Macquarie Research China Banks6 November 2018 2Investment summaryWhat to do after strong performance in 3Q18 After the correction in 2Q18, China banks outperformed the market and we expect the strong trend tocontinue into 2H18. In particular, we believe the market became hesitant to chase stocks where highexpectations were built into valuations. In contrast, we believe China banks remain a good defensiveplay because the market has very low expectations for the banking sector, evidenced by the lowvaluations in terms of PE and PB.The big four banks outperformed the HSCI after 2Q18, but we expect less upside than what wepreviously anticipated because the pressures on NIM should intensify into 2019/2020, although theimproving asset quality should be partially reflected in prices (China Banks - Time to buy; UpgradingCITIC and BoCom). Among the big four banks, we expect BOC-H to be the most attractive because itshould benefit from Fed rate hikes, which should offset the impact of NIM pressure in its RMB books.In contrast, we expect joint-stock banks, which have strong credit card franchises and less exposure toWMPs, to outperform over the next year. In particular, we upgraded the TPs for BoCom’s H and Ashares due to strong growth in its credit card business and a conservative strategy for WMPs andcorporate lending. In addition, CITIC-H also appears to be attractive in terms of valuation, especially inour unconventional valuation matrix (please refer to Appendix - Unconventional Valuation Matrix). Fig 1 Relative performance of H-share banks (vs. HSCI)Fig 2 Unconventional valuation matrix (H-shares) * From the end of September to 2 November 2018. Source: WIND, Macquarie Research, November 2018 Note: Book values were adjusted for loan-loss coverage andcapitalization. Stock prices as of 2 November 2018. Source: Macquarie Research, November 2018Recommendation changes Picking BoCom as our top pick is a non-consensus call. Why BoCom is our top pick Among all the banks, we prefer banks with bigger contributions from credit card business, which shouldinclude transaction fees for both credit cards and debit cards and fees/net interest income on instalmentloans. In contrast, as we expect wealth mgmt.-related fees to decline further, we suggest investors avoidbanks with larger exposures to this product line. In particular, we highlighted on page 9 of China Banks -Time to buy; Upgrading CITIC and BoComthat the contribution of wealth mgmt. business to the net profitshould be bigger because the associated costs are very low, especially for manufacturing parts. Among the banks, BoCom and CITIC were relatively better positioned because we estimate that thecontribution from credit card business to their pretax profit should be large enough to offset adverse impactfrom contraction in wealth mgmt.-related businesses. On the other hand, we believe CMB and MSB willface a contraction fees in 2019E and therefore a slowdown in PPoP growth over the next two years.-15% -10% -5% 0% 5% 10% 15% 20% 25% CMBBoComCITICMSBICBCBOCCCBABC 2Q183Q184Q18* 2.0 2.5 3.0 3.5 4.0 4.5 0.400.600.801.001.201.40 CMB ICBC ABC CITIC MSB BOC BoCom Priceto Adjusted BV (18E) Pr ice toP PO P( 19 E) CCB Macquarie Research China Banks6 November 2018 3Among BoCom and CITIC, we feel more comfortable with the reserves, capitalization and the product mixof on-/off-balance-sheet WMPs. We raise our BoCom-H and BoCom-A TPs by 7% and 10%, respectively,and upgrade BoCom-A to OP from N. We raise our PPoP growth forecasts by 12%/8% for 2019E/20E toreflect (1) strong growth in credit card revenue due to market share gains; (2) lower funding costs fromfalling interbank rates and replacement of on-balance-sheet WMPs with cheaper structured deposits; (3)relatively conservative WMP business (i.e. small off-balance-sheet WMPs) and diversified loan portfolio.Though net profit forecasts remain unchanged due to provisions needed to clean up the legacy book, webelieve its PPoP growth will be sustained and