China Citic Bank - Asset quality improvement as key share price driver

  • Expect further NPL drop in FY23F with early retreat from risky areas and more resilient risk control
  • Its risk reporting is largely in line with peers, but the asset quality improvement overlooked by the market
  • Expect c.8% earnings CAGR for FY22-25F on steady loan demand and lower credit costs
  • Reiterate BUY on a higher HK$ 5 TP with attractive valuation of 0.3x FY23F P/B and 10.5% dividend yield
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A turnaround story in asset quality to drive re-rating.

CITIC Bank’s share price performance had underperformed its peers in 2017-2021 with a deteriorating trend in asset quality. Asset quality has been improving since 2021 after change of senior management and the bank made an effort on NPL disposals, driving re-rating of the stock when its valuation was at a discount to peers.

 

Now that the NPL risks has been largely digested, looking ahead, we expect asset quality improvement trend to carry on and continue to be a positive share price driver. Our key arguments are as follows:

 

1) Risk reporting largely in line with peers  

Looking into the details of CITIC Banks’ risk profile, we conclude that its risk reporting can be considered to be prudent and largely in line with peers. Its better-than-peers improvement in asset quality is not due to a more relaxed reporting standard for NPLs. Its NPL/>90 days overdue ratio has gradually improved from below 1 in 2016/17 to >1.3 since 2019.

 

In addition to NPL ratio, CITIC Bank’s special mention loan ratio has also been falling in the last 5 years. The migration ratio from special mention loan to NPL dropped from c.48% in FY20 to c.29% in FY22 and is largely in line with its joint-stock bank peers. The falling trend in special mention loan and migration ratios have paved the way for a further fall in the NPL ratio.

 

CITIC Banks’ NPL over Stage 3 loan ratio was 87% in FY22, indicating that it has covered 87% of Stage 3 loans, which are loans already impaired. The ratio was at the lower end of our covered joint stock banks, still largely in line. Its NPL coverage ratio was 208.9% in 1Q23, also in line with peers. 

 

2) Structural change in its loan book and risk models

CITIC Bank has taken heed from the high credit risks in earlier years. It has now adjusted its risk model and approval benchmarks. We see a structural improvement in its loan book. Loans in developed regions to total loans increased from c.37% in FY18 to c.41% in FY22. Loan exposure to risky industries dropped from c.35% in FY16 to c.19% in FY22. The exposure to the property sector has dropped from c.10% in FY16 to c.5.4% in FY22. Corporate customers’ quality is also higher. Currently, more than 60% of its corporate customers have an internal A rating. The strategic change in its risk control helps with the long-term healthy growth of its loan book.

 

3) Trending better than peers in areas of concern

The property sector remains the key sector of concern for China banks in FY23 and we also expect to see continuous pressure on retail loans in 1H23 as the residential balance sheet may need more time to recover. Compared with peers, we believe CITIC Bank has better asset quality trends in these two areas of concern in FY23F.

 

In the property sector, CITIC Bank’s NPL ratio hit a peak earlier than the industry and it retreated earlier from the sector. The ratio dropped y-o-y in FY22 while the average NPL ratio in property sector of major China banks under our coverage was still on an upward trend. We expect CITIC Bank’s NPL ratio in property sector to be on a downward trend with lower new NPL formation in 1H23, while the NPL ratio of some of its peers may peak in 2Q23.

 

In the retail sector (mainly credit card loans and mortgage), CITIC Bank’s NPL ratio was slightly higher than the industry average, but the rate of increase in its NPL ratio was lower than the industry average in the challenging year in FY22 (e.g. CITIC’s NPL was up by 8bps y-o-y while industry average was up by 16bps).

 

The 1-90-day delinquency ratio of underlying assets of CITIC Bank’s MBS product in May 2023 was in the range of 0.13%-0.68%, averaging 0.43%. This latest leading indicator for mortgage asset quality was largely stable for CITIC Bank and we don’t expect a material deterioration in its mortgage NPL ratio in 2Q23.

 

On the credit card side, the policy that allowed delayed repayment of principal and interest came to an end in Mar 2023, which may lead to downgrading of some credit card loans in 2Q23. Meanwhile, CITIC Bank is making more effort on disposal of credit card NPLs in 2Q23. Overall, we expect a small increase in NPL ratio on the credit card side in 2Q23.  

 

Earnings upside from improving asset quality

Based on the above analysis, we expect CITIC Bank’s NPL ratio to continue on an improving trend in FY23/24F as a result of structural changes. Its NPL ratio dropped by 14bps y-o-y to 1.21% in 1Q23. We expect asset quality in FY23/24 to be slightly better than 1Q23 as the economy recovers in China and the bank’s continuous efforts to improve its risk management. We believe consensus forecast and current market valuation has not yet fully priced in these positives.

