Unmasking China's Shadow Banking System

ANCHOR REPORT
China banks
EQUITY RESEARCH
Unmasking the shadow banking system
June 24, 2011 Research analysts China Banks Lucy Feng - NIHK lucy.feng@nomura.com +852 2252 2165 Donger Wang - NIHK donger.wang@nomura.com +852 2252 1590
Shadow banking exposure less than feared and more than priced in
Policy focus on total social financing rather than just bank loan growth to bring an estimated CNY8.5tn of shadow banking loans into view. Our in-depth study of Chinas shadow banking suggests it accounts for a much smaller proportion of GDP than the US experience in 2007, and comprises mostly SME loans rather than structured derivatives. With pre-emptive policies already slowing these loans, we think the recent correction in bank valuations is a buying opportunity. ICBC is our top pick, with the least exposure to shadow loans on our analysis. CCBs risk of entrusted products is much higher than peers and we downgrade it to NEUTRAL. Key analysis in this Anchor Report includes:
Study of trust and entrusted loans, with scenario analysis of the impact
on various banks capital adequacy.
Regulation changes shifting to quality of capital from quantity. Public housing unlikely to become another LGFV issue. Detailed
scenario analysis.
Bigger role for rural financial institutions and opportunities for ABC and
CRCB, given extensive rural networks.
See Appendix A-1 for analyst certification and important disclosures. Analysts employed by non-US affiliates are not registered or qualified as research analysts with FINRA in the US.
China banks
Banks
EQUITY RESEARCH
Unmasking the shadow banking system
June 24, 2011
Shadow banking exposure less than feared and more than priced in
Chinas shadow banking is different from that of the US The deleveraging of the US shadow banking system magnified the impact of falling housing prices on the financial system. With Chinas total shadow banking loans reaching CNY8.5trn (our estimate), we think the market is rightly concerned. But we point out that: 1) Chinas shadow bank loans accounted for 21% of GDP and 17% of loans in 2010, vs 44% and 96% for the US in 2007; 2) some shadow operators lend to under-financed SMEs in China, unlike in the US where the majority relate to mortgage-backed structured derivatives; 3) the CBRC has already undertaken pre-emptive measures on overheated shadows like trust loans and credit guarantee companies, the growth of which has since declined substantially. Tighter liquidity could suffocate SMEs, but still ample policy power We believe there is potential for a gradual shift in liquidity monitoring from M2 and bank loans to total social financing, which could lead to stricter regulation of shadow banking in China and an even tighter liquidity environment. SMEs may be at the forefront of such risk given their less diversified funding channels and vulnerability to any economic slowdown. However, we think the Chinese regulators success in managing financial institution reform, with over 40% legacy NPLs, puts it in a strong position to manage this challenging and delicate task. The central bank also has ample balance sheet capability to ensure the soundness of the financial system, which remains its top priority. Stocks: market discounting more than it should again We cut our rating on CCB and trim our TPs for ICBC, CCB, BOCOM, CMB and CRCB. Our analysis indicates that valuations (P/BVs of 1.0-1.4x for FY12F, implying ROEs of 12-14%) more than factor in the combined bleak scenarios of LGFV NPL write-off, interest rate deregulation, and higher normalized credit cost and tier-1 ratios in our three-stage Gordon Growth model. We expect positive catalysts to re-emerge ahead of the interims.
Fig. 1: Stocks for action: H-share China banks
Potential upside/ downside (%) 32 28 9 38 15 37 31 2 38
Anchor themes We think the operating environment remains favourable for Chinese banks in 2011F, but negative sentiment from uncertainties over policies and asset quality continues to weigh on valuations. Nomura vs consensus We downgrade CCB to NEUTRAL on its exposure to shadow credit and possible shortfall in capital against the backdrop of increasing regulatory oversight.
Research analysts
China Banks Lucy Feng - NIHK lucy.feng@nomura.com +852 2252 2165 Donger Wang - NIHK donger.wang@nomura.com +852 2252 1590
Bloomberg Company China (H-share) ABC ICBC CCB BOC BOCOM CMB CITIC Bank Minsheng CRCB ticker 1288 HK 1398 HK 939 HK 3988 HK 3328 HK 3968 HK 998 HK 1988 HK 3618 HK Rating BUY BUY NEUTRAL BUY NEUTRAL BUY BUY NEUTRAL BUY
Price target (HK$) 5.20 7.50 7.02 5.20 8.30 24.82 6.50 7.40 6.52
Current price (HK$) 3.94 5.84 6.44 3.77 7.24 18.08 4.97 7.29 4.71
Note: Prices as of 21 June close. Source: Bloomberg, Company data and Nomura research
See Appendix A-1 for analyst certification and important disclosures. Analysts employed by non US affiliates are not registered or qualified as research analysts with FINRA in the US.
Rating: See report end for details of Nomuras rating system.
Nomura | AEJ China banks
June 24, 2011
Contents
4
Executive summary
7
Monetary policy unlikely to be eased any time soon
Regulation on new capital framework shift in focus to quality from quantity of capital Bail-out of LGFV loans
10
Regulation of shadow banking system
11
Catalysts
13
Macro and monetary policy

13
Economic growth showing signs of slowdown
14
Monetary policy unlikely to ease any time soon
17
Regulation changes
17
CBRC rolls out stricter regulatory rules for China banks
23
New regulations on cross-industry financial holding companies
24
Shadow Banking Business
28
Wiping off trust loans 1% of total bank loans
31
Entrusted loans RWA funding pressure
33
Two tales: wealth management products
34
SMEs who is borrowing at above 10% pa rate?
34
SME business has drawn more attention from banks over the past year...
36
...due to higher lending rates...
37
... which is starting to erode the profit margin of SMEs
38
Case study SMEs in Wenzhou
38
Credit guarantee companies
June 24, 2011
40
Public housing program in the spotlight

40
Public housing program smaller funding size for China banks
40
Public housing development plan for 12th Five Year Plan
40
Surging financing demand from public housing projects
41
Financing gap for the public housing program
41
Banks lack enthusiasm in this area
42
Multiple funding sources for the public housing program
43
How much of the CNY900bn needs to be financed by China banks?
45
Rural financing
45
Improvement of rural financing
45
Continuous development of new-type rural financial institutions
46
Rural financial institutions more important role
46
Historical burden on rural financial institutions
47
Still opportunities for other commercial banks
48
Agricultural Bank of China ICBC China Construction Bank-H Bank of China (H-share) Bank of Communications China Merchants Bank China CITIC Bank China Minsheng Bank - H Chongqing Rural Commercial Bank Appendix A-1
54
60
66
71
77
83
88
93
99
June 24, 2011
Executive summary
In the past five to seven weeks, the market has showed more signs of weakness with the Hang Seng Index down by 6.1%-6.5% vs a 5.8%-6.7% fall in the HSCEI. Globally, weak economic data, the end of QE2, and more problems in Greece are reminding the market of all the ills that still plague the US and global economies. China stocks, particularly Chinese banks, have their own issues arising from recent negative news pieces, such as a 2trn to 3trn LGFV bail-out (reported by Reuters), the CBRCs new rules on increasing the risk weighting of 1/3 of banks asset classes, as well as elevated inflation in June vs. sluggish industrial production. This points to more downside risk to economic growth, with little scope for easing monetary policy in the near term. Against this backdrop, the sectors valuation quickly reverted to the years beginning level, with an average return of -5.3% YTD vs. +12% at the end-April peak. The shadows did not only come from the shadow banking system. In this Anchor Report we dive into the details of loans and credit that are hidden from banks balance sheets and analyse the driving forces that shape investor sentiment and banks performance: 1) regulatory changes are ongoing (ie, more capital and provisioning); 2) the boom of the underground credit market amid tight liquidity and capped banking loans; and 3) the inflation curve and rate hikes (when will they peak?). While we believe uncertainty surrounding the provision and capital requirements for LGFV (Local Government Financing Vehicle) loans capped banks absolute performance earlier this year, rate hikes which raised banks net interest margin in 4Q10 and 1Q11 are the key driving force of Chinese banks outperformance in the first quarter, in our view. Nevertheless in view of our expectation that banks NIMs are likely to peak in 2Q11, together with renewed talk about the new capital framework and the governments bail-out plan on LGFV loans since early June, the outperformance of Chinese banks has been largely removed. With the market and banking stocks remaining in correction mode, it is time to review our risk/reward scenario by looking at the potential damage to the market from a perceived LGFV crisis vs. the real deterioration in sector fundamentals (earnings, asset quality, long-term ROEs): In below charts and tables we list all the upcoming regulatory and operational changes/risks that the sector faces, which we map into banks earning metrics through a 3 stage Dupont analysis. Then we derived the bear case LT ROEs, which we compared with the market-implied ROEs. Our reversed Gordon Growth approach highlights some interesting conclusions drawn by the market: Bail-out. It believes that a CNY2-3bn bail-out may happen and this could wipe out onethird of the banks earnings and cut sector ROE to 10.5%-20.7%. Rate liberalization. The market believes that China banks NIMs will drop to 1.8% to 2.4% in the medium term after rate liberalization. It also believes that fee income growth will never pick up to 20% of operating income in the long term, albeit from a 40%-50% CAGR since 2005 (company data). Recurring capital raising. The market believes listed banks will raise USD124bn (CNY800bn) in equity capital in the next three years because Core Tier 1 will decrease by 2% (vs. our estimate of 1.3%) from implementation of BASEL 3 hence risk weighting changes. Credit cycle. The market believes Chinese banks credit cost will increase to 80-90bps due to 3% pa of gross NPL formation in the long run, which is more than triple the current level of below 1%. There is always a possibility that one or all of the above could happen in the not too distant future. Yet the long-term return of Chinese banks will likely be above the mid-teens, in our view, with solid growth in fee income encouraged by policy makers through further deregulation. We consider this the single most important factor to support the sectors long-term prospects.
June 24, 2011
In our view, assuming a proportion of 25%-40% for fee revenue, China banks can weather a much lower NIM of 1.8% to 2.2% (for the big five banks), moderate credit growth of 8%-10%, and an increase in credit cost to 80-90bps due to 3% pa of gross NPL formation in the long run. In short, at 1.1x-1.6x P/B (2011F) and 0.97x-1.36x P/B (2012F), we see little downside and a 10%-15% re-rating of sector stock prices seems almost possible with potential solid interims around the corner in August.
Fig. 2: Bear Case Three-Stage ROE outlook under various assumptions on risks and challenges
As % of total assets Current (%) Distressed level (2011) Chg Medium term (2012-14) Interest rate deregulation leading to lower margins Chg Long term (2015-19) Interest rate deregulation leading to lower margins Chg
Net interest income
2.02-2.59
unchanged
0bp
(40bps)
(40bps)
Non-interest income Revenue (%) SG&A PPOP (%)
0.49-0.86 2.87-3.31 (0.94)-(1.16) 1.75-2.25
unchanged
0bp 2.87-3.31
Fee income continued to increase by 20% y-y albeit with slowing loan volume growth
Fee income continued to increase by 20% y-y albeit with slowing loan volume +10-17bps growth 2.58-3.06
+10-17bps 2.58-3.06
unchanged
0bp 1.75-2.25
unchanged
0bp 1.62-2.08
unchanged
0bp 1.62-2.08
Loan loss provision
(0.14)-(0.39)
unchanged
0bp
30% increase in through-thecycle average credit cost to guard against soft landing economy
(9-34bps)
30% increase in throughthe-cycle average credit cost to guard against soft landing economy
(9-34bps)
LGFV provision Operating pretax (%) Business tax & surcharges Profit tax Normalised ROA (%) Non-operating gain/(loss) Reported ROA (%) (0.44)-(0.59) 1.02-1.37 (0.05)-0.02 1.02-1.37 1.49-1.95
Take one-off write-off on 2011F earnings, by 1) 20% haircut for 30% of LGFV loans spun off to Chinese government; 2) 50% provision on remaining lower grade LGFV loans not sold to the government (25-60 bps) unchanged 0.98-1.67 unchanged unchanged 0bp 0.62-1.15 unchanged 0bp 0.62-1.16 unchanged unchanged unchanged 0bp 0.73-1.09 0bp 0.73-1.09 1.06-1.62
unchanged 1.06-1.62 unchanged unchanged 0bp 0.73-1.09 unchanged 0bp 0.73-1.09 Higher tier 1 ratio given risk weighting changes or higher requirement on core capital
Equity multiplier (x) Normalised ROE (%) Market PB - 2011 (x) Implied PB (x)
15.5-18.7 18.0-24.1 1.02-1.38
unchanged
0bp 10.5-20.7
unchanged
0bp 13.6-18.1
(1.5-4.7bps) 10.2-15.2
0.78-2.24
1.22-1.87
0.74-1.45
Source: Company data, Nomura estimates
We would like to respond to investor questions about how to model a potential LGFVs crisis with the area having deep China characteristics, which some investors may not be completely familiar with. Typically people say that any credit crisis around the globe can be summed up in five stages of grieving: denial, anger, bargaining, sadness and acceptance. Below, we draw a parallel between the five widely accepted stages of grieving and the potential for a perceived crisis of LGFV sequel. In April 2011, Chinese banks assured investors during annual results briefings that LGFV risks were under control after one year of clean-ups (un-bundling, reclassifications, top up collaterals and provisioning). Sector stock prices rose by 10% on average in March and April on strong earnings and relief from concern about local government debts. Two
June 24, 2011
months later, bank stocks began a slide that ultimately eroded 14.6% of its total market cap (the stage of anger in our view).
Fig. 3: Chinese banks earnings and capital estimated impact from regulation overhang (LGFV loans, new capital framework and shadow banking)
Impact on 2011F earnings on LGFV loan write-off and provisioning RMB'mn % of haircut as 2011F PBT Total impact on 2011F PBT ABC 13.0% 29.0% ICBC 13.6% 13.6% CCB 13.8% 33.9% BOC 12.8% 38.9% BCOM 16.3% 38.5% CMB 16.4% 16.4% Citic Minsheng 18.9% 18.9% 38.1% 46.8% CRCB 19.2% 19.2% Ave. 18.0% 28.4% Base case: we assume Chinese banks write off 20% of LGFV loans (RMB2.5trn) sold to government in the bail-out plan Worse case: in addition to the write-off, Chinese banks take 50% loss provisioning on lower grade of LGFV loans not taken up by government
Tier 1 ratio impact from new capital framework 2010 (RMBmn) Incremetnal RWA as % of total RWA Total tier 1 impact ABC 15% (136) ICBC 14% (127) CCB 14% (131) BOC 14% (135) BOCOM 11% (95) CMB 11% (80) CITIC Minsheng 11% (88) 11% (84) CRCB 17% (234) Ave. 13% (123)
Tier 1 ratio impact from charging 50% risk weighting on entrusted loans (43% of shadow banking loans) RMB'bn % of total loans Total tier 1 impact ABC ICBC 5.8% (27) CCB 13.7% (63) BOC BOCOM 5.6% (24) CMB 7.3% (28) CITIC Minsheng 7.9% (29) 3.7% (12) (31) CRCB Ave.
Note: ABC, BOC, CRCB did not release entrusted loan for 2010
Source: Nomura estimates
In our view, market participants appear of the view that LGFV risks werent contained, hence, we think investors are convinced that the outcome of ongoing negotiations will result in the government paying a CNY2-3tn (source: Reuters; 31 May) bill to buy the toxic assets from the banks. This implies to us that bank stocks would be headed to a hard-landing before a hard-landing for the toxic assets arrived. We believe credit cycles arrive in phases and LGFVs is a symptom, not the problem. Regardless of a potential government bail-out or not, a solution like this is to buy time and simply pushed the risks further into the future, in our view. Much like the reduction in the risk weighting of SMEs, it helps less on allocating credit to the much needed private sector but is more likely to cause loose credit prudence on a false belief of low risk.
Fig. 4: YTD, H-share banks sector performance against indices with events
(%) 115 110 105 100 95 90 85 12/31/2010 Sector 1/31/2011 2/28/2011 Hang Seng Index Announcement of new capital framework by Market reports of CBRC CBRC 's proposing new capital rules 3/31/2011 HSCEI 4/30/2011 5/31/2011 1st rate hike in 2011
2nd rate hike in 2011
Talk of government bail-out on LGFV loans
Talk of BOA selling part of CCB stake
representsRRRhike
Source: Bloomberg, Nomura research
June 24, 2011
Fig. 5: H-share banks stock price performance YTD
Fig. 6: H-share banks stock price performance YTD

(%) ABC ICBC CCB BOC BOCOM CMB Citic Minsheng CRCB Sector Hang Seng Index HSCEI MSCI Financials - World MSCI Financials - Europe 1m (17) (9) (12) (12) (9) (9) (8) (1) (20) (11) (7) (6) (3) (4) (6) 3m (6) (4) (9) (9) (8) (12) (4) 8 (26) (7) (4) (4) (5) (5) (5) 6m (5) 1 (8) (9) (8) (8) 0 10 (15) (5) (6) (4) (6) (8) (8) 1y na (1) (1) (4) (19) (8) (5) 5 na (3) 4 0 (2) (6) (5) YTD (1) 1 (8) (9) (7) (8) (1) 9 (16) (4) (5) (4) 5 (6) 2
(%) 15 10 5 0 (5) (10) (15) (20)

Minsheng BOCOM CMB Sector BOC HSCEI CRCB ICBC Citic HSI CCB ABC
MSCI Financials - US
Note: closing prices as of 21 June, 2011 (20 June for MSCI index) Source: Bloomberg, Nomura research
Note: closing prices as of 21 June, 2011 Source: Bloomberg, Nomura research
Monetary policy unlikely to be eased any time soon

