12)
Impact on T1 CAR (pct) (0.95) (0.74) (0.77) (0.70) (0.72) (0.33) (0.55) (0.80)Note: assume the current risk weight of LGFV loans to be 50%. As some of the banks did not disclose the detailed proportion under different coverage ratio, we couldonly estimate based on the data available and assume the same proportion as the nationwide results as of 30 June 2010
Source: Nomura research estimates
Sensitivity analysis on FY11F NPAT
After taking into consideration the loan-loss provision ratio requirement of 2.5% which
will likely be implemented by the regulator, the impact on credit costs and hence
earnings would be dampened, in our view. We estimate that ABC would be the most
affected, given its comparatively lower coverage ratio (160% as of 30 September,
2010) and hence less excess provision. For some of the listed banks such as CMB,
Citic and Minsheng, there would be no further impact if they were to meet the 2.5%
loan-loss provision ratio.
We conducted a sensitivity analysis under three scenarios assuming that all banks
would have met the loan-loss provision ratio requirement of 2.5% by the end of 2011.
In ourbase case, where we assume allowance of 35% and 100% to be applied to
NPL derived from ca
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