 

CITIC Bank’s credit cost peaked in 2019 at 2% and has been dropping thereafter to reach 1.42% in FY22. Its earnings CAGR improved from 3.9% in 2016-19 to 7.1% in 2019-22 accordingly. Looking ahead, we expect a further drop in credit cost in FY23-25F to 1.25-1.3% vs FY22. We expect earnings CAGR for FY22-25F to further improve to 7.9% on significantly lower credit costs than in previous years, though there were challenges from NIM side.

 

How much upside in valuation?

With market having concerns on its asset quality and growth, CITIC Bank (H-share) has long been trading at a discount to peers. The stock is now trading at c.0.27x FY23 P/B and offers 10.5% FY23F dividend yield. Even after its share price outperformance YTD, it is still trading at a discount to peers of 0.41x FY23F P/B. Meanwhile, its ROE of 13.9% and earnings growth of 10.3% y-o-y in 1Q23 were both at the higher end of its peers. In our view, CITIC Bank’s valuation is underpriced by the market.

Our TP of HK$5 implies c.0.39x FY23x P/B, on par with its peers average. We expect the trading gap with peers to gradually narrow as it delivers improving earnings. Still, the target multiple we have assigned to CITIC Bank is lower than its peers. In terms of internal control, risk management and capital adequacy ratio, CITIC Bank still ranks at the lower end among peers and there is room for further improvement. The A-H spread now is at 80% or more, or significantly higher than the 5-yr average of c.56%. We see its H-share as a better buy than the A-share. 

Completion of rights issue as a near-term catalyst

CITIC Bank has a relatively low CET-1 ratio compared to peers at 8.8% as of the end of 1Q23 and is just above the regulatory requirement of 8% as a D-SIB. As of the end of FY22, its CET-1 ratio was 0.56ppts lower than the peer average. Market has been concerned about its capital ratio especially in FY22 especially with the weak China property sector and mortgage suspension triggering a systematic risk.

In Apr 2022, CITIC Bank announced a rights issue for its A/H shares to raise no more than Rmb 40bn. Existing shareholders will be offered no more than 3 new shares for every 10 existing shares. The pricing and timeline of the right issue is not yet known.  The right issue has not yet been completed and the market expects it to be completed soon with the new management team recently coming on board.

We expect the completion of right issue as a near-term catalyst for CITIC Bank’s share price. Although there will be some share dilution and short-term volatilites, we expect the market should have already largely digested the negative impacts given the share price had dropped by c.14% in 2022 after the rights issue announcement. We think the final completion of the deal will remove these uncertainties. And the bank's loan balance and earnings growth is likely to be higher supported by the capital raised. Similar right issue case on A-share show that share price reacts positively in the medium term after the deal completion, despite of the share dilution,  if the bank could properly use the capital for growth purposes. 

We believe in CITIC Bank’s case, the capital could be well used to support growth and generate higher returns in the medium term. The completion of the deal is expected to improve the CET-1 ratio by 0.63ppt. We expect the concerns on its tight capital position to ease after the deal completion. Also, as an SOE, we expect it to also continue to benefit from the SOE revaluation theme.

Synergies with CITIC Group to unlock more value

In Mar 2022, CITIC Financial Holdings was established. CITIC Bank has some synergies with entities under the same parent company CITIC Group (267 HK). For example, the Financial Holdings company, Bank and Brokers under CITIC brand share their resource channels and wealth management capabilities to provide better wealth management services to clients.

 

As an important part of the Group, we see that CITIC Bank’s share price will have an increasing correlation with CITIC Group. The share price correlation between the two entities in recent 5 years reached 0.9. On one hand, we expect the Group’s resources to further strengthen CITIC Bank’s NPL disposal and wealth management capabilities. On the other hand, the Group’s share performance is likely to be positively impacted by an improving CITIC Bank as well.  

 

 

 

 

 

 

ANALYST CERTIFICATION

The research analyst(s) primarily responsible for the content of this research report, in part or in whole, certifies that the views about the companies and their securities expressed in this report accurately reflect his/her personal views. The analyst(s) also certifies that no part of his/her compensation was, is, or will be, directly or indirectly, related to specific recommendations or views expressed in the report. The research analyst (s) primarily responsible for  the content of this research report, in part or in whole, certifies that he or his associate[1] does not serve as an officer of the issuer or the new listing applicant (which includes in the case of a real estate investment trust, an officer of the management company of the real estate investment trust; and in the case of any other entity, an officer or its equivalent counterparty of the entity who is responsible for the management of the issuer or the new listing applicant) and the research analyst(s) primarily responsible for the content of this research report or his associate does not have financial interests[2] in relation to an issuer or a new listing applicant that the analyst reviews.  DBS Group has procedures in place to eliminate, avoid and manage any potential conflicts of interests that may arise in connection with the production of research reports.  The research analyst(s) responsible for this report operates as part of a separate and independent team to the investment banking function of the DBS Group and procedures are in place to ensure that confidential information held by either the research or investment banking function is handled appropriately.  There is no direct link of DBS Group's compensation to any specific investment banking function of the DBS Group. 