CPI inflation rebounded to 5.5% y-y in May after a minor and tentative slide in April, driven by the food price and non-food price inflation in the month, per the National Statistics Bureau. While it is widely expected that CPI inflation will moderate in 2H11, we believe there is a small possibility that monthly readings will post a consecutive decline in the following six months, considering: 1) the current inflation cycle is being driven not only by food prices but a number of structural factors, such as rising real unit labour costs and the rebalancing of the economy toward consumption, which may last for several years. 2) PPI inflation remained at 6.8% y-y in May, higher than expected and suggesting that pipeline pressure on CPI inflation is still high. 3) The PBoCs survey on urban households future price expectation remains elevated. On expectation of a volatile trajectory for CPI in 2H11, our economics team expects two more hikes, one in June and one in 3Q11 (Asia Economic Weekly, 6 May). Banks typically outperform in the early cycle of rate hikes. Considering 12 required reserve ratio hikes and four interest rate increases in a row, we think funding cost upside potential may compress Chinese banks NIM expansion via the gradual re-pricing of deposits and possible asymmetric rate hikes, compounded by the implementation of daily monitoring of the loan to deposit rate.
Fig. 7: Food and non-food inflation
food cpi non-food cpi
Fig. 8: Household inflation expectations
25 20 15 10 5 0 -5
(%) 85 80 75 70 65 60 55 50
Mar-01 Oct-01 May-02 Dec-02 Jul-03 Feb-04 Sep-04 Apr-05 Nov-05 Jun-06 Jan-07 Aug-07 Mar-08 Oct-08 May-09 Dec-09 Jul-10 Feb-11
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Source: Bloomberg, Nomura research
Jan-11
Jul-05
Jul-06
Jul-07
Jul-08
Jul-09
Jul-10
Source: CEIC, Nomura research
June 24, 2011
Regulation on new capital framework shift in focus to quality from quantity of capital
The new capital framework proposing a more stringent asset-risk weighting reported by the 21st Century Business Herald is not what the market generally expected. We think many believe that the minimum requirement on tier 1 ratio (8.5%) and CAR (10.5%) by the CBRC is already stricter than BASEL III. In particular, we think the magnitude of the capital shortage more than CNY400bn (for all H-share listed banks) significantly depressed market sentiment, especially given the substantial amount of equity raising completed in 2010.
Fig. 9: Estimated impact on Tier-1 ratio of new CAR rule
2010 (RMBmn) Tier 1 ratio CAR RWA (RM B'm) Core capital Total capital Property Incremental RWA as % of total RWA Tier 1 ratio impact Interbank assets Incremental RWA as % of total RWA Tier 1 ratio impact Retail claims excluding mortgage Incremental RWA as % of total RWA Tier 1 ratio impact Operating risk Incremental RWA as % of total RWA Tier 1 ratio impact S ME Incremental RWA as % of total RWA Tier 1 ratio impact Corporate loan over 5 years Incremental RWA as % of total RWA Tier 1 ratio impact Total tier 1 impact ABC 9.8% 11.6% 5,383,694 524,910 623,970 ICBC 10.0% 12.3% 7,112,357 709,102 872,686 CCB 10.4% 12.7% 6,015,329 625,594 762,744 BOC 10.1% 12.6% 5,887,170 594,015 740,606 BOCOM 9.4% 12.4% 2,370,648 222,130 293,012 CMB 8.0% 11.5% 1,446,883 116,329 165,957 CITIC 8.5% 11.3% 1,385,262 117,055 156,673 Minsheng 8.1% 10.4% 1,280,847 103,364 133,720 CRCB 14.8% 16.3% 148,206 21,905 24,172
5.0% (47) 2.8% (27) -1.9% 19 8.5% (76) -1.2% 11 1.8% (17) (136)
3.6% (35) 1.6% (15) -1.9% 19 8.8% (81) -1.2% 12 2.9% (28) (127)
3.3% (34) 1.1% (11) -1.2% 12 9.0% (86) -1.2% 12 2.4% (25) (131)
3.7% (36) 3.6% (35) -1.4% 14 7.8% (73) -1.2% 12 1.8% (18) (135)
3.0% (27) 2.0% (18) -1.6% 15 6.9% (61) -1.2% 11 1.6% (15) (95)
3.9% (30) 4.0% (31) -3.4% 28 7.7% (58) -1.9% 15 0.6% (5) (80)
2.6% (22) 4.2% (34) -1.0% 9 6.2% (49) -1.7% 15 0.7% (6) (88)
5.1% (39) 4.6% (36) -0.4% 4 6.4% (49) -4.7% 39 0.4% (3) (84)
4.1% (58) 8.7% (118) -3.1% 48 7.9% (108) -1.5% 23 1.4% (21) (234)
Note: Approximately half of the Tier 1 ratio reduction for CRCB comes from risk weighting changes on interbank assets. This negative impact can more likely be absorbed by CRCB if the bank shortens the maturity of interbank assets. By the new CAR rule, interbank assets with an original maturity within 3 months are required to have less than half the risk weighting of a maturity over 3 months. Source: 21st Century News, Nomura estimates
In our view, the consultation paper on the new CAR rule, if confirmed, reflects: 1) the shift in the regulators focus to quality of capital; and 2) the regulators intention to apply the CAR framework to support the central governments restructuring of economic growth. We think the CBRC stresses the quality of capital by differentiating risk weightings on asset categories. The risk weighting is divided into 10 categories under the new CAR rule. For example, risk weighting of high-risk sectors like properties are revised up to 150% and 100%. The highest group of risk weighting at 1,250% is assigned to investments in some equities and properties. Likewise, risk weighting is also differentiated with a downward revision for asset classes favoured by the central government, like small enterprises and retail loans, and upward adjustment for those sectors that are discouraged, such as LGFV loans and long-term corporate loans. In this sense, we reckon the new capital framework, if implemented, is a platform for the CBRC to dynamically fine-tune its capital requirement for commercial banks in China. We cannot rule out the possibility that the CBRC will unveil new guidelines contingent on macro conditions and the central governments industrial policy. The above table shows the estimated impact on the tier 1 ratio of Chinese banks if the new capital framework is implemented. We estimate a net reduction of 80bps to 234bps
June 24, 2011
for H-share banks. Joint stock banks like Citic, Minsheng and CMB would be less affected thanks to their exposure to retail and small enterprise loans and lower exposure to long-term loans and property loans, in our view. The initial underperformance of large banks to joint stock banks following the news report appears contradictory to large banks more prudent risk management with regards to provision policy, diversified loan portfolios and lower LGFV loan exposure. As mentioned, greater loan exposure to more traditional industries probably explains the difference, in our view. However, we continue to favour large banks on account of their current strong capital base and conservative risk management practices. Hence, the risk weighting changes on interbank assets are more absorbable through proactive balance sheet management. In particular, if a phase-in period is suggested along with the official unveiling of the new rule, the real negative effect on large banks may be muted, in our view, as they would accelerate the pace to be better aligned with the regulators policy direction. In addition, the transparency offered by a comprehensive capital framework integrating BASEL III as well as Chinas specialized economic conditions will likely be a long-term positive for Chinese banks, in our view.
Fig. 10: Difference between Tier 1 ratio (1Q11) and CBRCs minimum requirement
Minsheng and CRCB's figure is 4Q10, assumes CBRC requires 9.5% tier 1 ratio for big 5 banks and 8.5% for others
Fig. 11: China banks Tier 1 CAR (1Q11)

Minsheng and CRCB's figure is 4Q10
(%) 6.5 5.5 4.5 3.5 2.5 1.5 0.5 (0.5) (1.5)
CRCB CCB BOCOM CITIC ICBC CMB BOC ABC Minsheng
(%) 15 14 13 12 11 10 9 8 7 6
BOCOM Minsheng CRCB CCB CITIC ICBC CMB BOC ABC
Source: Company data, Nomura research
Bail-out of LGFV loans

We believe the MOFs internal discussion to carve out LGFV loans prompted a negative market response due to the potential 20% haircut born by Chinese banks. Our sensitivity analysis shows that if 30% of LGFV loans (CNY3trn for all banks) are spun off with a 20% discount, Chinese banks 2011 pre-tax profit may be written down by an average of 13%. We think joint stock banks would be most negatively affected considering their higher LGFV loan exposure in the asset mix.
June 24, 2011
Fig. 12: Estimated impact on 2011F earnings by LGFV loan write-off and provisioning
RMB'mn ABC ICBC CCB BOC BCOM CMB Citic Minsheng CRCB Ave.
Base case: we assume Chinese banks write off 20% of LGFV loans (RMB2.5trn) sold to government in the bail-out plan as a haircut total LGFV as of Dec 2010 total LGFV as % of total loan 30% of LGFV loan spin off 20% write-off on the spin off write off as % of 2011F PBT 395,300 8.0% 108,718 21,744 13.0% 649,600 9.6% 178,658 35,732 13.6% 540,000 9.5% 148,515 29,703 13.8% 380,000 6.7% 104,510 20,902 12.8% 177,400 7.9% 48,790 9,758 16.3% 135,100 9.4% 37,156 7,431 16.4% 118,400 9.4% 32,563 6,513 18.9% 197,200 18.6% 54,235 10,847 38.1% 18,500 15.1% 5,088 1,018 19.2% 18.0% 10.5%
Worse case: in addition to the write-off, Chinese banks take 50% loss provisioning on lower grade of LGFV loans not taken up by government total lower grade LGFV loans remaining lower grade LGFV loans not spin off 50% provision on remaining lower grade LGFV to 2011F PBT Total impact on 2011F PBT
162,073
162,400
234,681
190,000
75,395
14,402
710
59,160
37
53,355
86,166
85,490
26,605
4,925
16% 29%
0% 14%
20% 34%
26% 39%
22% 39%
0% 16%
0% 19%
9% 47%
0% 19%
10.3% 28.4%
Some market participants have compared the proposal with the banking sector restructuring starting from 1998, citing the similarities in worrisome asset quality problems subsequent to high credit growth led by policy loans. Nevertheless, banks overall asset quality is much more benign at this stage compared with the late 1990s, in our view. The NPL ratio for state-owned banks reached 39.3% in 2008, compared with 1.1% for all commercial banks in 2010, while the provision coverage ratio reached 180% in the same period, per company data and CBRC. In the late 1990s, the substantial NPLs could have resulted in negative equity for stateowned banks, if all were written down, based on our calculations. The NPL-to-equity ratio hit 3.8x in 1998 and stayed elevated at 2.5x in 2001 even following a CNY270bn capital injection for the big four banks in 1998 and CNY1.4trn in non-performing assets spun off in 1999. The current (2010) ratio of NPL to equity is 0.28x. Hence, in our worst case, where 30% of existing LGFV loans (CNY14.4trn) turn into NPLs, the NPL-to-equity ratio would still be below 1x.
Regulation of shadow banking system

The regulatory oversight on loan quota has given rise to a variety of other financing channels such as trust loans, entrusted loans, credit guarantee and micro-financing firms. These tools, classified as the shadow banking system, complement the capital needs from social public housing projects and SMEs against the backdrop of tightened bank liquidity, in our view. New bank loans as a percentage of total social financing decreased from 90% in 2003 to 53% in 2010. The control of market liquidity by means of growth targets on bank loans and M2, in our view, may not be as effective as it was previously. Nevertheless, the potential shift in the growth target from bank loans to total social financing to better gauge the money supply could prompt a smaller pool of credit supply on the market. In the late interest rate cycle, we believe joint stock banks are particularly vulnerable to such a change, on potential rising NPLs from SMEs, compounded by the funding cost pressure stemming from intense deposit competition following the daily monitoring of the loan-to-deposit ratio in June. Below is our scenario analysis of capital shortage for banks if we bring the shadow banking loans onto banks balance sheets. Our base case assumes entrusted loans and trust loans for which commercial banks play the role of intermediates are brought onto the balance sheet of all banks. Accordingly, CNY303bn of capital may be raised to maintain the core capital ratio of
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June 24, 2011
Chinese banks at 10.1% as of 2010. In our worst case, when all shadow banking loans are restructured as bank assets, there is a potential capital shortfall of CNY599bn.
Fig. 13: Shadow banking system as % of total loans
Small loan companies, 0.4%
Fig. 14: Capital adequacy scenario analysis

RMB'bn 2010 Bear Case Base Case
Trust companies, 1.3% Financing lease companies, 1.4% Credit guarantee companies, 1.8% Private lending (), 4.8%
Source: CBRC, Nomura research
Pawn loan, 0.1% Entrusted loans, 7.3%
Capital Ratio Capital adequacy ratio Core capital adequacy ratio Capital Shortage (if capital ratios unchanged) Capital adequacy Core capital adequacy Assumptions Shadow Banking System Loans (RMB'bn) bear case (all shadow banking loans) base case (entrusted loans + trust loans) On-balance sheet risk-weighted assets Total loans On-balance sheet risk-weighted assets as % of total loans
Source: CBRC, Nomura estimates
12.2 10.1
10.7 8.8
11.4 9.4
0 0
724 599
366 303
8,500 4,300 35,537 50,923 70% 41,469 59,423 70% 38,538 55,223 70%
Catalysts
1) 10% rebound on valuation call we are near the 1Q09 trough Given the recent sell-down on regulation and macro risk, Chinese banks are approaching attractive territory from a valuation perspective, in our eyes. We view the trough valuation in 1Q09 as the support level, considering the risks from weak US/EU economic data, potential share disposal by foreign strategic shareholders after lock-up expiry, a macro-economic slow-down, a sharp decline in NIM led by asset yields in 1Q09 at least as serious as current concerns on unfavourable regulation changes and continued monetary tightening. From this perspective, we believe the 1Q09 trough PB (as displayed in the below table) offers value to long-term investors, with risk/reward skewed to the upside.
Fig. 15: Market implied ROE vs 2011F ROE
(%) 25 20 15 10 5 0
BOCOM Minsheng CMB BOC CRCB ICBC CCB Citic ABC
Fig. 16: Current PB vs 1Q09 Trough/Historical low

(x) 2.2 2.0 1.8 1.6 1.4 1.2 1.0 0.8 0.6
ABC
implied ROE by 1 year rolling forward PB 2011F ROE by Nomura
Current rolling forward PB 1Q09 trough
Minsheng
BOCOM
Source: Bloomberg, Nomura estimates
Note: historical low is used for ABC, Minsheng and CRCB as they were not yet listed in 1Q09 Source: Bloomberg, Nomura estimates
CRCB
CCB
ICBC
CMB
BOC
Citic
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June 24, 2011
2) Weak GDP growth and peaking inflation may trigger an easing of monetary policy We believe that below 9% real GDP growth may trigger a series of social and economic problems in China, which may force Chinese banks to loosen their harsh stance. If Chinese banks lead the underperformance of the market due to increasing worries on a potential hard landing scenario, we expect the financial sector to bottom ahead of other industries. Our economics team forecasts real GDP growth of 9-9.5% y-y in the next six quarters. 3) 2011 interim results still strong and solid but only a few will likely surprise on the upside We believe the net interest margin for 2Q11 will be a non-event for Chinese banks. The implementation of daily monitoring of the loan-to-deposit ratio, deposit re-pricing and potential asymmetric rate hikes to contain the inflation will likely compress banks margin in 2H11 on rising funding cost pressure. Net fee income growth could still surprise on the upside in 2Q11, given the continuing robust sales of wealth management products in April and May. Credit cost and NPL ratios are still satisfactory, filtering through strong PPOP to bottom line. Downgrading FY11F earnings forecasts on more cautious margin view We have slightly cut our forecasts for FY11F earnings growth by 2-5% mainly to reflect our more cautious view on margin expansion. On 7 May 2011, we cut our FY11F NPAT forecast by narrowing margin expansion in 2Q11. We continue to believe that NIM expansion will likely peak in 2Q11, and remain flattish in 3Q11 before contracting in 4Q11. Since we see rising likelihood of asymmetric rate hikes for the rest of this year, we think Chinese banks are likely to face margin contraction in 2H11, especially if the PBoC raises the demand deposit rate by a larger magnitude in the coming months, given that re-pricing on time deposits and demand deposits should be completed by then. We now expect 12bps NIM expansion in FY11F for CMB, 10-11bps for ABC, ICBC and CCB and 5-9bps for the other H-share banks. Based on our lower earnings forecasts for FY11F, we have cut our FY11F target prices for ICBC (to HKD7.50 from HKD7.60), downgraded CCB to NEUTRAL from Buy (to HKD7.02 from HKD8.60), BCOM (to HKD8.30 from HKD9.00), CMB (to HKD24.82 from HKD26.86) and CRCB (to HKD6.52 from HKD6.68).
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Macro and monetary policy

