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Summary of DBS Group Research: Equity - A brighter 2H14

Core Content

The DBS Group Equity Research report from June 30, 2014, provides an optimistic outlook for the banking sector in the second half of 2014 (2H14). The report addresses concerns over shadow banking defaults and competition from internet financing, while highlighting the positive macroeconomic environment and the potential for share price recovery.

Main Concerns and Analysis

1. Shadow Banking and Internet Financing

• Shadow Banking Size: Estimated at Rmb30.5tn as of May 2014, representing 38% of the system loan book, 19% of China's bank assets, and 54% of 2013 GDP.
• Relative Size: Compared to other major economies, China's shadow banking system is relatively small.
• Simpler Products: Chinese shadow banking products are simpler and more transparent than those in the U.S. and other advanced economies.
• Risk Exposure: Banks have Rmb14.4tn of risk exposure in shadow banking products with a potential NPL ratio of 4.3%.
• Regulatory Impact: Recent regulatory developments and RRR cuts help limit banks' exposure and allow them to move shadow banking assets back onto the balance sheet.

2. Market Concerns and Share Price Dynamics

• Market Overreaction: The market is over-concerned about shadow banking defaults and internet financing competition.
• P/BV and NPL: The sector is trading at a moderate discount to FY13 book values, with low P/BVs limiting share price downside.
• Provisions and Capital: Existing provisions and excess capital can absorb NPL ratios up to 4.0%, providing a buffer against potential losses.
• Capital Adequacy: Preferred stock issuance and IRB capital rules support capital adequacy.

3. Macroeconomic Outlook and Policy Support

• GDP Growth: The government has set a 7.5% GDP growth target for 2014, which is considered the minimum acceptable level.
• Monetary Policy: PBOC has been injecting liquidity to ease seasonal liquidity pressure and support the real economy.
• Credit Growth: Loan growth in 2014 is expected to be strong, with M2 growth of 13.4% in May 2014 and total new loans of Rmb4.7tn.
• Policy Adjustments: CBRC is expected to ease loan-to-deposit (LTD) rules to support small enterprises, likely in 2H14.

4. Sector Performance and Valuation

• Sector Averages: The sector's P/BV is relatively low, indicating potential for recovery.
• Earnings Growth: The banking sector is projected to grow earnings by 11% and achieve ROE levels of 19% in 2014.
• Dividend Yields: Dividend yields are expected to be better than in 2013.

Key Recommendations

Top Picks

• CHINA ABC (1288):

  • Closing Price: HK$3.43
  • P/BV: 0.89
  • PER: 4.6
  • Yield: 7.6%
  • ROE: 20.8%
  • Target Price: HK$4.50
  • Upside: 31.2%
  • Rating: Buy

• CMBC (1988):

  • Closing Price: HK$7.00
  • P/BV: 0.78
  • PER: 3.9
  • Yield: 6.4%
  • ROE: 21.9%
  • Target Price: HK$9.00
  • Upside: 28.6%
  • Rating: Buy

• ICBC (1398):

  • Closing Price: HK$4.90
  • P/BV: 0.92
  • PER: 4.7
  • Yield: 7.4%
  • ROE: 20.7%
  • Target Price: HK$6.31
  • Upside: 28.7%
  • Rating: Buy

• CCB (939):

  • Closing Price: HK$5.84
  • P/BV: 0.92
  • PER: 4.7
  • Yield: 7.4%
  • ROE: 21.1%
  • Target Price: HK$7.46
  • Upside: 27.7%
  • Rating: Buy

Reasons for Top Picks

• CHINA ABC: Favorable YTD trends, rural exposure, and competitive advantage.
• Minsheng: H-share discount to A-shares, and potential for improved capital and asset quality due to a better macro environment.

Additional Insights

• Liquidity Injection: PBOC has injected significant liquidity since 2012, with a net injection of Rmb1,417bn in 2013.
• Government Debt: Government debt is far below critical levels, even under worst-case scenarios. Total government debt is estimated to be 39-50% of GDP.
• Local Government Debt: Local government debt is overstated in media reports, and even under the worst-case scenario, it remains manageable.
• Infrastructure Investment: A significant portion of shadow banking funds is invested in infrastructure projects, which are considered relatively safe.

Conclusion

The report concludes that the banking sector is poised for recovery in 2H14, driven by improved macroeconomic conditions, supportive monetary and fiscal policies, and a relatively healthy financial environment. Despite concerns over shadow banking and competition from internet financing, the sector's low P/BVs, strong capital buffers, and earnings growth potential make it attractive. The top picks for the report are CHINA ABC and Minsheng, with both showing strong fundamentals and potential for upside.