the bank is on the right track to rebuild its value. Fig 3 Revenue contribution by product line (2018E)Fig 4 Profit contribution by product line (2018E)* Note: Revenue for credit cards include net interest incomes on revolvingcredit and instalment loans plus spending fees. Source: Company data, Macquarie Research, November 2018 Note: We assumed cost-income ratio of 10% for WMPs and 60% pluscredit cost of 1.5% for credit card business. Source: Company data, Macquarie Research, November 2018Other recommendation changes Despite asset quality likely improving further, we cut TPs for big four banks, which include ICBC, CCB,ABC and BOC by 31-37% for their H-shares and 28-33% for the A-shares to reflect (1) weaker loan growthand pressures on spreads for lending to the SOE sector; and (2) falling interbank rates and loweredexpectations for domestic rate hikes. We downgrade the A shares of big four banks to N from OPpreviously. A-shares of the big four banks have outperformed the CSI300 by 13-26% for the year-to date.To reflect higher credit risks going forward, we lower our TPs for CMB-H and CMB-A by 5% and 7%,respectively. Similarly, we also cut the TPs for MSB-H and MSB-A by 13% and 13%. We also trim our TPsfor CITIC-H and CITIC-A by 9% and 7%, respectively, because we believe stronger PPoP growth will liftnormalized ROE, which will partially offset higher credit costs. Fig 5 China banks - Recommendation changes RecommendationPrice TargetsStock Ticker Pre. New Pre. New ChangeH-ShareABC 1288 HK OP OP 6.0 4.1 -32%BOC 3988 HK OP OP 5.9 4.1 -31%BoCom 3328 HK OP OP 6.7 7.2 7%CCB 0939 HK OP OP 12.0 7.6 -37%CITIC 0998 HK OP OP 6.5 5.9 -9%CMB 3968 HK UP UP 22.0 21.0 -5%ICBC 1398 HK OP OP 9.3 6.4 -31%MSB 1988 HK N N 6.2 5.4 -13%A-ShareABC 601288 CN OP N 5.2 3.6 -31%BOC 601988 CN OP N 5.0 3.6 -28%BoCom 601328 CN N OP 5.8 6.4 10%CCB 601939 CN OP N 10.0 6.7 -33%CITIC 601998 CN N N 5.6 5.2 -7%CMB 600036 CN UP UP 19.5 19.0 -3%ICBC 601398 CN OP N 8.0 5.6 -30%MSB 600016 CN UP UP 5.4 4.7 -13%Source: Macquarie Research, November 20180% 5% 10% 15% 20% 25% 30% ABCBOCBoComCCBCITICCMBICBCMSB Credit CardsWealth Mgmt. Business 0% 5% 10% 15% 20% 25% 30% 35% ABCBOCBoComCCBCITICCMBICBCMSB Credit CardsWealth Mgmt. Business Macquarie Research China Banks6 November 2018 4Forecast changes To reflect the weaker loan growth and rising pressures on corporate loans, especially for SOEborrowers, we cut the PPoP growth of the sector by 3% for 2019E and 7% for 2020E. In particular, wecut the PPoP growth of the big four banks by 5% and 10%, respectively, for 2019E and 2020E to reflectweaker pricing power for the corporate borrowers, falling interbank rates and rising deposit costs. Assuch, we cut the net profit forecasts by 4%/5% for big four banks for 2019E/2020E and expect theirprofit growth will stay at ~6% over the next two years (vs. previous forecasts of 8%).In contrast, we increase the PPoP growth of joint-stock banks to reflect strong credit card revenues andfalling interbank rates. Thus we trim our net profit forecasts for joint-stock banks by less than 1% for thesame period and keep EPS forecasts unchanged. We expect the profit growth of joint-stock banks tostay the same at ~7-8% because we expect higher provisions needed for asset quality of their majorborrowers (i.e.,. the private sector).Fig 6 China banks – forecast changesPPoPEPS 2018E 2019E 2020E 2018E 2019E 2020EABC -3% -11% -13% -5% -4% -6%BOC 3% -3% -7% -3% -4% -7%BoCom 11% 12% 8% 0% 1% -1%CCB 0% -6% -13% -3% -6% -9%CITIC 6% 11% 7% 2% -1% -2%CMB 6% 5% 2% 3% 5% 7%ICBC 1% -3% -9% -4% -5% -7%MSB 3% 2% 5% -1% 1% 5%All Banks 2% -3% -7% -2% -4% -5%Big Four 0% -5% -10% -3% -5% -7%Joint-stock Banks 7% 7% 5% 1% 2% 3%Source: Macquarie Research, November 2018Fig 7 China banks - Valuation summary StockPER PER PBR PBR ROE ROE DividendStock Ticker Rating TP Price TSR 18E 19E 18E 19E 18E 19E Yield 18EH-Share (HK$) BoCom 3328 HK OP 7.20 5.93 27% 5.5 5.2 0.61 0.57 11.3% 11.2% 5.6%BOC 3988 HK OP 4.10 3.46 24% 5.1 4.9 0.6