Economic growth showing signs of slowdown
Chinas economic growth looks to be slowing in 2Q11, as indicated by lower-thanprevious month industrial production for three months in a row as of May 2011 (14.8% y-y in March; 13.4% in April and 13.3% in May) and a weaker May PMI reading (52.0 versus 52.9 in April and 53.4 in March) (according to a report in Asia Economic Weekly, 27 May 2011). In light of the effects of higher inflation, tightening monetary policy, power shortages as well as Japans recent earthquake, our economics team downgraded its 2011 GDP growth forecast to 9.4% y-y from 9.8% and 2012 GDP growth to 9.2% y-y from 9.5% previously. Meanwhile, our economics team expects one more 25bp rate hike in June and another in 3Q11. However, they have cut from their assumptions one 25bp deposit and lending interest rate hike call, and now expect only two 25bp hikes for the lending rate and four 25bp hikes for deposit rates for 2012F. Below are the details of our revised economic forecasts.
Fig. 17: Details of economic forecasts
Note: Numbers in bold are actual values; others forecast. Interest rate and currency forecast are end of period; other measures are period average. All forecast are modal forecasts (i.e., the single most likely outcome). Table last revised 10 June 2011. Source: CEIC, Nomura Global Economics.
According to the PBoCs 5,000 entrepreneurs survey, the diffusion index of inventory level dipped to 49.6% in 1Q11 from 50.3% in 4Q10, suggesting that firms started destocking at the beginning of this year, given that a reading of below 50 indicates contraction in activity. If this trend continues in the coming quarters, we are concerned that a de-stocking process similar to that of late 2008 and 2009 when inventory dragged down real GDP growth by 0.2pp and 0.4pp, respectively, based on our estimates, might repeat itself this year, albeit in a milder way. Provided this proves to be true, we think it would further weigh on Chinas economic growth and we expect to see increasing signs of a slowdown in 2Q11.
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June 24, 2011
Fig. 18: Inventory level of 5,000 entrepreneurs survey

Diffusion Index
(%) 60 55 50 45 40 35 30
Jun-92 Mar-93 Dec-93 Sep-94 Jun-95 Mar-96 Dec-96 Sep-97 Jun-98 Mar-99 Dec-99 Sep-00 Jun-01 Mar-02 Dec-02 Sep-03 Jun-04 Mar-05 Dec-05 Sep-06 Jun-07 Mar-08 Dec-08 Sep-09 Jun-10 Mar-11
Source: CEIC, PBoC, Nomura research
Monetary policy unlikely to ease any time soon

CPI inflation rebounded to 5.5% y-y in May after a minor and tentative slide in April from 5.4% in March to 5.3% driven both by food prices and non-food price inflation in the month. Although it is widely expected that CPI inflation should moderate in 2H11, we believe there is a small possibility that the monthly readings will post a consecutive decline in the following six months, especially when households inflation expectations remain elevated as suggested by the PBoCs survey on urban households future price expectation which stands at 72.2% for 2Q11F. Instead, we see a volatile trajectory for CPI inflation in 2H11F, thus we think it would be hard to ease monetary policy any time soon.
Fig. 19: Chinas CPI inflation
(% y-y) 25 20 15 10 5 0 (5)
Jan-07 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11
CPI CPI: non food CPI: Food
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June 24, 2011
Fig. 20: Urban households future price expectation

Diffusion index
(%) 85 80 75 70 65 60 55 50
Apr-03 Oct-05 Apr-08 Aug-01 Sep-03 Aug-06 Nov-02 Nov-07 Sep-08 Dec-04 May-05 Dec-09 Jan-02 Jun-02 Jan-07 Jun-07 May-10 Feb-04 Mar-01 Mar-06 Feb-09 Oct-10 Jul-04 Jul-09 Mar-11
After six hikes since the beginning of this year and 12 hikes since 2010, the RRR level for both large banks and smaller ones has reached a historical (since 2003) high at 21.5% and 19.5%, respectively, and we think the PBoC might have overdone on this. We think the consecutive RRR hikes will only drain liquidity from the system and inevitably hurt certain industries such as residential property. While the CBRC recently rolled out measures to encourage Chinese banks to make more loans to SMEs, including a lower risk weight for SME loans, we do not think this will solve the financing problem for SMEs.
Fig. 21: RRR
Historical high level
(% y-y) 25 20 15 10 5 0
21-Sep-03 21-Dec-03 21-Mar-04 21-Jun-04 21-Sep-04 21-Dec-04 21-Mar-05 21-Jun-05 21-Sep-05 21-Dec-05 21-Mar-06 21-Jun-06 21-Sep-06 21-Dec-06 21-Mar-07 21-Jun-07 21-Sep-07 21-Dec-07 21-Mar-08 21-Jun-08 21-Sep-08 21-Dec-08 21-Mar-09 21-Jun-09 21-Sep-09 21-Dec-09 21-Mar-10 21-Jun-10 21-Sep-10 21-Dec-10 21-Mar-11
RRR: Large depository institution RRR: Small and medium depository institution
By contrast, we think the PBoC is already behind the curve in terms of rate hikes as the real deposit rate has remained negative since February 2010 with the gap between CPI inflation and one-year deposit rate increasing. With slowing economic growth yet elevated CPI inflation, we think there is a high possibility that the PBoC will announce asymmetric rate hikes over the rest of the year. If this turns out to be the case, we see greater pressure for Chinese banks earnings growth in 2011F.
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June 24, 2011
Fig. 22: CPI versus 1-year deposit rate

Rate hike behind the curve
(% y-y) 10 8 6 4 2 0 (2) (4) CPI 1-year deposit rate
(% p.a.) 10 8 6 4 2 0 -2 -4
Jan-07 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11
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June 24, 2011
Regulation changes
CBRC rolls out stricter regulatory rules for China banks
On 3 May, 2011, China's banking regulator announced stricter regulation rules for commercial banks to improve the ability of the country's banking and financial institutions to combat risks. The China Banking Regulatory Commission (CBRC) said it would set the minimum capital adequacy ratio for banks of systemic significance at 11.5%, while that for banks with non-systemic significance at 10.5%. The banks need to meet the new standards by the end of 2013 and the end of 2016, respectively. The criterion of a bank's significance will be determined within this year, the CBRC said on its website. Banks will be restricted from engaging in structurally complicated and highly leveraged transactions to prevent excessive risk taking. The systemically important banks are also being told to reduce their share of loans to a single debtor or customer group among their total capital assets. The new regulation standards will be implemented starting 1 January 2012.
Fig. 23: New regulatory framework for China banks
Regulatory Framework
Timetable to meet the new requirement Standard level (%) Capital Core T1 capital T1 capital Total capital Conservation buffer Counter-cyclical buffer Additional capital for systemically important banks 5.00 6.00 8.00 2.50 0-2.50 1.00 By end-2013 By end-2014 By end-2015 By end-2016 By end-2017 By end-2018 By end-2016 By end-2017 By end-2018 By end-2019 By end-2020 By end-2021 SIB non-SIB
Leverage Leverage ratio 4.00 By end-2013 By end-2016
Provision Coverage ratio Loan-loss provision ratio 150.00 Current requirement 2.50 By end-2013 Current requirement By end-2016;
by end-2018 for banks with difficulties

Source: CBRC
The new rules are in line with our expectation and largely the same as those reported in February when the rules were approved by the State Council. However, the new rules are stricter than the international standard in terms of: 1) core T1 CAR is introduced at a level of 5%, 0.5pp higher than the Basel III requirement; 2) leverage ratio is 1% higher than the Basel III requirement, at a level of 4%; 3) loan-loss provision ratio is confirmed to be 2.50% with 150% requirement for coverage ratio at the same time, while the Basel Committee is still working on the specifications for this criteria, per the Committee; and 4) the new rules are enacted one year earlier than required by Basel III and banks will have to meet the new standards by the end of 2013 for SIBs and the end of 2016 (for non-SIBs) versus the end of 2018 as required by Basel III.
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June 24, 2011
Fig. 24: Differences between the CBRCs new framework and Basel III
CBRC's new framework Common Equity (%) T1 Leverage Ratio (%) Provision Ratios Commence Period Grace Period
Basel III 4.50 3.00 not specified 1-Jan-13 by end 2018
5.00 4.00 2.5% for loan loss ratio and 150% for coverage ratio 1-Jan-12 by end 2016
Given that most Chinese banks already meet the new requirement on Tier 1 CAR and total CAR, we do not see another round of capital-raising plans from China banks in the near term due to the new regulation. However, we believe that most joint-stock banks might face pressure from the new requirement on the loan loss provision ratio of 2.5%. That said, given the six-year grace period, we believe these banks should be well positioned to weather the headwinds from higher credit costs in order to meet the new requirement. Overall, we do not think the new rules will have material impact on the sector. Rather, we believe it should be positive for the development of China banking sector in the long run.
Fig. 25: Financial ratios of China banks (1Q11)
Financial ratios
(%) Tier 1 CAR Total CAR Provision Coverage Ratio Loan Loss Provision Ratio ICBC 9.7 11.8 247 2.5 CCB 10.3 12.5 229 2.5 BOC 10.0 12.4 206 2.1 ABC 9.6 11.4 197 3.5 Bocom 9.2 12.1 198 2.1 CMB 7.7 10.9 335 2.1 Citic 8.2 11.1 231 1.5 Minsheng 8.0 11.0 301 2.0 CRCB 14.8 16.3 173 4.1
Regulation proposed new CAR rule on Chinese banks According to an unconfirmed Chinese-language report in the 21st Century Business Herald (8 June), the CBRC recently issued a consultation paper on "the New Administrative Rules on Capital Adequacy Ratio" to commercial banks. The draft, according to the newspaper, has consolidated 11 complementary guidelines on the implementation of new capital rules as well as the yet to be officially released "the Guideline on the Calculation of Capital Adequacy Ratio for Commercial Banks". If the report is accurate, the new framework would appear to place a more stringent capital requirement for Chinese banks in the aspects of minimum core tier 1 and CAR ratio, credit asset risk weighting, operating risk and the definition of tier 2 capital. 1) Minimum core tier 1 and CAR ratio As the draft of "the Guideline on the Calculation of Capital Adequacy Ratio for Commercial Banks" was revealed by 21st Century Business Herald in early May, commercial banks will be obliged to maintain tier 1 and CAR ratios no lower than 6% and 8%, a conservation buffer of 2.5%, a counter-cyclical buffer of 0-2.5% and an additional 1% for systemically important banks. In our view, the forthcoming capital raising plans by CMB, Minsheng and Citic Bank are tied in with the likely revised requirements on tier 1 ratio and CAR. 2) Operating risk Under the consultation paper, operating risk would require bank capital. According to the abovementioned news report, basic indicator approach, standard approach and standard replacement approach are advised in the draft of the new guideline. The basic indicator approach, the simplest, measures the asset risk weighting on operating risk taking into account banks' operating revenue. We estimate the inclusion of operating risk could weigh negatively on H-share banks' tier 1 ratio by 49-108bps, with joint-stock banks (except CRCB) less affected than the big five banks.
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June 24, 2011
3) Credit asset risk weighting Credit asset risk weighting is expected to have the greatest impact on tier 1 ratio and CAR on commercial banks, because 10 different risk weightings are set aside including 0%, 50%, 75%, 100%, 150%, 1,250%. The CBRC has the discretion to adjust risk weighting for high-risk assets to above 150% contingent on economic conditions and government policies on specific industries. In comparison, the highest category of credit asset risk weighting in the existing CAR rule is 100%. a) Risk weighting on property would be revised up to 150% from 100%. H share banks tier 1 ratios would decline accordingly by 22 to 58bps; Bocom, CITIC and CMB would be less impacted, based on our estimates, given lower exposure to real estate loans. b) Risk weighting on inter-bank assets would be lifted from 0-20% to 20-100%. H-share banks tier 1 ratios would, by our estimation, about to drop by 11 to 118bps (CRCB is the outlier at 118bps). Large banks would be less impacted, in our view, thanks to a smaller proportion of inter-bank assets to total assets. c) Risk weighting of corporate loans over five years would be raised by 15% to 115%. We estimate that H-share banks tier 1 ratios would decline between 3 and 28bps. Minsheng, Citic and CMB would be less affected, we believe, in view of light exposure. d) Risk weighting of retail loans (excluding personal housing loans) would drop to 75% from 100%, which looks favourable for H-share banks tier 1 ratios by an increase of 948bps. CRCB and CMB would be the largest two beneficiaries, we find. e) Risk weighting of small enterprise loans below CNY5m would also be revised down to 75% from 100%, given they would be reclassified as retail loans under the CBRC's earlier notice, in order to encourage financing to small enterprises. Therefore, tier 1 ratios for H-share banks would rise by 11 to 23bps, per Nomura estimate. Total impact on tier 1 ratio We estimate 80-234bps negative impact on tier 1 ratio for H-share banks. Joint stock banks Citic, CMB and Minsheng would likely be less affected thanks to their higher exposure to retail and small enterprise loans and lower exposure to long-term loans and property loans. Definition of Tier 2 capital The consultation paper also ties tier 2 capital with loan provisioning. Excess provisioning would be included in the calculation of tier 2 capital and the inadequate amount would be deducted. Moreover, tier 2 capital items such as convertible bond, hybrid bond and longterm sub-debt would be discounted based on remaining maturities. When their maturities are less than five years, a 20% discount on the total outstanding would be applied each year towards the maturity of the bonds. Financial Institutions under Supervision Apart from Chinese and foreign commercial banks, the proposed new rule would also apply to county banks, auto finance companies, financing lease companies and consumer finance companies. On balance, we believe if the consultation paper is confirmed and implemented, there could be significant impact on Chinese banks' capital as well as asset allocation decisions. At the forefront of capital concerns, joint-stock banks like CMB and Minsheng seem less unfavourably affected to us thanks to better positioning on loan exposure. In terms of business directions, Nomura will pay close attention to whether there will be a squeeze on loans to the property sector and rush into small enterprises and retail loans. While we think it is strategically important to have this loan mix migration, any excess lending is not deemed to be healthy. Last but not least, we do think the consultation paper would leave sufficient flexibility for regulators to dynamically fine-tune the new CAR rule contingent on macro conditions. Considering the high likelihood of a soft landing for the macro economy, we advise the direction of the adjustment would be more likely to head toward a more stringent supervision in view of the CBRC's stance to be "counter-cyclical".
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June 24, 2011
Fig. 26: Draft of the New Version of the Administration on Capital Adequacy Ratio of Commercial Banks
Credit Risk Weighting Changes for On Balance Sheet Items
Loans to: Infrastructure Property development LGFVs Claims on Public-sector Entities Claims on PRC public-sector entities invested by the PRC central government Claims on PRC Commerical Banks Claims on PRC incorporated commercial banks with: - an original maturity of 3m or less
(0% for certain claims on PRC incorporated commercial banks as specified by CBRC)
Current RW
100% 100% 100%
New RW
110% 150% 100-300%
50%
100%
0% 0% 20% 20%
20% 50% 50% 100%
- an original maturity of 3m to 4m - an original maturity of more than 4m Hybrid bonds and subordinated bonds of PRC incorporated commercial banks Claims on non-PRC Commercial Banks or Securities Companies Claims on non-PRC commercial banks and securities companies incorporated in other countries or regions where the sovereign or region is rated at AA - or above Claims on non-PRC commercial banks and securities companies incorporated in other countries or regions where the sovereign or region is rated below B Claims on Foreign Sovereign Debt Claims on foreign sovereign debt with credit rating of below BClaims on Retail Loans Claims on individuals other than personal residential mortgages Claims on Corporate Loans Claims on corporate where the credit rating is below BBClaims on term loans with maturity over 5 years Equity Investments Non-deducted equity investment in financial institutions Equity investment in businesses other than financial institutions Property not self-occupied
20% 100%
50% 150%
100%
150%
100%
75%
100% 100%
150% adjsuted for maturity multiplier
100% 100% 100%
250% 1250% 1250%
Credit Risk Weighting Changes for Off Balance Sheet Items Loan equivalent credit business (including issuance of acceptance draft, financing guarantees, etc) Irrevocable credit commitment (credit card commitment, bond underwriting amount, etc) with original maturity less than 1 year Irrevocable credit commitment (credit card commitment, bond underwriting amount, etc) for with original matuirty more than 1 year Recocable credit commitment Trade related contingent liability Transaction related contigent liability Repurchase agreement with credit risk rested on the bank
Source: 21st Century Business Herald
Current RW 100% 0% 50% 0% 20% 50% 100%
New RW 100% 75% 75% 0% 20% 50% 100%
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June 24, 2011
Fig. 27: Estimated impact on Tier-1 ratio by new CAR rule o