 

COMPANY-SPECIFIC / REGULATORY DISCLOSURES

1.

DBS Bank Ltd, DBS HK, DBSVS or their subsidiaries and/or other affiliates have a proprietary position in China CITIC Bank Corp Ltd (998 HK) recommended in this report as of 12 Jun 2023.

2.

DBS Bank Ltd, DBS HK, DBSVS, DBS Vickers Securities (USA) Inc (“DBSVUSA”), or their subsidiaries and/or other affiliates beneficially own a total of 1% or more of the issuer's market capitalization of Postal Savings Bank of China Co Ltd (1658 HK) as of 12 Jun 2023.

3.

Compensation for investment banking services:
DBS Bank Ltd, DBS HK, DBSVS, their subsidiaries and/or other affiliates of DBSVUSA have received compensation, within the past 12 months for investment banking services from China CITIC Bank Corp Ltd (998 HK), Bank of China Ltd (3988 HK), Bank of China Ltd (601988 CH), Agricultural Bank of China Ltd (1288 HK), Agricultural Bank of China Ltd (601288 CH), China Construction Bank Corp (939 HK), China Construction Bank Corp (601939 CH), Industrial & Commercial Bank of China Ltd (1398 HK), Industrial & Commercial Bank of China Ltd (601398 CH), Bank of Communications Co Ltd (3328 HK), Bank of Communications Co Ltd (601328 CH), China Merchants Bank Co Ltd (3968 HK), China Merchants Bank Co Ltd (600036 CH), Ping An Bank Co Ltd (000001 CH), China Everbright Bank Co Ltd (6818 HK) and China Everbright Bank Co Ltd (601818 CH) as of 31 May 2023.

DBS Bank Ltd, DBS HK, DBSVS, their subsidiaries and/or other affiliates of DBSVUSA, within the next 3 months, will receive or intend to seek compensation for investment banking services from China CITIC Bank Corp Ltd (998 HK), Bank of China Ltd (3988 HK), Bank of China Ltd (601988 CH), Agricultural Bank of China Ltd (1288 HK), Agricultural Bank of China Ltd (601288 CH), China Construction Bank Corp (939 HK), China Construction Bank Corp (601939 CH), Industrial & Commercial Bank of China Ltd (1398 HK), Industrial & Commercial Bank of China Ltd (601398 CH), Bank of Communications Co Ltd (3328 HK), Bank of Communications Co Ltd (601328 CH), China Merchants Bank Co Ltd (3968 HK), China Merchants Bank Co Ltd (600036 CH), Ping An Bank Co Ltd (000001 CH), China Everbright Bank Co Ltd (6818 HK) and China Everbright Bank Co Ltd (601818 CH) as of 31 May 2023.

4.

DBS Bank Ltd, DBS HK, DBSVS, their subsidiaries and/or other affiliates of DBSVUSA have managed or co-managed a public offering of securities for Bank of China Ltd (3988 HK), Industrial & Commercial Bank of China Ltd (601398 CH) and China Merchants Bank Co Ltd (600036 CH) in the past 12 months, as of 31 May 2023.

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5.

Disclosure of previous investment recommendation produced:
DBS Bank Ltd, DBSVS, DBS HK, their subsidiaries and/or other affiliates of DBSVUSA may have published other investment recommendations in respect of the same securities / instruments recommended in this research report during the preceding 12 months. Please contact the primary analyst listed on page 1 of this report to view previous investment recommendations published by DBS Bank Ltd, DBS HK, DBSVS, their subsidiaries and/or other affiliates of DBSVUSA in the preceding 12 months.

 

 

 

[1] An associate is defined as (i) the spouse, or any minor child (natural or adopted) or minor step-child, of the analyst; (ii) the trustee of a trust of which the analyst, his spouse, minor child (natural or adopted) or minor step-child, is a beneficiary or discretionary object; or (iii) another person accustomed or obliged to act in accordance with the directions or instructions of the analyst. 

[2] Financial interest is defined as interests that are commonly known financial interest, such as investment in the securities in respect of an issuer or a new listing applicant, or financial accommodation arrangement between the issuer or the new listing applicant and the firm or analysis.  This term does not include commercial lending conducted at arm's length, or investments in any collective investment scheme other than an issuer or new listing applicant notwithstanding the fact that the scheme has investments in securities in respect of an issuer or a new listing applicant. 

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