China Banks 12 July 2018Contents
How has the China bond market evolved over the past decade 4
Is it solely an SOE financing market ......... 5
Is bond default risk a concern ....... 7
Who owns the corporate bonds . 14
The tip of the Iceberg ....... 16
Recovery case studies ........ 19
May Yan
Analyst
may.yan@ubs
+852-2971 7157
Noel Chan
Analyst
S1460516100001
noel-y.chan@ubssecurities
+86-213-866 8845
Alex Zhou
Analyst
alex-huanan.zhou@ubs
+852-3712 4218
Alex Ye
Analyst
alex.ye@ubs
+852-3712 3594
China Banks 12 July 2018China Banks – H
P2
UBS Research THESIS MAP a guide to our thinking and what's where in this report
MOST FAVOURED
CCB, ICBC, CMB, CQRCB
LEAST FAVOURED
Huishang
PIVOTAL QUESTIONS Q: Where are China banks in terms of the NPL cycle
China banks’ share prices tend to jump between short-term and long-term economic and asset
quality cycles. We believe the private-sector NPL cycle peaked in 2015-16 and the SOE sector NPL
cycle will occur at a manageable pace in the next three to five years. In the long term, asset quality
improvement is likely to be driven by China’s economic transition to a more sustainable growth
model; i.e. the rise of new economy industries, industrial and consumption upgrades, SOE reforms,
etc. We believe the transition has started.
China Banks – H: Finding value in a decelerating economy, 25/07/17
Q: Will the tightening theme in the financial sector continue
Yes. A key theme at the 19th Party Congress was continued tightening of regulations for the
financial sector and prevention of systemic risk with a particular focus on shadow banking. Our view
that China banks are shrinking their exposure to shadow banking is supported by the fact that the
balance of interbank WMPs decreased by Rmb2trn in H117. We expect tighter supervision to be a
recurring theme in the longer term, and to be carried out in a gradual and orderly manner. The
impact will be more negative for mid- and small-sized banks than large banks, in our view.
H117: Shadow banking's turning point, 29/09/17
Q: What should be the sustainable level of ROE for China banks
We believe China banks’ decade-long de-rating has reached the bottom. Based on our top-down and
bottom-up analyses, we estimate average medium-term ROE of 12-13%, assuming that banks need
to retain a 10% core tier-1 capital ratio, interest rates will not be cut significantly and the SOE NPL
cycle is gradual. With our estimated COE at 12-14%, valuations for some high-quality banks with less
capital pressure, decent asset quality and less exposure to shadow banking should be above 1x P/BV.
China Banks – H: Finding value in a decelerating economy, 25/07/17
UBS VIEW
We expect a further re-rating of the sector with improving trends for NIM, asset quality and moderate
profit growth in 2018, amid a steady economic outlook and receding financial system risk. We like
banks with strong funding, low exposure to shadow banking, stable asset quality, low equity-raising
pressure but undemanding valuations. We have Buy ratings on CCB, ICBC, CMB and CQRCB.
EVIDENCE Major listed China banks’ gross NPL formation continued to stabilise in 2017, with a few banks
witnessing significant improvement. Margins appear to be recovering with loan rates rising, while the
impact of benchmark rate cuts has worn off. In particular, banks with more stable funding benefited
from elevated market rates in response to regulators’ tightening measures, which nonetheless have
moderated recently. Some macro data show signs of softening but in general continue to hold up.
WHAT'S PRICED IN China banks are trading at 0.75x one-year forward P/BV, still below the historical average since 2010.
The below-the-book valuation, despite banks’ decent reported ROE, may suggest the market is still
concerned about a potential debt crisis, given China’s rising debt leverage and likely under-recognition
of NPLs with SOEs. We think the market has priced in significantly lower ROE for banks in the long term.
China banks avg. one-year forward PE
1-year forward PE ratioHistorical avg.
+1SD-1 SD
China Banks 12 July 2018How has the China bond market
evolved over the past decade
Chinese government bonds were first issued in 1950 by the Ministry of Finance.
Issuance was terminated in 1958, but resumed in 1981 to fund national construction
projects. After many years of development, China's bond market currently ranks the
third biggest in the world in terms of the balance of outstanding issuance. It has
grown from only Rmb11trn (US$1.7trn) in 2008 to around Rmb75trn (US$11.3trn)
as at end-2017, registering a CAGR of 24% during 2008-17.
Figure 2: Market size – China's bond marketFigure 3: Outstanding bond balance by country
Source: WIND Source: BIS, World Bank, data as of 2017
Corporate bond size now over Rmb15trn
China's bond market was dominated by treasuries and policy bank bonds a decade
ago, but local government bodies have become one of the biggest borrowers in
recent years due to the policy-driven swap between local government debt and
municipal bonds, coupled with a steady increase in corporate bonds. Corporate
bonds (including enterprise bonds, company bonds, medium-term notes and
commercial paper (CP) which amounted to Rmb14.5trn at end-2017)) accounted
for 20% of the outstanding balance of the bond market as at end-2017, up from
10% as at end-2008. Asset backed securities (ABS) and private placement notes
(PPN) made up Rmb3.9trn, or 5% of the outstanding balance.
Figure 4: Breakdown of China's bond market by sizeFigure 5: Breakdown of corporate bond by size (end-2017)
11%。