2010 (RMBmn) Tier 1 ratio CAR RWA (RM B'm) Core capital Total capital Property Incremental RWA as % of total RWA Tier 1 ratio impact Interbank assets Incremental RWA as % of total RWA Tier 1 ratio impact Retail claims excluding mortgage Incremental RWA as % of total RWA Tier 1 ratio impact Operating risk Incremental RWA as % of total RWA Tier 1 ratio impact S ME Incremental RWA as % of total RWA Tier 1 ratio impact Corporate loan over 5 years Incremental RWA as % of total RWA Tier 1 ratio impact Total tier 1 impact ABC 9.8% 11.6% 5,383,694 524,910 623,970 ICBC 10.0% 12.3% 7,112,357 709,102 872,686 CCB 10.4% 12.7% 6,015,329 625,594 762,744 BOC 10.1% 12.6% 5,887,170 594,015 740,606 BOCOM 9.4% 12.4% 2,370,648 222,130 293,012 CMB 8.0% 11.5% 1,446,883 116,329 165,957 CITIC 8.5% 11.3% 1,385,262 117,055 156,673 Minsheng 8.1% 10.4% 1,280,847 103,364 133,720 CRCB 14.8% 16.3% 148,206 21,905 24,172
5.0% (47) 2.8% (27) -1.9% 19 8.5% (76) -1.2% 11 1.8% (17) (136)
3.6% (35) 1.6% (15) -1.9% 19 8.8% (81) -1.2% 12 2.9% (28) (127)
3.3% (34) 1.1% (11) -1.2% 12 9.0% (86) -1.2% 12 2.4% (25) (131)
3.7% (36) 3.6% (35) -1.4% 14 7.8% (73) -1.2% 12 1.8% (18) (135)
3.0% (27) 2.0% (18) -1.6% 15 6.9% (61) -1.2% 11 1.6% (15) (95)
3.9% (30) 4.0% (31) -3.4% 28 7.7% (58) -1.9% 15 0.6% (5) (80)
2.6% (22) 4.2% (34) -1.0% 9 6.2% (49) -1.7% 15 0.7% (6) (88)
5.1% (39) 4.6% (36) -0.4% 4 6.4% (49) -4.7% 39 0.4% (3) (84)
4.1% (58) 8.7% (118) -3.1% 48 7.9% (108) -1.5% 23 1.4% (21) (234)
Source: 21st Century Business Herald, Nomura research
Fig. 28: Estimated impact on 2011F earnings of LGFV loan write-off and provisioning
RMB'mn ABC ICBC CCB BOC BCOM CMB CiticMinsheng CRCB Ave.
Base case: w e assume Chinese banks w rite off 20% of LGFV loans (RMB2.5trn) sold to government in the bail-out plan as a haircut total LGFV as of Dec 2010 total LGFV as % of total loan 30% of LGFV loan spin off 20% w rite-off on the spin off w rite off as % of 2011F PBT 395,300 8.0% 108,718 21,744 13.0% 649,600 9.6% 178,658 35,732 13.6% 540,000 9.5% 148,515 29,703 13.8% 380,000 6.7% 104,510 20,902 12.8% 177,400 7.9% 48,790 9,758 16.3% 135,100 9.4% 37,156 7,431 16.4% 118,400 9.4% 32,563 6,513 18.9% 197,200 18.6% 54,235 10,847 38.1% 18,500 15.1% 5,088 1,018 19.2% 18.0% 10.5%
Worse case: in addition to the w rite-off, Chinese banks take 50% loss provisioning on low er grade of LGFV loans not taken up by government total low er grade LGFV loans remaining low er grade LGFV loans not spin off 50% provision on remaining low er grade LGFV to 2011F PBT Total impact on 2011F PBT
162,073 53,355
162,400 0
234,681 86,166
190,000 85,490
75,395 26,605
14,402 0
710 0
59,160 4,925
37 0
16% 29%
0% 14%
20% 34%
26% 39%
22% 39%
0% 16%
0% 19%
9% 47%
0% 19%
10.3% 28.4%
Regulation: Local government vehicle loans bail-out not necessary Reuters (China May Shift Local Government Debt, 31 May 2011) reported that China regulators were planning to take CNY2-3tn of debt load off local governments. The bailout plan, as per the Reuters report, involves the set-up of asset management companies to pay off LGFV loans from banks and to lift a ban on local governments issuing bonds. The market has reacted negatively to this news on the concern that banks may be required to dispose of their loans at a discount.
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June 24, 2011
Our sensitivity analysis shows that in our worst case, Chinese banks profit before tax would be cut by an average of 28%. Minsheng bank would be most negatively affected of our universe (47% of 2011F pre-tax profit) considering its highest LGFV loan exposure to total loans. Additionally, the news report also stirred bearish views that there may have been hidden asset quality problems on LGFV loans that were not revealed by Chinese banks. In particular, the PBoCs financial report published on 1 June suggests total LGFV loans by end of 2010 may have reached as much as CNY14.4trn, much higher than the CBRCs statistics of CNY9trn as of Nov. 2011. We think this has compounded market concern on the creditability of LGFV loan information disclosure by Chinese banks. In our view, although the discussed bail-out plan proposed by MOF with the reference from the banking sector restructuring in 1998, is intended to remove the risk associated with LGFV loans written by Chinese banks, it is not necessary. First of all, we think banks overall asset quality is much more benign at this stage compared to the late 1990s. As a result of policy lending to state-owned companies under restructuring in 1990s, Chinese banks accumulated substantial NPLs. Before the establishment of asset management companies in 1999, the NPL ratio reached 39.3% in 1998 for state-owned banks, according to CEIC. This compares to 1.1% for commercial banks in 2010. Even we presume in our worst case that LGFV loan arrived at CNY14.4trn and 30% were NPL, the total adjusted NPL ratio for commercial banks in 2010 would have been 10%, lower than any year between 1998 and 2004, based on our calculations. Second, in late 1990s, banks internal capital could not cover its NPL. The NPL-to-equity ratio touched as high as 3.8x in 1998 and dropped below 2.5x in 2001 even with CNY270bn capital injection into the big 4 banks in 1998 and CNY1.4trn non-performing asset spin off in 1999. On the other hand, in our worst case, where 30% of existing LGFV loans (CNY14.4trn) are NPLs, the NP-to-equity ratio was 0.8x, and provisioning coverage stood at 21%. Some bearish views also consider the LGFV as a severe burden to Chinese financial system, but we think these are exaggerated. Even if we regard LGFV loans (CNY14.4trn, the highest estimate by institutes / academics) as government debt, the total government debt to GDP for China was still 52%, close to the average of other major economic entities. In addition, this aggregate amount of government debt represents 2.5x of total national fiscal revenue, still lower than the US, Japan and Germany. In this regard, we reckon the exposure of LGFV loans on the nations level is still manageable. We believe the worry of repayment risk of LGFV loans lies in it being closely tied to the property market, given the resource of land reserve of local governments can not only be used as collateral but also generate sales revenue. Take Chongqing municipality as an example, approximately 20% of LGFV loans are charged with land use rights. On the back of rising property price in the past few years, land sales revenue have outgrown the fiscal income of local governments and the ratio of land sales revenue to local governments disposable income has increased from 16% in 2008 to 27% in 2010. This concern could possibly be fueled by the decline of land sales revenue by 14% y-y in first five months in China.
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June 24, 2011
Fig. 29: NPLs of state owned banks between 1998 and 2001
(RMB bn) Equity Loan Asset Provision NPL NPL ratio Provision to loan NPL / equity
1996 261 3,625 5,948 43
1997 274 4,482 7,213 36
1998 559 5,361 8,253 30 2107 39%
1999 570 5,746 9,176 71 1689 29% 1.2% 3.0
2000 598 5,825 9,839 60 1701 29% 1.0% 2.8
2001 663 6,466 10,325 102 1642 25% 1.6% 2.5
1.2%
0.8%
0.6% 3.8
Fig. 30: Local Government Disposable Income (Land Sales Revenue +Budgetary Fiscal Income) (CNYmn)
12,000,000 10,000,000 8,000,000 6,000,000 4,000,000 2,000,000 0 2004 2005 2006 2007 2008 2009 2010
Fig. 31: Land sales as % Local Government Disposable Income

land sales revenue to local government disposable income 30% 25% 20% 15% 10% 5% 0% 2004 2005 2006 2007 2008 2009 2010
local budgetary fiscal income land sales revenue
New regulations on cross-industry financial holding companies

As it becomes the norm for players in the financial sector to carry out cross-industry business, we think new rules are necessary to bridge the regulatory gap as there is currently not an official authority to monitor the operations of a financial group. According to a Chinese-language report published by the 21st Century Business Herald on 18 March, 2011, the PBoC is going to initiate new regulations on financial holding companies. In the new regulations, there would be clearer and more precise definition and legal status of financial holding companies. Besides, the entry criteria for financial holding companies would also be lifted and clearly defined. As at the end of 2010, dozens of state-owned enterprises hold or have significant stake in close to a hundred financial companies, including banks, finance companies, trust companies, financial lease companies, securities, insurers, guarantee companies, etc. According to the 21st Century Business Herald, state-owned enterprises such as State Grid Corporation, Aviation Industry Corporation, AviChina Industry & Technology Company Limited, Baosteel, Minmetal, COFCO have already formed a cross-industry group with financial companies. Meanwhile, private enterprises such as New Hope, Asia Standard, Wanxiang Group and China-Orient are also becoming financial holding companies. In principle, securities, funds, trusts, insurance companies and other non-financial companies are not encouraged by the CBRC to act as controlling shareholders of banks. CBRC Chairman Liu Mingkang stressed that commercial banks should be prudent in expanding their business into other financial areas, according to the news report. The
23
June 24, 2011
article went on to say that the CBRC intends to lay down stringent approval procedures and have strict examination before non-financial companies are allowed to hold a stake in financial companies. It was further disclosed in the article that non-financial companies need to obtain approval from the regulator if they would like to hold more than 5% capital of a financial company. For those non-financial companies which currently are holding companies of banks, the regulator would require them to lower the proportion they hold. We think this would restrict the sources of funding for banks especially when they are eager to raise capital in the coming areas in order to comply with the regulators tightened capital requirement. We think some enterprises might not care for the idea of injecting capital into a commercial bank if they cannot have a significant stake in it. As a result, expansion and growth of banks could be hindered, in our view. CBRC Chairman Liu Mingkang advocated that banks should expand into other business only when they have the capability to manage the new business effectively. As at the date of the news report (18 March, 2011), there are eight commercial banks that have set up fund management companies, four commercial banks with approval to hold stake in insurance companies, seven commercial banks have set up or invested in financial leasing companies and two commercial banks have invested in trust companies.
Fig. 32: Investment of commercial banks in other financial businesses
Type of other financial business Fund management companies Insurance companies Financial leasing companies Trust companies
Source: 21st Century Business Herald
Number of commercial banks that have investment therein 8 4 7 2
An exit mechanism would also be introduced by the CBRC for banks that would like to invest in other financial business. The ROE and ROA of the investee need to stand at least at the same level of those of the investor as well as the industry average level after a certain period of time, otherwise, the investing banks would be required to exit from that business. The CBRC stressed that banks need to consider their capital level and the integration with the investee before expanding to other areas within the industry. In our view, it is a way for the regulator to restrict banks from aggressive expansion and hence prevent potential systemic risks. We think it is positive for banks in terms of risks management as they need to be more cautious in entering other financial businesses and need to ensure the adequate liquidity and capital of potential investee. The risk of the investee becoming a burden would be lowered, in our view.
Shadow Banking Business

According to the 21st Century Business Herald, the CBRC Chairman has in the past few months repeated on several occasions his strong stance on supervising the shadow banking business in China. The shadow banking system originated in the US in the form of mortgage-backed securities. It has been extended to reference to the credit supply outside the banking system, including financing from non-bank institutions and loan business where banks act as intermediates. The table below shows the decreasing contribution of new bank loans to the total social financing from 92% in 2002 to 53% as of March 2011. The expansion of the various forms of credit supply through non-bank systems has discounted the effort and effectiveness of the monetary tightening through bank loans and M2 in China.
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June 24, 2011
Fig. 33: China new CNY loans and total social financing
(RMB bn) Total new RMB loans y-y growth Total social financing y-y growth % of new RMB loans to social financing
2002 1,853 2,015 92%
2003 2,770 49% 3,419 70% 81%
2004 2,260 -18% 2,868 -16% 79%
2005 2,350 4% 2,862 0% 82%
2006 3,180 35% 4,010 40% 79%
2007 3,630 14% 5,921 48% 61%
2008 4,911 35% 6,868 16% 72%
2009 9,590 95% 14,082 105% 68%
2010 7,934 -17% 14,270 1% 56%
1Q11 2,240 -14% 4,190 -7% 53%
In our view, the current restrictive policy provides a leeway for shadow banking business to grow rapidly and if not controlled could inflate the asset prices through the undesired credit bubble. For example, the balance of shadow banking business in the US was estimated to reach USD6.5trn at the start of 2007 (Timothy Geithner quoted in a report in The 21st Century Business Herald in August 2009), compared with total outstanding loans of USD6.8trn and GDP of USD14.7trn at that time. Through financial derivatives, credit exposure is removed from banks balance sheet and transformed into securities with high leverage. Upon the defaults of large-scale mortgage loans (the underlying assets) in 2007, asset re-pricing is magnified through the deleveraging process. Commercial banks are not immune from the crisis due to their investments and guarantees on a portion of these asset back securities or their credit derivatives. The vast amount of provisioning and write off due to the asset de-leveraging and NPLs then wipe off the banks equity capital and trigger the capital shortfall and follow-on equity raising. Because the financial derivatives in China are still underdeveloped, the shadow banking system points to traditional loan business re-packaged to trust products and wealth management products or undertaken by non-banking institutions. Figure 36 displays a list of shadow banking businesses in China. The estimated total loan balance reached as much as CNY8.5trn in 2010, about 17% of total bank loan outstanding and 21% of GDP. We acknowledge that these non-bank institutions have played a very important role in debt financing, especially to small and medium-sized enterprises, evidenced by total loan size of individual financing firms. For example, the total outstanding guarantees by each credit guarantee company at the end of 2010 is CNY148mn and the same number for the micro-financing company is at CNY75mn. As the SMEs, which contribute to over 50% Chinas GDP, are under-banked (receiving less than 40% of total bank loans), we believe the development of shadow banking business (micro-financing) is likely to be favoured by the government. Nevertheless, we think the risks of shadow banks to the financial system lie in the loose regulations (under-provisioning and low capital requirement) and aggressiveness of the players pursuing abnormal returns without carefully assessing the counterparty risks, which can inject excess liquidity into the system albeit the strict control on bank lending. If the regulator tightens the oversight of shadow credit, which would help to monitor credit growth of total social financing in China more effectively, we believe borrowers in the shadow banking system, like SMEs and real estate companies, would be more vulnerable to a further drain on the credit supply.
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June 24, 2011
Fig. 34: US and China shadow banking systems

China 2010 Balance GDP Debt Market Bank Loan Equity Market Shadow Banking Business Total Financing Total Financing excl. Shadow Banking RMB'bn 39,800 19,601 47,919 26,542 8,518 102,580 94,062 US$'bn % of GDP 6,151 3,030 7,406 4,102 1,317 15,855 14,538 100% 49% 120% 67% 21% 258% 236% US 2007 US$'bn % of GDP 14,660 31,775 6,783 17,900 6,500 62,958 56,458 100% 217% 46% 122% 44% 429% 385%
Note: Shadow Banking Business in US in 2007 is by Geitner's estimate in 2009, including hedge fund, Structured Investment Vehicle, Conduits, Monoline Insurance Companies, Investment Banks Note: Shadow Banking Business in China in 2010 is by our summary, including outstanding loan balance in credit guarantee companies, private lending, small loan companies, trust companies, entrusted loans, financing lease and pawn loan companies
Fig. 35: China shadow banking as of 31 December, 2010

Est. loan size of China's shadow banks as % of total gross loan of Chinese banks
Trust companies, 1.3% Financing lease companies, 1.4%
Small loan companies, 0.4% Pawn loan, 0.1%
Entrusted loans, 7.3%
Credit guarantee companies, 1.8%
Private lending (), 4.8%

26
Nomura | AEJ
Fig. 36: China shadow banking business

Regulator Issuing Governing Rules 2010 Est. Size (O/S Balance) (RMB'bn) % of total bank loans (2010) Min. Registered Capital Requirement
Business
Key Governing Rules Notice of Several Issues of Entrusted Loan Business by Commercial Banks (2000) Further Guidance on Bank Trust Cooperation (2011) Several Opinions on Private Lending Case Hearing by the High Court (1991) Provisioning Rules Governing Credit Guarantee Companies (2010), Guidelines on License Management of Credit Guarantee Companies (2010) Administrative Rules on Financial Leasing Companies (2007) Measures on the Administration of Foreign Investment in the Leasing Industry (2005) Administrative Rules on Trust Companies' Net Capital (2010), Notice of Standard for Net Capital Calculation of Trust Companies (2011)
2010 Size (Number of companies)
Source of 2010 Est. Size
Capital Leverage Requirement
Source of other capital
China banks
Entrusted Loans
PBOC, CBRC
NA
3,660
7.3%
Our estimate
NA
NA
NA
Private Lending ()
The High Court
NA
2,400
4.8%
Head of Research Institute of PBOC CBRC official in credit guarantee division
self capital
NA
Only self capital is allowed, prohibiting collecting funds from public
Credit Guarantee Companies
Seven Ministries of State Council, CBRC
6030
893
1.8%
Outstanding guaranteed liability not over 10x of net assets
RMB5m
NA
Financing Lease Companies
CBRC, MOFCOM
181
700
1.4%
China Lease Association
Capital adequacy ratio no less than 8%
RMB100m
Lease deposits, financial bonds, interbank market, shareholders' deposits
Trust Companies
CBRC
NA
636
1.3%
CBRC
Net capital no less than 100% of risk weighted assets, net capital no less than 40% of net assets Bank borrowings no more than 50% of total equity
net capital no less than RMB200m
From trustees
Small Loan Companies
PBOC, CBRC
Guiding Opinions on Trial Business of Small Loan Companies (2008)
2614
198
0.4%
PBOC
RMB5-10m
Bank borrowing from no more than 2 banks, bank borrowings no more than 50% of equity capital
Pawn Loan
MOFCOM (2005), State Council (2011)
Administrative Rules on Pawn Loans (2005) Draft of New Administrative Rules on Pawn Loans (2011)
4433
32
0.1%
Ministry of Commerce
Bank loans no more than registered capital
RMB5-10m
Bank loans no more than registered capital
Total
8,519
17.0%
Source: Nomura research
June 24, 2011
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June 24, 2011
Below is our scenario analysis on capital shortage for banks if we bring the shadow banking loans on to banks balance sheet. Our base case assumes entrusted loans and trust loans, for which commercial banks play the intermediates role, to be brought onto the balance sheet of all banks. Accordingly, CNY303bn capital shall be raised to maintain the core capital ratio of Chinese banks at 10.1% as of 2010. In our worst case when all shadow banking loans be restructured as banks assets, there comes up with a capital shortfall of CNY599bn.
Fig. 37: Capital adequacy scenario analysis (sector)
(RMB bn) Capital Ratio Capital adequacy ratio Core capital adequacy ratio Capital Shortage (if capital ratios unchanged) Capital adequacy Core capital adequacy Assumptions Shadow Banking System Loans (RMB'bn) bear case (all shadow banking loans) base case (entrusted loans + trust loans) On-balance sheet risk-weighted assets Total loans On-balance sheet risk-weighted assets as % of total loans
Source: Nomura research, CBRC
2010
Bear Case
Base Case
12.2 10.1
10.7 8.8
11.4 9.4
0 0
724 599
366 303
8,500 4,300 35,537 50,923 70% 41,469 59,423 70% 38,538 55,223 70%
The following sections examine the credit-related trust products, wealth management products and entrusted loans, the surveillance of which have been underscored by the CBRC in the past year.
Wiping off trust loans 1% of total bank loans

A trust company is a non-banking financial institution that raises capital from its trustees and collectively makes investments from the pool of capital. Trust products could be divided into two categories: credit related and non-credit related (eg, wealth management products). Credit-related trust products can be further broke down into: 1) bank related: collected funds from trustees are used to purchase existing loans from commercial banks; 2) non bank related: collected funds from trustees are directly lent to corporate. By distribution channels, trust companies are divided into bank-trust and collective unit trust In July 2010, the CBRC ordered trust companies and banks to reduce the balance of credit-related trust products and re-book them onto the balance sheet of banks, due to the rising cases of commercial banks deliberately securitizing loans, especially LGFVrelated infrastructure loans, to trust products that are sold to trustees.
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June 24, 2011
Fig. 38: Bank trust products gross sales

1Q10 Size Bank-Trust Products - sale volume (units) Bank-Trust Product - sales value (RMB'bn) Credit-related Bank-Trust Product - sales volume (units) Credit-related Bank-Trust Product - sales value (RMB'bn)* % Credit-related to Bank-Trust Products % Credit-related to Net New Loans % Credit-ralated to Total Loan Balance Other Characteristics Average Duration Expected Annual Yields 3 Month Deposit Rate 273 3.0% 1.71% 254 3.1% 1.71% 118 2.8% 1.71% 188 3.2% 1.71% 2.25% 4% 92% 4% 0% 0% 241 3.7% 2.25% 2.60% 3% 93% 4% 0% 0% -13% 31% -16% -2% 0% 2% 91% 6% 0% 0% -32 NA NA 1,015 560 380 210 37% 8% 0.5% 2Q10 1,627 1,134 623 434 38% 21% 1.0% 3Q10 1,413 1,107 318 249 23% 15% 0.5% 4Q10 1,522 1,045 109 75 7% 5% 0.2% 1Q11 1,964 1,732 159 140 8% 6% 0.3% Y-Y 93% 209% -58% -33% -29% -2% 0.0% Arp.11 804 453 28 16 3% 2% 0.0%
Industry Breakdown - Bank-trust product unit sales Infrastructure Non-credit Related Money Market Investme Commercial and Industrial Real Estate Others 16% 61% 20% 3% 0% 11% 59% 26% 3% 1% 11% 77% 12% 0% 0%
* The sales value of credit related bank trust products are not provided by Use Trust Studio. We estimate the value based on the percentage of credit related products to total trust proudcts in terms of volume, multplied by the size of trust products.
Source: Nomura Research, Use Trust Studio
Credit-related Bank-Trust Products slumped in 1Q11 Following the Notice by the CBRC in July 2010, monthly sales of credit related bank-trust products have fallen sharply from CNY200bn in June 2010 to about CNY40bn each month during 1Q11, according to Use Trust Studio, an independent research institute specializing in Chinas trust products. While the launch of total bank-trust products continued breaking new highs this year, most funds collected are channelled to money market financial products like interbank borrowings, bank acceptance draft and corporate bonds, etc. The expected annual yield of 3.2%-3.7% (compared with 1.7% to 2.6% of 3 month fixed deposit rates) offers investors a low-risk inflation protective investment channel. As a result, the percentage of credit related bank-trust products to total trust products has come down from almost 40% during 2Q10 to lower than 10% in recent months. Banks to reorganise outstanding trust loans on the balance sheet According to the CBRC, total outstanding trust loans stood at CNY636bn, accounting for 1.2% total outstanding loans in the banking industry, in 2010. These trust loans, according to most banks, are being gradually migrated to on-balance-sheet. Considering the continuing lacklustre sales of credit related bank trust products due to the regulatory control and the vast amount of products issued in 2Q and 3Q last year set to mature in 1H11, we reckon the outstanding balance of credit-related bank trust products could see a moderate decline in 1H11. This is broadly in line with some banks guidance, indicating the size of credit-related bank trust products as a percentage of total outstanding gross loans at less than 1% in current quarter.
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June 24, 2011
Fig. 39: Monthly sales of bank-trust products

New Loan Growth(LHS) (RMB'bn) - LHS 2,000 1,500 1,000 500 0 -500
Jan-10 Jan-08 Jan-09 Jan-11 Jul-09 Jul-08 Oct-09 Jul-10 Oct-08 Apr-09 Oct-10 Apr-10 Apr-08 Apr-11
Fig. 40: Monthly sales of bank-trust products vs 1 year real interest rate
(RMB bn) 1,000 800 600 400 200 0
number of new issuance (RHS) - RHS
5 3 1 -1 -3 -5
1yr real interest rate(LHS)LHS (%) number of new issuance (RHS) - RHS
(%) 1,000 800 600 400 200 0
Apr-09
Jan-08
Jan-09
Jan-10
Source: Use Trust Studio, Nomura research
Source: CEIC, Use Trust Studio, Nomura research
Fig. 41: Trust loans as % of total banking loans

(RMB bn) 700 600 500 400 1.2 300 200 100 0
2003 2004 2005 2006 2007 2008 2009 2010
Fig. 42: Monthly sales of credit-related bank-trust -products

(%) 1.6 1.4 60% 50% 40% 30% 20% 1 0.8 10% 0%
Oct-08 Oct-09 Oct-10 Apr-08 Apr-09 Apr-10 Jan-08 Jan-09 Jan-10 Jan-11 Apr-11 Jul-08 Jul-09 Jul-10
total trust loans(LHS) (RMB'bn) - LHS (RHS) % to total loans - RHS
Credit related bank trust product as % of total bank trust product - LHS (LHS) number of new credit related bank trust products(RHS) - RHS
Jan-11
Apr-11
Oct-08
Apr-08
Oct-09
Oct-10
Apr-10
Jul-08
Jul-09
Jul-10
250 200 150 100 50 0
Bringing back to the balance sheet will it cause liquidity-driven NPL problem? As the CBRC has required banks to bring the outstanding credit-related trust products back to the balance sheet, we believe approximately 1% of total existing loans will be squeezed out given the loan quota. Compounded by a series of reserve ratio hikes, it may accelerate the imbalanced loan supply and demand, and is likely to trigger some liquidity driven NPL problem. To further elaborate, SMEs are particularly vulnerable given their capital demand is organic and they do not have easy access to other financing channels. Admittedly, the fast-growing corporate debt market, particularly in 1Q11, has compensated for the declining credit-related trust products sales in the same period. Nevertheless, we believe the majority of corporate direct financing is associated with SOEs and large listed companies. The average size of financing of each deal, for example, was CNY1.2bn and CNY1.6bn for corporate debt and commercial paper in 1Q11. According to the definition by four ministries of the state council, SMEs are companies with annual sales and total assets lower than CNY300m and CNY400m respectively.
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June 24, 2011
Fig. 43: Corporate direct financing

Issuing Size (RMB'bn) Corporate Debt Mid Term Commercial Paper Short Term Commercial Paper Total Direct Financing Net New Bank Loans Trust Loan Issuance (our estimate)
Source: Wind, Nomura research
1Q10 91 115 162 368 2,603 202
2Q10 50 175 192 416 2,015 425
3Q10 114 139 209 462 1,672 250
4Q10 122 67 126 315 1,630 75
1Q11 102 188 283 573 2,256 135
YoY 12% 63% 75% 56% -13% -33%
Fig. 44: Examples of trust products sold by Chinese banks

Sales fees (applied to total proceeds) (%) Custodian fee (applied to total proceeds) (%)
Issue date
Bank
Product
Client
Product Type
Size (RMB'm)
Term (days)
Yield
Total fees (%)
Minimum Investment (RMB)
30/04/2010
CCB
2010 27th part
Ningxia Western Thermal Power
Credit Related
200
179
3.18
0.39
0.05
0.44
100,000
18/5/2010
SPD
2010 66th part
A group of companies in Fujian Province
Credit Related
NA
365
4.4
NA
NA
NA
500,000
13/5/2010
BOC
3 month revolving wealth management product RMB wealth management product (90 days)
Financial products (i.e. interbank, PBOC bills, bank acceptance draft, corporate bond, etc)
Finance
5000
182
2.55
NA
NA
NA
50,000
18/6/2010
ICBC
Trust loan projects 0-70% trust loan projects, 0-50% bond market, 0-50% bank deposit Ministry of Railways, Large SOEs, liquid and high credit rated bonds and mid-term bills Financial products (i.e. interbank, PBOC bills, bank acceptance draft, corporate bond, etc) Trust loans of premium companies, money market, high credit rated corporate bonds Trust loans of premium companies, money market, high credit rated corporate bonds Guizhou Jinyuan Group
Credit Related
211
90
2.85
0.4
0.03
0.43
50,000
15/7/2010
ABC
2010 1074th part
Hybrid
3500
28
2.15
NA
0.05
NA
50,000
21/9/2010
CMB
Trust Loan No. 227
Hybrid
200
169
2.8
NA
NA
NA
50,000
2/11/2010
ICBC
RMB wealth management product (30 days) 3 month revolving wealth management product
Finance
3000
30
2.5
0.4
0.02
0.42
100,000
18/11/2010
BOC
Hybrid
6000
95
2.5
0.2
0.08
0.28
50,000
22/2/2011
ABC
2011 1047th part
Hybrid Credit Related
5000
182
3.2
NA
NA
NA
50,000
25/3/2011
CCB
2011 20th part
500
364
4.41
NA
NA
NA
50,000
Entrusted loans RWA funding pressure

Entrusted loans are a form of agency business in which the fund capital is provided by the trustor to the target borrower (the trustee) for specified uses, with designated amounts, maturity periods and interest rate by the trustor. The bank helps to collect the principal sum with interest on the trustor's behalf.
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June 24, 2011
In our view, although banks only act as intermediaries and do not assume any guarantees, the underlying credit risk of entrusted loans should be watched and evaluated by the regulator more carefully, given the size and sector exposure of entrusted loans. Larger size to total bank loans The outstanding amount of entrusted loans ranged from 4 to14% for H-share listed banks in 2010, compared with 1.2% for total banking system loans by outstanding creditrelated trust products, on our estimates. In the PBoC's 1Q11 financial statistics review, new entrusted loans took up 7.6% of total social financing, in contrast to 0.2% for creditrelated trust products. High exposure to real estate industry Credit exposure to the real estate industry of entrusted loans could be much heavier than credit-related trust products (16% in 2010), in our view. Per the 21st Century Business Herald in May, of 17 entrusted loans (amounting to CNY1.4bn) offered by publicly listed companies year to date, more than half of the trustees are real estate-related companies. These trustors are rewarded with an average interest rate of 15.8% for the exposure to the high risk sector. The news report also highlights the repayment risk for the entrusted loans to property developers. Three listed companies have reported further loan provisioning, loan recall and maturity extension of the entrusted loans granted to counterparties. Scenario analysis: RWA with credit risk weighting of 50% In the following table, we assume entrusted loans are required to be included in the calculation of risk weighted assets and assigned a credit risk weighting of 50%. Our findings are that CCB has the highest percentage of entrusted loans to total gross loans and would encounter a 60bp reduction in Tier 1 ratio for 2010. On the other side, Minsheng has the smallest size of entrusted loan business in both absolute amount terms and proportion to total gross loans. The Tier 1 impact on Minsheng is about 20bps, the lowest among H-share banks we cover.
Fig. 45: Chinese banks adjusted capital adequacy ratio assuming 50% RWA of entrusted loans
(RMB bn) 10A entrusted loan 10A gross loan % of gross loan 10A RWA 10A adj. RWA 10A Tier 1 10A adj. Tier 1 10A CAR 10A adj. CAR Capital shortfall Market cap as % of market cap
ICBC 395,216 6,790,506 5.8% 7,112,357 7,309,965 10.0 9.7 12.3 11.9 19,702 1,653,814 1.2%
CCB 778,349 5,669,128 13.7% 6,015,329 6,404,504 10.4 9.8 12.7 11.9 40,474 1,500,391 2.7%
CMB 104,013 1,431,451 7.3% 1,446,883 1,498,890 8.0 7.8 11.5 11.1 4,181 316,706 1.3%
Bocom 124,254 2,236,927 5.6% 2,370,648 2,432,775 9.4 9.1 12.4 12.0 5,821 351,349 1.7%
Citic 99,662 1,264,245 7.9% 1,385,262 1,435,093 8.5 8.2 11.3 10.9 4,211 202,637 2.1%
Minsheng 38,810 1,057,571 3.7% 1,280,847 1,300,252 8.1 7.9 10.4 10.3 1,566 162,049 1.0%
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June 24, 2011
Fig. 46: % of entrusted loans to total gross loans by Chinese banks

ICBC CCB CMB BOCOM Citic Minsheng
14% 12% 10% 8% 6% 4% 2% 0% -2% 2006
2007
2008
2009
2010
Note: ABC, BOC and CRCB no disclosure of the entrusted loans Source: Company data, Nomura research
Two tales: wealth management products

Surging overall sales in 1Q11 In 1Q11 over 4,000 wealth management products were launched, with the total size reaching more than CNY4trn, surpassing one half of last year's amount, according to Hexun News. We highlight the following drivers: 1) growing demand for inflationprotected investment products given lingering negative interest rates; 2) outflows from savings deposits (specifically long-term deposits) given a flattening yield curve with higher hikes for short/medium-term rates; 3) intense competition for deposits in view of tightened bank liquidity; and 4) wealth management product sales can boost fee income.
Fig. 47: Wealth management product sales
RMB'bn Number of issuance (units) Value of issuance (RMB'bn) Net new bank loans (RMB'bn) Net new bank deposits (RMB'bn) credit related WM as % of net new loans credit related WM as % of net new deposits credit related WM as % of total WM
Source: Benefit, Nomura research
1Q10 1,914 1,250 2,604 4,038
4Q10 3,152 2,060 1,632 1,714
1Q11 3,691 4,170 2,255 3,969
yoy 93% 234% -13% -2%
2010 9,958 7,000 7,926 12,034
3% 1% 1%
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Fig. 48: Corporate bond (listed on SHEX) yield curve
Fig. 49: Wealth management product sales

Expected Annual Yields for WM % 1 month 1Q11 Average 3.2 3.4 3.7 4.4 5.5 Fixed Deposit Rate by PBOC As of 6 April 2.85 2.85 2.85 3.05 >3.25
(%)
6
1-3 months 3-6 months 6-12 months
4 Mar-10 3 Sep-10 Mar-11 2 1 3 5 7 9 11 13 15 17 19 Jun-10 Dec-10 May-11
more than 12 months

Source: Benefit, Nomura research
Duration:Years
Source: Wind, Nomura research
Credit-related wealth management products growth curbed by regulatory oversight In contrast, sales of credit-related wealth management products hit CNY56.3bn in 1Q11, merely 1.4% of the total wealth management product issuing amount. The total issuance declined by 47.5% y-y, in our view, due to tightened oversight of sales of credit-related bank-trust products. Some commercial banks stated that a significant proportion of wealth management funds are investing in products issued by trust companies. Low duration and high yields More than 90% of wealth management products have a maturity less than six months, taking advantage of rising short-term yields. Fig 49 shows the expected annual yield compared with the benchmark savings rate with matching duration. High growth expected to continue Like trust products, we believe the super-nominal growth experienced in 1Q11 may continue at least for the next one-two quarters given the lack of market mechanism for deposit rates. In this sense, wealth management products are a stepping stone for deposit liberalization. Coupled with continuing restrictive monetary policy, short-term rates may still climb, in our view.
SMEs who is borrowing at above 10% pa rate?

With stricter loan controls and five consecutive RRR hikes this year, Chinese banks have been struggling with tighter credit and liquidity since the beginning of the year. As loan growth has been capped by the PBoC, banks have charged a higher premium on loans so as to achieve sustained margin expansion in order to deliver decent earnings growth. In particular, they have been raising lending rates on SME loans aggressively, currently at a premium of up to 50%, given the rigid lending demand from SMEs for working capital, and allocating a larger proportion of new loans to SMEs, per the 21st Century Business Herald. Nevertheless, the strong growth and higher yields of SME loans are not a result of solid operating performance of SMEs but tight liquidity. Given limited loan quota for SMEs by Chinese banks under tightened credit yet inelastic funding demand of the former, SMEs need to turn to loan sources where they are charged even higher interest rates. We think the higher lending rate is starting to erode the profit margins of SMEs.
SME business has drawn more attention from banks over the past year...
Under tightened credit, we believe Chinese banks have been developing SME business more aggressively since last year, given higher yields from SME loans. This is also true for large-cap banks that used to focus on large corporate but now have been setting up
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SME lending centres one after another. The table below shows that SME loans of major Chinese banks grew by 46% y-y by end-2010, on average, accounting to 4.2%-52.4% of total loans for H-share banks. Among the H-share banks listed below, BOC, Citic and Minsheng used different measurements for SME loans as defined by themselves, while all the other six banks applied the same definition, i.e. loans extended to small and medium-sized enterprises as defined by National Bureau of Statistics (NBS). That is why the SME loan sizes of BOC and Citic were far smaller than those of peers as the data did not include loans to medium-sized enterprises over the same period. However, for Minsheng, although it adopted a different definition set by itself, we included Shang Dai Tong (SDT) loans in its SME loans, although these were classified as retail loans in its 2010 annual report.
Fig. 50: SME loans of H-share banks
SME loans by end-2010
2010 ABC ICBC CCB BOC BOCOM CMB CITIC Minsheng CRCB Balance (RMBmn) 1,947,000 3,429,206 1,585,220 239,365 754,700 388,418 68,070 238,518 64,000 y-y growth (%) 22 19 29 35 46 26 73 133 31 Total loans (RMBmn) 4,956,741 6,790,506 5,669,128 5,660,621 2,236,927 1,431,451 1,264,245 1,057,571 122,145 % to total loans (%) 39.3 50.5 28.0 4.2 33.7 27.1 5.4 22.6 52.4
Fig. 51: Definition of SME loans

Definitions by H-share banks
Banks ABC ICBC CCB BOC BOCOM CMB CITIC Minsheng CRCB Loans to small-sized enterprises Included Included Included Included Included Included Included Included Included Loans to medium-sized enterprises Included Included Included Excluded Included Included Excluded Included Included Definition Definition by NBS Definition by NBS Definition by NBS Definition by the Bank Definition by NBS Definition by NBS Definition by the Bank Definition by the Bank Definition by NBS
Source: NBS, Company data, Nomura research
Fig. 52: Definition of SMEs by NBS

Official SME definitions No. of employees (less than)* Sales (less than, unit RMB)* Total assets (less than, unit RMB)* 2,000 300m 400m 3,000 300m 400m 500 150m na 200 300m na 3,000 300m na 1,000 300m na 800 150m na
Industrial Construction Retail Wholesale Transportation Postal services Hotel and restaurant
* Satisfaction of one of the three conditions enables the qualification. Source: NBS, Nomura research
Specifically, in the case of ICBC, as of end-2010, according to company data, the number of small-sized corporate customers with lending balance at ICBC increased by 18,838, to 63,081, compared with a year ago, three times the growth in 2009. By end2010, ICBCs SME loans made up over half (50.5%) of its total loans with the trend continuing at the beginning of this year. In 1Q11, loan balance of small-sized enterprises increased by CNY53.5bn from the end of last year, which accounted for 35.7% of the total new corporate loans in the first quarter. ICBCs outstanding corporate loans for small-sized enterprises grew by 11.6% ytd in 1Q11, 8.2% higher than the overall loan growth rate. According to management, annual new loan quota for small-sized corporate should exceed CNY100bn in the coming five years and ICBC Zhejiang Branch has become the first provincial branch that has reached such a loan quota.
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According to the PBoCs latest monetary report, total SME loans increased by CNY911.4bn in 1Q11, accounting for 40.7% of total new loans in the quarter. As of endMarch 2011, SME loans grew by 24.8% y-y, 21.6% higher than that of large-sized corporate loans over the same period. In particular, loans for small-sized corporate grew by CNY497.9bn (or 54.6% of total new SME loans) in 1Q11, increasing by 48.7% y-y as of March 2011.
...due to higher lending rates...

We attribute the rapid growth in SME loans to higher loan yields. In an environment of tightened credit, banks tend to allocate more of their loan quotas to those with higher yields in order to boost margin expansion. According to the PBoC, banks can charge up to 4x above benchmark lending rates for loans, and as of March 2011, 55.82% of bank loans were charged at a lending rate above the benchmark, versus only 43% at the end of last year, a new high since records began in 2008. Among all the bank loans charged with above-benchmark rates, 18.25% were charged at a premium of 10%, 17.76% at a premium of 10-30%, 6.96% at a premium of 30-50%, 9.24% at a premium of 50-100% and 3.6% at a premium of 100%; and all saw a noticeable rise from the previous month, per the PBoC. More specifically, 10% above benchmark is only applied to state-owned enterprises. 20% and 30% above benchmark is applied to larger listed companies and smaller listed companies respectively. For SMEs and personal business loans, the lending rate could be as high as 40-50% above benchmark, and even reach 60-70% above benchmark in some cases.
Fig. 53: Lending rates for different types of borrowers
Type of borrower State-owned enterprises Larger listed companies Smaller listed companies SMEs Personal business loans
Lending rate 10% above benchmark 20% above benchmark 30% above benchmark 40-50% above benchmark, 60-70% under some circumstances 40-50% above benchmark, 60-70% under some circumstances
Fig. 54: % of loans charged with above-benchmark lending rates

(% of loans) 60 55 50 45 40 35 30
Jun-08 Feb-09 Jun-09 Feb-10 Jun-10 Feb-08 Aug-08 Aug-09 Dec-08 Dec-09 Aug-10 Dec-07 Dec-10 Feb-11 Apr-08 Apr-09 Oct-08 Oct-09 Apr-10 Oct-10
Source: PBoC, CEIC and Nomura research
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Fig. 55: % of loans charged at above benchmark rates

(% of loans) 20 15 10 5 0
Aug-10 Sep-10 Oct-10 Apr-10 Nov-10 Dec-10 Jan-10 Jun-10 May-10 Mar-10 Jan-11 Jul-10 Mar-11 Feb-10 Feb-11
10% above benchmark 30-50% above benchmark 100% above benchmark
10-30% above benchmark 50-100% above benchmark
Source: PBoC, CEIC and Nomura research
However, even though SMEs are willing to pay such high interest rates in order to get funds for the continuity of business operations, they are still facing severe difficulties in obtaining loans from banks, especially under a tightening monetary environment such as status quo, on our analysis. As their financing needs remain strong yet bank loans cannot meet demand for credit due to tightened liquidity and credit, many SMEs need to borrow from sources that charge even higher interest rates, on our analysis. According to data released by the CBRC Wenzhou Branch, the interest rate in Wenzhous black market reached 17.29% pa in January, 18.09% in February and 18.46% in March 2011.
... which is starting to erode the profit margin of SMEs

In our view, the strong growth and higher yields on SME loans are not because of solid operating performance of SMEs but tightened liquidity. SMEs are generally underfinanced as banks tend to make more lending to large corporates in order to better control risks and reduce the cost even in a loose monetary environment. Under current tightened credit, it becomes even harder for SMEs to get funds, on our analysis. Given the rigid financing demand for working capital in order to continue their business, many SMEs are forced to pay a higher-than-affordable interest rate for bank lending, which has started to erode SME profit margins, on our analysis. For instance, in Wuhan, banks charged at a premium of 10-15% for SME loans between 2008 and 2010, whereas currently they are charging at a premium of 30-50% for most of the cases with a few even at a premium of 60-80%, per the 21st Century Business Herald. This means that SMEs need to pay an interest rate of at least 8.2% for one-year bank loans (one-year benchmark lending rate currently stands at 6.31% pa), on our analysis. In contrast, according to the Ministry of Industry and Information Technology of the Peoples Republic of China, the average profit margin of Chinese enterprises now stands at 6%, lower than the interest rate that banks are charging for SME loans. If this trend continues, we think SMEs would face severe financing problems for the continuity of their business as even if they could borrow money from banks or the black market that charge a higher interest rate, they may not be able to pay back the money. This, combined with rising commodity prices, appreciation of the CNY and higher labour cost, has been squeezing the profit margin of SMEs, on our analysis. Thus, we think the credit risk from SME loans is increasing, although we believe that it is too early to judge whether SME loans will erode banks asset quality in the coming quarters.
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Case study SMEs in Wenzhou

Wenzhou is one of the cities in China that is full of SMEs with a strong desire for credit, per the 21st Century Business Herald. In light of capped loan growth and tightened credit, banks in Wenzhou have placed more emphasis on SME business given higher yields. According to the CBRC Wenzhou Branch, as of end-March 2011, the outstanding amount of SME loans reached CNY137.8bn, accounting for 23.79% of total loans in Wenzhou, 1.55% higher than that in the same period last year. By the end of March this year, SME loans increased by CNY9.7bn compared with end-2010, making up 35.23% of total new loans in Wenzhou over the same period, 8.02% higher than that in the same period last year, with year-to-date growth of 7.5% exceeding overall loan growth by 2.6pp. Regardless of the rapid growth in SME loans and larger financing support that banks try to provide to SMEs, bank loans are still far from meeting the funding demand from SMEs in Wenzhou, given the tightened liquidity and credit, even though SMEs pay a much higher premium for bank lending, on our analysis. With tightened credit and limited bank lending available, SMEs in Wenzhou have to increasingly turn to other lending sources for working capital. Based on a survey of 350 local enterprises conducted by Wenzhou Financial Office, as of end 1Q11, black market bank lending accounted for 16% of SMEs total operating fund, 6pp higher than in the same period last year, while equity funding and bank lending accounted for 56% and 28%, respectively, with the proportion of bank lending decreasing by 2% compared with the same period in 2010. The higher percentage share of black market bank lending in total operating funding indicates higher funding costs for SMEs as lending interest rate rose to 23.01% pa in January, 24.14% pa in February and 24.81% p.a. in March 2011, according to the PBoC Wenzhou Branch. However, any interest rate exceeding 4% pa or even above 10% pa is not for normal production and business operations, on our analysis. Based on another survey by the PBoC Wenzhou Branch conducted among 50 SMEs in Wenzhou in 1Q11, profit margin of these SMEs stood at 16.04% in the first quarter this year, which is far below the lending rate in 1Q11. We believe the higher lending interest rate has begun to erode SMEs profit margin, which would in turn weigh on the asset quality of SME loans for Chinese banks.
Credit guarantee companies

Growth in credit guarantee activities In 2010, the credit guarantee industry in China achieved further growth. At the same time, the financial strength of credit guarantee companies benefited from the active participation of State-owned capital, private capital and foreign capital. Although these companies grew steadily in terms of business scale and risk management capability, we think the credit guarantee industry at large is confronted with the challenge of imbalanced development between regions, and some companies are still facing exceptionally high risks. Rectification of credit guarantee industry In 2010, the CBRC continued to be leading agency in the inter-agency taskforce on the supervision of credit guarantee activities. Under the guidance of the State Council and together with the National Development and Reform Commission (NDRC), the Ministry of Industry and Information Technology (MIIT), the Ministry of Finance (MOF), the Ministry of Commerce, the PBoC, and the State Administration of Industry and Commerce (SAIC), the CBRC issued a set of regulatory documents, including the Provisional Rules Governing Credit Guarantee Companies in March 2010, the Guidelines on License Management of Credit Guarantee Companies in September and the Guidelines on Corporate Governance of Credit Guarantee Companies in November. The rectification of guarantee companies mainly started in the second half of 2010 as required by the CBRC. Since then, banks became more reluctant to cooperate with guarantee companies and it was more difficult for guarantee companies to be granted credit limit by banks, per the 21st Century Business Herald. From 31 March, 2011, onward, they require an operating license to cooperate with banks. Those failing to meet
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the requirements could not have an operating license. As required by the CBRC, banks would have to evaluate the corporate governance, risk management and capital level of guarantee companies before doing business with them. In our view, the new regulation is positive for the banks in terms of risk management as the capital level and capability of guarantee of credit guarantee companies are typically doubted, given insufficient monitoring over the industry and banks cannot control guarantee companies from over-leveraging. Besides, the ways that credit guarantee companies replenish capital (such as using high interest rates to attract deposits) may disrupt the normal financial order. After implementation of the new requirement, banks will restrict exposure to credit guarantee companies at not more than 10x of net assets in order to limit the risks exposed to the industry. The market expects that a number of credit guarantee companies will be eliminated after the cleaning-up is completed. Hike in rate of credit guarantee fee Tightened credit and liquidity not only led to a rise in lending rate, the rate of guarantee was also pushed up according to an article in the 21st Century Business Herald on 17 March, 2011. The rate of guarantee generally rose 1pp from 2.5% to 3.5%, representing 40% growth. Under some circumstances, borrowers are required to pay 15-20% as a deposit. In our view, the higher credit guarantee fee, together with rising lending rate, make it difficult for SMEs to borrow. The funding cost could reach higher than 11% for a one-year loan assuming the lending rate is 30% above benchmark and the rate of guarantee is 3.5%. The repayment burden for borrowers would be heavy, given interest rates might rise further. We think the resulting higher default risks would be an overhang for lending banks. As part of efforts to improve the guarantee for credit business to small enterprises, the CBRC issued the Provisional Rules Governing Credit Guarantee Companies in 2010, which provided regulatory requirements on the market entry and risk control of credit guarantee industry. Impact on banking industry We think such tighter monitoring measures and more standardized regulations for the credit guarantee industry can help to ensure the strength and repayment ability of credit guarantee companies. Potential losses for banks in case of default of borrowers could as a result be reduced (provided that those loans are guaranteed by credit guarantee companies). As of 31 December, 2010, major China banks generally had around onefifth of guaranteed loans to total loans (except BOCOM as information is not available), where ICBC had the lowest proportion at 15.8% and Minsheng had the highest at 25.9%. Given such a significant proportion, we think the implementation of tighter and more standardized regulations for the credit guarantee industry is necessary and beneficial to China banks in terms of asset quality and risk management.
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Public housing program in the spotlight

Over past weeks, Chinas public housing program has drawn growing attention from the market. Investors are worrying if this would play out as another LGFV issue while the current one remains to be solved, per the 21st Century Business Herald. We understand that the major concerns of investors on the public housing program are centred on its asset quality given the lower yields and returns of the projects. However, in our opinion, despite certain similarities shared by the public housing program and LGFV projects, the impact on China banks is different and there is a small likelihood that the public housing program will become another LGFV issue given: 1) its smaller scale; 2) banks lower desire to lend for these projects; 3) and multiple available financing channels.
Public housing program smaller funding size for China banks

With the central government embarking on the public housing construction program at the beginning of this year, it has been under wide discussion, for both its funding scale as well as how much will need bank lending. In this section, we analyse the financing gap for the public housing project for this year to better gauge the likely financing needs for China banks.
Public housing development plan for 12th Five Year Plan

The central government announced plans to construct 36mn units of public housing during the 12th Five Year Plan, among which 10mn units of public housing could start this year. In a bid to achieve the central governments target for this years public housing development, local governments have announced their public housing development plans for the 12th Five Years as below.
Fig. 56: Public housing development plans of major cities during the 12th Five Years
Public housing plans
New floor space for public housing (Thousand sqm) 10,000 16,160 26,350 1,180 20,000 20,000 10,000 20,000 27,000 15,980 New units of public housing (Thousand units) New floor space for public housing (Thousand sqm) 4,000 10,000 22,113 5,500 2,800 5,000 2,023 New units of public housing (Thousand units) 292 100 116 80 58 130 100 20 30
Cities Beijing Shanghai Guangzhou Shenzhen Tianjin Dalian Nanjing Suzhou Hangzhou Xaimen Wuhan Chengdu Chongqing Xi'an
Cities
1,000 Wuxi 1,000 Hefei - Zhengzhou 240 Jinan 400 Fuzhou - Nanning 290 Guiyang 50 Nanchang - Urumqi 17 Harbin - Shijiazhuang - Yinchuan - Sanya 316
Source: China Index Academy, Nomura research
Surging financing demand from public housing projects

With the kicking-off of the construction for public housing across the country since this year as required by the central government, we saw a surge in financing demand for these projects. The PBoC revealed on 28 April that new public housing loans grew by CNY65.1bn in 1Q11, up 40.1% ytd, which contributed to 38.8% of the CNY167.8bn increase in total new loans for real estate developers in the first quarter this year. On a regional basis, PBoC Beijing Branch disclosed that, as of end-March 2011, the outstanding amount of public housing loans in Beijing City reached CNY24.2bn, up by CNY6.4bn compared with the beginning of this year which accounted for 55.4% of the CNY11.6bn increase in total new loans for real estate developers over the same
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period. Also in Chongqing, as of 1Q11, the outstanding amount of public housing loans exceeded CNY30bn for the first time, standing at CNY30.7bn. And in the first quarter of this year, loans lent to public housing projects amounted to CNY2.4bn, accounting for 7.8% of the total outstanding amount. It was also reported by 21st Century Business Herald that Shanghai will build 40,000 public rental housing units in 2011, accounting for 14.4% of the total public housing projects for the year, with floor space of 40-50 sqm for each house. Assuming a construction cost of CNY10,000 per sqm, 40,000 public rental housing units require CNY20bn.
Financing gap for the public housing program

According to the Ministry of Housing and Urban-Rural Development of the Peoples Republic of China (MOHURD), it would require around CNY1.3-1.4trn to construct the 10mn units of public housing in 2011F. It is widely expected that the central government will offer CNY100bn at the most this year given that it provided CNY80bn of fiscal subsidy for public housing in 2010. Besides, we assume that CNY200bn from land premium in 2010 would be used for public housing in 2011 as it is required that no less than 10% of land sales revenue should be used for the following years public housing construction. Moreover, National Development Bank signed a contract with MOHURD on 2 March 2011 to lend CNY100bn for public housing projects, according to the banks website. Assuming that local governments raise CNY100bn, this means that at least CNY900bn needs to be financed for the 10mn units of public housing this year, on our numbers. This is far less than that for LGFV loans as of end 2010, the outstanding amount of LGFV loans reached CNY7.66bn.
Fig. 57: Financing sources for public housing program
Sources of financing
Income from land sale, RMB200bn
Local governments, RMB100bn NDB, RMB100bn Others - including banks, insurers, SSF, trusts and PE, RMB900bn
Banks lack enthusiasm in this area

We believe, compared to 2008-09 when they rushed to provide lending for LGFV loans, banks now are less enthusiastic in making a large amount of loans to the public housing program as demand for bank loans has been very strong since later last year yet credit has been tightened. Lower returns on public housing projects and concerns about fully paying back the principle have prevented banks from putting a large proportion of new loans into this sector, on our analysis. Taking Chongqing as an example, according to Mr. Huang Qifan, Mayor of Chongqing Municipal Government, Chongqing will construct 40mn sqm of public rental housing within the next three years, for which the Chongqing government will invest CNY30bn and the remaining CNY70bn will need to be financed by financial institutions, per the plan. Based on the governments estimate, annual rental income for this public rental housing should be CNY4.8bn. Assuming CNY0.6bn for the annual maintenance fee and a 6% annual interest rate for the CNY70bn, the annual rental income of CNY4.8bn may only cover the annual interest fee for the lending. This
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implies that the project could not repay the principle by itself an obstacle in encouraging banks to lend to these projects. We think banks will be cautious in making loans to public housing projects.
Multiple funding sources for the public housing program

For the CNY900bn financing gap for the public housing projects, we believe that, apart from bank loans, LGFV bonds would serve as another important financing source for public housing projects going forward. According to Wind Statistics, 70 LGFV bonds have been issued as of 18 April 2011. This compares with approximately 40 LGFV bonds issued in 2010 in total. The rise has partially compensated for the contracted new CNY loans in 1Q11 to support infrastructure projects and public housing in China. Just to name a few, on 23 March 2011, Jingdezhen State-owned Asset Management Company issued corporate bonds to raise CNY0.8bn, out of which CNY0.65bn, or 48.98% of the total proceeds, will be used for public housing projects in Leping Mining Area in Jiangxi Province. Also, Beijing Fengtai State-owned Asset Management Centre also issued a total of CNY2bn corporate bonds, of which CNY1.6bn (80% of total) will be used for public housing related projects in Beijing. Besides, we think that trust funds, social security funds, insurance funds and special funds for public housing should also help to finance the project. For instance, the first investment fund mainly for investment in public housing with private capital has been developed and is expected to issue within this year. The fund proposes to have a maturity of seven years and initially raise CNY10bn of capital and expects to expand to CNY50bn within three years. On 26 February 2011, National Social Security Fund signed to provide CNY3bn trust loans for Nanjing Public Housing construction, with a maturity of two years plus eleven months and interest rate of 6.05%. China Real Estate Chamber of Commerce disclosed that it is trying to set up Jianyin Jingrui Public Rental Housing Construction Investment Fund as a special fund for public housing development with a size of around CNY20bn. In particular, insurance companies have been active in financing public housing business. For example, on 9 March, 2011, China Pacific announced the setting up of Pacific-Shanghai investment plan on public rental housing bonds where China Pacific and Shanghai Land Group would initiate the investment plan on a 10-year bond investment to raise CNY4bn for the development and construction of 500,000 sqm of public rental housing in Shanghai. On 15 May, 2011, Ping An Insurance (Group) Company of China Ltd. signed an agreement with Shanghai Chengtou Holding Co., Ltd. to jointly launch a social security housing bond investment plan to raise not more than CNY3bn, which will be used to fund the latter's social security housing project in Shanghai. This is the country's first social security housing project with investment from an insurance company. The interest rate on 50% of the bond amount is fixed at 6.4532% and the rate on the rest will be 5.1% lower than the benchmark interest rate set by the central bank, per the plan. Caixin also reported on 24 May, 2011, that seven insurers, namely China Pacific, China Life, PICC, Huatai Insurance, Taikang Life, China Pingan and China Taiping Insurance, will invest up to CNY80bn in Beijings subsidized housing projects. We think the main driver for these insurers to invest in public housing project is to match its longer-term liabilities with assets of longer duration.
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How much of the CNY900bn needs to be financed by China banks?

Although there has been a diversifying of financing sources for the public housing program, we doubt non-banking financials will provide a large percentage of capital for the public housing program, i.e. bank lending will be key to filling the CNY900bn financing gap. Indeed, bank financials for the end of last year reflected that China banks, especially large-cap ones, have been active in financing public housing projects. Based on company reports, as of end-November 2010, the outstanding loan amount of major banks for economic housing developers stood at CNY75.1bn, up by 32% y-y and 8pp higher than the average growth rate of loans for real estate developers. In particular, ICBC has cumulatively lent CNY9.4bn to public housing developers in 2010, up by 55% y-y, with an outstanding amount of CNY14.4bn (up by 43% y-y); BCOM provided CNY45bn to public housing developers in 2010; ABC has cumulatively lent CNY12.6bn to public housing developers since 2008; and CCB lent a total of CNY4.43bn to public housing developers in 2010, CNY3.14bn higher than that at the beginning of the year with year-end outstanding amount of CNY11.3bn. Particularly, CCB Beijing Branch signed a contract with the Beijing government in November 2010 to provide CNY20bn for public housing projects. According to the 21st Century Business Herald, CCB Beijing Branch has lent CNY2-3bn as of end-April this year. Given the lack of data on how much non-banking financials will finance for public housing projects, we conducted a sensitivity analysis under four different scenarios in order to better understand the potential impact on China banks: 1) assuming nonbanking financials provide 10% of CNY900bn; 2) assuming non-banking financials finance 20% of CNY900bn; 3) assuming non-banking financials offer 30% of CNY900bn; and 4) assuming non-banking financials offer 50% of CNY900bn. We assume, under all the four scenarios, the remaining financing needs from public housing projects will be met by bank lending. The sensitivity result shows that, under scenario 1 where non-banking financials provide 10% of CNY900bn and banks finance the remaining CNY810bn, banks loan growth would be boosted by 0.67-1.82pp with NPAT growth increasing by 0-3.9pp in 2011F. Meanwhile, FY11F CAR and Tier-1 CAR would be reduced by 0.05-1.90pp and 0.051.30pp), respectively.
Fig. 58: Sensitivity analysis under scenario 1
Scenario 1
Base line forecast Loan growth in FY11F NPAT 2011F (y-y) growth (y-y) ABC ICBC CCB BOC BOCOM CMB CITIC Minsheng CRCB 14.2 14.5 13.0 11.8 16.3 18.1 16.8 18.6 16.4 34.7 21.3 19.2 15.5 18.4 34.1 20.7 21.3 30.9 FY11F T1 FY11F CAR CAR 12.5 12.2 12.1 12.2 12.2 11.5 12.5 12.5 14.6 10.1 9.9 10.0 9.6 8.5 8.6 10.3 8.7 13.4 Scenario 1 Loan growth in FY11F NPAT 2011F (y-y) growth (y-y) 15.9 16.1 14.5 12.8 18.1 19.8 18.4 20.3 17.1 35.3 22.0 19.2 16.1 18.7 38.0 22.4 21.7 31.3 FY11F CAR 12.3 11.9 11.9 12.2 10.3 11.3 12.2 12.4 14.5 FY11F T1 CAR 10.0 9.6 9.9 9.5 7.2 8.5 10.1 8.6 13.4
Under scenario 2 where non-banking financials provides 20% of CNY900bn and banks finance the remaining CNY720bn, banks loan growth would be boosted by 0.6-1.6pp with NPAT growth increasing by 0-3.5pp in 2011F. Meanwhile, FY11F CAR and Tier 1 CAR would be reduced by 0.05-1.70pp and 0.04-1.20pp , respectively.
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Scenario 2
Under scenario 3 where non-banking financials offer 30% of CNY900bn and banks provide CNY630bn, we estimate that banks loan growth would be boosted by 0.51.41pp while NPAT growth increases by 0.3-3.0pp in 2011F. In the mean time, FY11F CAR and Tier 1 CAR would be lowered by 0.04-1.50pp and 0-1.00pp, respectively.
Scenario 3
Base line forecast Loan growth in FY11F NPAT 2011F (y-y) growth (y-y) ABC ICBC CCB BOC BOCOM CMB CITIC Minsheng CRCB 14.2 14.5 13.0 11.8 16.3 18.1 16.8 18.6 16.4 34.7 21.3 19.2 15.5 18.4 34.1 20.7 21.3 30.9 FY11F CAR 12.5 12.2 12.1 12.2 12.2 11.5 12.5 12.5 14.6 FY11F T1 CAR 10.1 9.9 10.0 9.6 8.5 8.6 10.3 8.7 13.4 Loan growth in 2011F (y-y) 15.6 15.8 14.2 12.5 17.7 19.4 18.0 19.9 16.9 Scenario 3 FY11F NPAT growth (y-y) 35.1 21.6 19.2 16.0 18.6 37.1 21.9 21.6 31.2 FY11F FY11F T1 CAR CAR 12.4 11.9 12.0 12.2 10.7 11.4 12.2 12.4 14.5 10.0 9.7 9.9 9.6 7.5 8.5 10.1 8.7 13.4
In scenario 4 where non-banking financials meet 50% of the CNY900bn capital needs for the public housing program and banks provide the other half of CNY450bn, we calculate that banks FY11F loan growth should be lifted by 0.4-1.00pp and FY11F NPAT growth by 0.1-2.2pp. And we see an even milder impact of 0-1.10pp and 0-0.80pp, respectively, on banks FY11F CAR and Tier-1 CAR.
Scenario 4
Source: Company data and Nomura Research
We detected that, among all H-share banks, ICBCs CAR might be under pressure as it declined by 50bps in 1Q11 after taking into account the adjustment of LGFV risk weighting. However, our sensitivity analysis indicates that BCOM is the one that will likely be affected most by economic housing loan growth in 2011F. Apart from BCOM, we do not see another round of capital raising plans for China banks arising from growing economic housing project loans.
44
June 24, 2011
Rural financing
Improvement of rural financing
In 2010, the policy framework for the promotion of rural and agricultural finance was largely in place. Specifically, the CBRC expanded the geographic coverage of preferential policies and increased the number of provinces where the local banking entities would be rewarded for distinctive performance in growing agricultural and rural services. The CBRC also gave favourable treatments for banking institutions to set up a presence in underdeveloped regions. In addition, the CBRC promoted the introduction of preferential income tax policies and offered exemption of supervisory fees for all smalland medium-sized rural financial institutions. By the end of 2010, the outstanding balance of agriculture-related loans reached CNY11.8tn, increasing by CNY2.63tn or 28.8% from the beginning of the year. Such growth was 5.7pp higher than the average growth of all loans. The proportion of agriculture-related loans to the total loans witnessed a 1.6% year-on-year growth, which signified a powerful financial support to agricultural and rural development, per the CBRC. As of 31 December, 2010, there were 2,646 rural credit cooperatives, 85 rural commercial banks, 223 rural cooperative banks, and 395 new-type rural financial institutions. By the end of 2013, it is estimated that 1,300 more new-type rural financial institutions will be established in China to serve county areas with low banking coverage.
Fig. 62: Major players in China's county area banking (as at end-2010)
Type of institution Large Commercial Bank Policy Bank Postal Savings Bank Small and Medium-sized Financial Institutions Nam e of institution or sub-type Agricultural Bank of China Agricultural Development Bank of China Postal Savings Bank of China Rural Rural credit cooperative institutions: - rural credit cooperatives - rural commercial banks - rural cooperative banks New -type rural financial institutions: - village and tow nship banks - lending companies - rural mutual credit cooperatives
Num ber of institutions 1 1 1 2,646 85 223 349 9 37
Continuous development of new-type rural financial institutions

In 2010, the CBRC continued its efforts in promoting the new-type rural financial institutions. As of end-2010, a total of 395 new-type rural financial institutions were established, including 349 village or township banks, nine lending companies and 37 rural mutual cooperatives, per the CBRC. The deposits attracted by these institutions totalled CNY75.27bn, loans totalled CNY60.09bn, and profits totalled CNY950mn. Meanwhile, 86.7% of the loans made by these institutions went to rural and agricultural uses as well as to the small- and medium-sized enterprises (SMEs). Among all, loans dispersed to the SMEs alone numbered 31,000 and valued in aggregate CNY31.38bn or 52.2% of the total value, while loans extended to rural households numbered 237,000 and valued CNY20.74bn or 34.5% of the total.
45
June 24, 2011
Rural financial institutions more important role

Rural financial institutions generally focus their operations on the developing regions and areas at the county and township levels and have gained market share as a result of the industrialization and urbanization of these regions and areas. They are playing a more important role. As at the end of 2010, there were 2,954 rural financial institutions in total and their total assets and total liabilities exceeded CNY10tn, according to the CBRC. Total loans and deposits reached CNY5.7tn and CNY8.6tn respectively, where total loans accounted for 11.1% of total sector loans. Total profits grew by CNY28.5bn to CNY104.5bn. However, rural financial institutions still have a heavy burden carried forward from the past. There were still NPLs of CNY420.4bn and shortfall in provision of CNY220.0bn. Accumulated losses amounted to CNY56.2bn, per the CBRC. According to the CBRC, total net capital increased by CNY243.1bn last year. Overall CAR of rural financial institutions reached 8.7% (from -4.6% in 2006), the first time standing above the regulatory level of 8%. The number of rural financial institutions that met the 8% requirement in 2010 rose by 500 from a year earlier to 1,295. The increase in capital level was mainly driven by formation of rural commercial banks (42 newly formed), rural cooperative banks (38 newly formed) as well as a number of rural cooperatives. Increase in capital level enhanced the lending capability of rural financial institutions. Total new loans in 2010 amounted to CNY965.5bn, representing 20% y-y growth, the fastest since 2006. Among those new loans, CNY3.92tn or 68.4% were rural financing, representing y-y growth of 26%.
Fig. 63: Net new loans of rural financial institutions
(RMBbn) 1,200 1,000 800 600 400 200 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Historical burden on rural financial institutions

According to the CBRC, as at the end of 2010, rural financial institutions have set aside CNY194.2bn as provisions to loan losses, up by CNY33.9bn y-y. However, coverage ratio of 60.6% (up by 23pp) was still far below the regulatory standard of 150%. The industry may need a combined CNY220bn to meet the minimum regulatory 150% provisional coverage requirement, according to a Chinese-language report in the 21st Century Business Herald dated 18 March, 2011). CBRC has outlined that rural financial institutions as a whole must have a provisional coverage ratio of 100% by 2013; rural banking institutions and cooperatives must reach 150% by 2016 and 2018, respectively, with a loan-loss provision requirement of 2.5%. The CBRC is aiming at digesting the accumulated losses of CNY56.2bn by the end of 2012. The salaries for senior management of financial institutions in rural areas might be limited if there is an increase in losses, according to a Chinese-language report in the 21st Century Business Herald dated 18 March, 2011. And for those that have accumulated losses, dividends can only be paid once losses have been recovered.
46
June 24, 2011
Still opportunities for other commercial banks

As rural financial institutions are dragged by historical burden of losses and lagging behind asset quality, we think other commercial banks still have great potential in gaining market share in rural financing. Among listed China banks, we think ABC and CRCB look best placed given their already extensive operating networks in rural areas. We expect the government will still encourage lending to rural areas even in such a tightened credit environment. We think ABC and CRCB will still benefit from higher-than-average loan growth in 2011F and higher loan yield, given their stronger pricing power towards rural borrowers. In FY10, ABC reported 26.1% y-y growth in county loans (versus overall loan growth of 19.8%) while that of CRCB was 25.1% (versus overall loan growth of 20.0%).
Fig. 64: Total assets of banking institutions (2007-2010)
Balance (RMBbn) 2008 63,152 5,645 32,575 8,834 4,132 929 1,003 80 5,211 1,180 1,345 2,216 Percentage of total (%) 2008 2009 8.94 51.58 13.99 6.54 1.47 1.59 0.13 8.25 1.87 2.13 3.51 8.73 51.31 14.86 7.14 2.35 1.61 0.03 6.91 1.95 1.70 3.40
Institutions/Year Banking institutions Policy banks & the CDB Large commercial banks Joint-stock commercial banks City commercial banks Rural commercial banks Rural cooperative banks Urban credit cooperatives Rural credit cooperatives Non-bank financial institutions Foreign banks New-type rural financial institutions & Postal savings bank
2007 53,116 4,278 28,500 7,274 3,341 610 646 131 4,343 972 1,253 1,769
2009 79,515 6,946 40,800 11,818 5,680 1,866 1,279 27 5,495 1,550 1,349 2,705
2010 95,305 7,652 46,894 14,904 7,853 2,767 1,500 2 6,391 2,090 1,742 3,510
2007 8.05 53.66 13.69 6.29 1.15 1.22 0.25 8.18 1.83 2.36 3.33
2010 8.03 49.20 15.64 8.24 2.90 1.57 0.00 6.71 2.19 1.83 3.68
Fig. 65: Total owners equity of banking institutions (2007-2010)

Balance (RMBbn) 2008 3,790 381 1,961 441 267 53 65 5 222 231 142 22 Percentage of total (%) 2008 2009 10.04 51.74 11.65 7.04 1.41 1.72 0.12 5.86 6.09 3.75 0.58 9.14 49.42 12.69 8.07 2.51 1.91 0.04 5.27 6.42 3.77 0.75
2007 3,040 358 1,582 339 188 33 41 6 187 176 117 12
2009 4,444 406 2,196 564 359 112 85 2 234 286 167 33
2010 5,832 436 2,861 817 482 203 112 0 279 383 185 74
2007 11.77 52.06 11.16 6.19 1.09 1.35 0.21 6.14 5.78 3.86 0.39
2010 7.48 49.06 14.00 8.27 3.47 1.91 0.00 4.79 6.57 3.18 1.26
Fig. 66: Profit after tax of banking institutions (2007-2010)

Balance (RMBbn) 2008 583 23.0 354.2 84.1 40.8 7.3 10.4 0.6 21.9 28.5 11.9 0.7 Percentage of total (%) 2008 2009 3.94 60.72 14.42 6.99 1.25 1.78 0.11 3.76 4.88 2.04 0.11 5.27 59.86 13.84 7.43 2.23 2.02 0.03 3.41 4.47 0.96 0.48
2007 447 48.9 246.6 56.4 24.8 4.3 5.5 0.8 19.3 33.4 6.1 0.7
2009 668 35.3 400.1 92.5 49.7 14.9 13.5 0.2 22.8 29.9 6.5 3.2
2010 899 41.5 515.1 135.8 77.0 28.0 17.9 0.0 23.3 40.8 7.8 11.9
2007 10.95 55.20 12.63 5.55 0.96 1.22 0.17 4.33 7.47 1.36 0.15
2010 4.62 57.29 15.10 8.56 3.11 1.99 0.00 2.59 4.54 0.87 1.32
47
Agricultural Bank of China

FINANCIALS
1288.HK 1288 HK
EQUITY RESEARCH
2Q11 earnings growth expected to remain strong
June 24, 2011 Rating Remains Target price Remains Closing price June 21, 2011 Potential upside
Rural growth story largely remains intact; reiterate BUY

Action: Reiterate BUY with TP of HK$5.20 We continue to forecast 34.7% y-y NPAT growth for FY11 supported by 11bps of margin expansion and 38% y-y fee income growth. Although concerns over a hard-landing for the Chinese economy in 2H11 weigh on the market, our economics team does not see this as a baseline scenario and continues to forecast 9.2%-9.5% y-y growth for 2Q11-4Q11. Thus, we hold our view of rapid growth in county area banking business given less competition and still low penetration. ABC looks well positioned for stronger-than-peer growth by leveraging its liquid balance sheet (LDR stood at 55.71% as of 1Q11, the lowest among peers) and on rising demand for financial products in county areas. We reiterate a BUY rating with a TP of HK$5.20. Major beneficiary from potential government bailout on LGFV loans Chinas regulators were reported, as per Reuters, to have shifted as much as RMB3tn (US$463bn) of debt off local government, and, if this were to be true, we think ABC would be the one to benefit the most given its higher percentage of lower grade LGFV loans (41% as of end of November 2010). Catalysts Better-than-expected 2Q11 results could trigger a re-rating in near term. Valuation ABCs share price has corrected 17% over the past month. Trading at 8.2x FY11F P/E and 1.57x FY11F P/B, we believe its valuation is very attractive. We see any further weakness as an enhanced buying opportunity and at least a 10% rebound from the current level.
31 Dec Currency (CNY) FY10 Actual Old FY11F New Old FY12F New Old FY13F New
Buy
HKD 5.20 HKD 3.94 +32%
Anchor themes The operating environment remains favourable for Chinese banks in 2011F, but negative sentiment from uncertainties over policies and asset quality continues to weigh on valuations. Better visibility on regulatory policies (capital and provisioning) could trigger a rerating in the near term. Nomura vs consensus Our FY12 net profit forecast is 4% above consensus estimates due to our higher NIM and lower credit cost assumptions.
Research analysts
PPOP (mn) Reported net profit (mn) Normalised net profit (mn) Normalised EPS Norm. EPS growth (%) Norm. P/E (x) Price/adj. book (x) Price/book (x) Dividend yield (%) ROE (%) ROA (%)
164,146 203,316 203,316 246,260 246,260 297,268 297,268 94,873 127,766 127,766 158,091 158,091 194,278 194,278 94,873 127,766 127,766 158,091 158,091 194,278 194,278 0.32 29.8 10.4 2.0 2.0 1.6 21.4 1.0 0.39 21.2 N/A N/A N/A N/A 21.5 1.1 0.39 21.2 8.2 1.6 1.6 5.5 21.5 1.1 0.49 23.7 N/A N/A N/A N/A 22.6 1.2 0.49 23.7 6.3 1.3 1.3 7.2 22.6 1.2 0.60 22.9 N/A N/A N/A N/A 24.0 1.3 0.60 22.9 5.0 1.1 1.1 9.0 24.0 1.3
Key company data: See page 2 for company data, and detailed price/index chart. Rating: See report end for details of Nomuras rating system.
Nomura | ASIA Agricultural Bank of China
June 24, 2011
Key data on Agricultural Bank of China

ProfitandLoss(CNYmn)
Year-end 31 Dec Interest income Interest expense Net interest income Net fees and commissions Trading related profits Other operating revenue Non-interest income Operating income Depreciation Amortisation Operating expenses Employee share expense Op. profit before provisions Provisions for bad debt Other provision charges Operating profit Other non-operating income Associates & JCEs Pre-tax profit Income tax Net profit after tax Minority interests Other items Preferred dividends Normalised NPAT Extraordinary items Reported NPAT Dividends Transfer to reserves Valuation and ratio analysis FD normalised P/E (x) FD normalised P/E at price target (x) Reported P/E (x) Dividend yield (%) Price/book (x) Price/adjusted book (x) Net interest margin (%) Yield on interest earning assets (%) Cost of interest bearing liabilities (%) Net interest spread (%) Non-interest/operating income (%) Cost to income (%) Effective tax rate (%) Dividend payout (%) ROE (%) ROA (%) Operating ROE (%) Operating ROA (%) Growth (%) Net interest income Non-interest income Non-interest expenses Pre-provision earnings Net profit Normalised EPS Normalised FDEPS
FY09 296,147 -114,508 181,639 35,640 271 6,087 41,998 223,637 -10,775 0 -98,792 114,070 -44,289 4,147 73,928 0 0 73,928 -8,926 65,002 -10 0 0 64,992 0 64,992 -20,000 44,992 FY10 357,660 -115,508 242,152 46,128 -998 4,971 50,101 292,253 -11,296 0 -116,811 164,146 -43,536 124 120,734 0 0 120,734 -25,827 94,907 -34 0 0 94,873 0 94,873 -17,539 77,334 FY11F 434,079 -145,777 288,302 56,211 -909 -677 54,625 342,927 -11,861 0 -127,751 203,316 -36,252 0 167,064 0 0 167,064 -39,260 127,804 -37 0 0 127,766 0 127,766 -57,512 70,255 FY12F 517,904 -182,037 335,866 69,136 -1,244 937 68,829 404,696 -12,454 0 -145,982 246,260 -39,551 0 206,709 0 0 206,709 -48,577 158,132 -41 0 0 158,091 0 158,091 -71,159 86,931 FY13F 612,549 -222,391 390,158 85,044 -1,694 1,179 84,528 474,686 -13,077 0 -164,342 297,268 -43,251 0 254,017 0 0 254,017 -59,694 194,323 -45 0 0 194,278 0 194,278 -87,446 106,833 Notes
Continued NIM expansion
13.8 18.6 13.8 2.2 2.6 2.6 2.28 3.71 1.51 2.20 18.8 49.0 12.1 30.8 20.5 0.82 23.3 0.93
10.4 14.1 10.4 1.6 2.0 2.0 2.57 3.80 1.30 2.50 17.1 43.8 21.4 18.5 21.4 0.99 27.3 1.26
8.2 11.1 8.2 5.5 1.6 1.6 2.68 4.04 1.42 2.62 15.9 40.7 23.5 45.0 21.5 1.15 28.1 1.50
6.3 8.5 6.3 7.2 1.3 1.3 2.74 4.23 1.54 2.69 17.0 39.1 23.5 45.0 22.6 1.23 29.6 1.61
5.0 6.7 5.0 9.0 1.1 1.1 2.80 4.39 1.64 2.75 17.8 37.4 23.5 45.0 24.0 1.31 31.3 1.72
Priceandpricerelativechart(oneyear)
(HKD) 5 4.5 4 3.5 3 M ar 1 1 M ay 11 O c t 10 Dec 10 N ov 1 0 A ug 10 S ep 10 Feb 11 J an 11 J un 11 A pr 1 1 Price Rel MSCI China 130 125 120 115 110 105 100 95
(%) Absolute (HKD) Absolute (USD) Relative to index Market cap (USDmn)
1M -14.9 -15.1 -7.6 164,258.5 62.0 4.85/3.2 103.82
3M -3.7 -3.6 0.2
12M
-9.2 199.7 0.0 9.9 26.3 -7.3 -7.3
33.3 19.3 18.2 43.9 46.0 29.8 29.8
19.1 9.0 9.4 23.9 34.7 21.2 21.2
16.5 26.0 14.3 21.1 23.7 23.7 23.7
16.2 22.8 12.6 20.7 22.9 22.9 22.9
Estimated free float (%) 52-week range (HKD) 3-mth avg daily turnover (USDmn) Major shareholders (%) MOF Huijin
39.2 40.0
49
June 24, 2011
BalanceSheet(CNYmn)
As at 31 Dec Cash and equivalents Inter-bank lending Deposits with central bank Total securities Other interest earning assets Gross loans Less provisions Net loans Long-term investments Fixed assets Goodwill Other intangible assets Other non IEAs Total assets Customer deposits Bank deposits, CDs, debentures Other interest bearing liabilities Total interest bearing liabilities Non interest bearing liabilities Total liabilities Minority interest Common stock Preferred stock Retained earnings Proposed dividends Other equity Shareholders' equity Total liabilities and equity Non-performing assets (CNY) Balance sheet ratios (%) Loans to deposits Equity to assets Asset quality & capital NPAs/gross loans (%) Bad debt charge/gross loans (%) Loss reserves/assets (%) Loss reserves/NPAs (%) Tier 1 capital ratio (%) Total capital ratio (%) Growth (%) Loan growth Interest earning assets Interest bearing liabilities Asset growth Deposit growth Per share Reported EPS (CNY) Norm EPS (CNY) Fully diluted norm EPS (CNY) DPS (CNY) PPOP PS (CNY) BVPS (CNY) ABVPS (CNY) NTAPS (CNY)
FY09 FY10 FY11F FY12F FY13F 1,517,806 2,082,332 2,728,437 3,302,118 4,042,436 111,128 173,268 194,060 217,347 243,429 0 0 0 0 0 2,504,496 2,477,174 2,758,995 3,073,090 3,423,178 421,093 525,331 577,864 635,651 699,216 4,138,187 4,956,741 5,662,892 6,521,574 7,462,156 -126,692 -168,733 -200,140 -235,951 -275,229 4,011,495 4,788,008 5,462,752 6,285,623 7,186,927 141 141 141 141 141 111,973 121,391 123,819 126,295 128,821 0 0 0 0 0 19,659 31,470 28,323 25,491 22,942 184,797 138,291 79,650 80,446 81,251 8,882,588 10,337,406 11,954,041 13,746,202 15,828,340 7,497,618 8,887,905 10,276,556 11,886,157 13,752,013 714,218 617,995 680,950 753,700 836,972 163,681 112,189 165,936 170,057 174,591 8,375,517 9,618,089 11,123,441 12,809,914 14,763,576 164,146 177,081 181,942 187,033 192,370 8,539,663 9,795,170 11,305,383 12,996,946 14,955,946 106 165 167 168 170 260,000 324,794 324,794 324,794 324,794 39,817 27,945 70,844 129,059 200,972 20,000 17,539 57,512 71,159 87,446 23,002 171,793 195,341 224,075 259,012 342,819 542,071 648,491 749,087 872,224 8,882,588 10,337,406 11,954,041 13,746,202 15,828,340 120,241 100,405 89,618 89,002 88,315 Notes
Steady and low LDR
55.2 3.9
55.8 5.2
55.1 5.4
54.9 5.4
54.3 5.5
2.9 1.07 1.43 105.4 7.7 10.1
2.0 0.88 1.63 168.1 9.7 11.6
1.6 0.64 1.67 223.3 10.1 12.5
1.4 0.61 1.72 265.1 9.7 11.8
1.2 0.58 1.74 311.6 9.4 11.2
33.1 25.0 28.9 26.6 23.0
19.4 13.0 14.8 16.4 18.5
14.1 12.9 15.7 15.6 15.6
15.1 13.5 15.2 15.0 15.7
14.3 13.1 15.3 15.1 15.7
0.25 0.25 0.25 0.08 0.44 1.32 1.32 1.24
0.32 0.32 0.32 0.05 0.56 1.67 1.67 1.57
0.39 0.39 0.39 0.18 0.63 2.00 2.00 1.91
0.49 0.49 0.49 0.22 0.76 2.31 2.31 2.23
0.60 0.60 0.60 0.27 0.92 2.69 2.69 2.61
50
June 24, 2011
2Q11 earnings growth expected to remain strong

Following a solid 1Q11 performance, we expect ABC to continue to deliver strong earnings growth in 2Q11. We do not believe ABC would be the most affected if the Chinese economy were to experience a hard landing, and maintain our positive view on its county area banking. We continue to expect FY11F NPAT growth of 35% y-y, supported by 11bps of margin expansion and 38% y-y fee income growth.
Positive FY11F NPAT forecast with BUY rating and TP of HK$5.20

We continue to forecast 34.7% y-y NPAT growth for FY11 supported by 11bps of margin expansion and 38% y-y fee income growth. Although the market is fretting about a hardlanding for the Chinese economy in 2H11, our economics team does not see this as a baseline scenario and continues to forecast 9.2%-9.5% y-y growth for 2Q11-4Q11. Thus, we hold our view of rapid growth in county area banking business given less competition and still low penetration. ABC looks well positioned for stronger-than-peer growth by leveraging its liquid balance sheet (LDR stood at 55.71% as of 1Q11, the lowest among all H-share banks) and on rising demand for financial products in county areas. While we think NIM is likely to peak out in 2Q11 following an expansion of 9bps in the previous quarter, we expect fee income to maintain its growth momentum in 2Q11 so as to provide support to bottom line growth. We reiterate our BUY rating with TP of HK$5.20.
Least impact from potential government bailout of LGFV loans

Per a Reuters news report, Chinas regulators plan to shift as much as RMB3tn (US$463bn) of debt off local government. If the news is true, we believe ABC should benefit the most given its higher percentage of lower grade LGFV loans (41% as of end of November 2010). We view the news as largely positive for the bank given that it would remove concerns of default risks of LGFV loans, and relieve banks from the pressure of higher provisioning. We estimate that after the government bailout, ABC will only have a LGFV loan gap of RMB6.6bn which is likely to become NPLs and thus needs to be 25-100% provisioned. Our sensitivity analysis shows that this will lift ABC's FY11F credit cost by 0.03%-0.13% and reduce its FY11F NPAT by 0.99%-3.95%.
Fig. 67: Details of LGFV loans
By Individual banks (RMBmn, except %) 2010 Full - % of total LFGV loans Basic Partial No - % of lower grade LGFV loans Total
ABC ICBC CCB BOC BCOM CMB Citic Minsheng 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 389,400 622,500 406,300 209,850 79,925 116,142 218,680 133,350 59.0% 75.0% 56.5% 50.0% 57.5% 89.3% 99.4% 70.0% 270,600 41.0% 660,000 207,500 25.0% 830,000 312,300 43.5% 718,600 209,850 50.0% 419,700 59,075 42.5% 139,000 13,858 10.7% 130,000 1,320 0.6% 220,000 57,150 30.0% 190,500
Source: Company data and Nomura Research.
51
June 24, 2011
Fig. 68: Impact on FY11F credit cost and net profits

By Individual banks
ABC LGFV loans need to charge provision after the bailout (RMB mn) Assume 25% of provision charged Impact on FY11F credit cost Impact on FY11F NPAT Assume 50% of provision charged Impact on FY11F credit cost Impact on FY11F NPAT Assume 100% of provision charged Impact on FY11F credit cost Impact on FY11F NPAT
ICBC
CCB
BOC
BCOM
CMB
Citic
Minsheng
6,600 0.03% -0.99% 0.06% -1.98% 0.13% -3.95%
0 Nil Nil Nil Nil Nil Nil
24,860 0.14% -2.89% 0.28% -5.78% 0.57% -11.57%
41,970 0.17% -6.61% 0.35% -13.22% 0.70% -26.44%
3475 0.04% -1.46% 0.07% -2.91% 0.14% -5.83%
New rules on RWA weigh on capital ratio

CBRC proposed new capital rules with higher risk weighting for certain assets, such as infrastructure loans, property loans and LGFV loans, while lowering the risk weighting for SME loans and retail loans, as reported by 21st Century News on 9 June. Based on our estimates, the new rule would lift ABCs risk weighted assets by 15% and have a negative impact of 136bps on its tier 1 CAR on a net basis. With stricter standard on RWA, we see capital raising as a longer-term theme for Chinese banks in order to meet the higher CAR requirement.
Fig. 69: Impact of new rules on RWA
2010 (RMBmn) Incremetnal RWA as % of total RWA Total tier 1 impact
ABC 15% (136)
ICBC 14% (127)
CCB 14% (131)
BOC 14% (135)
BOCOM 11% (95)
CMB 11% (80)
CITIC Minsheng 11% (88) 11% (84)
CRCB 17% (234)
Overhang on lock-up expiry will be removed soon

We see short-term share price weakness partially due to the expiry on locked-up shares in mid-July 2011. By then, the H shares held by the six cornerstone investors, including Qatar Investment Authority and Standard Chartered Bank, would no longer be restricted from sales. In addition, the lock-up period for the remaining 50% of shares held by the other five cornerstone investors would also be over (the lock-up period of the other 50% shares already expired in January 2011). As such, from 16 July 2011 onwards, a maximum size of 12.36bn shares is likely to flow into the market. Such volume represents 69x average daily trading over the past three months, based on the 10 June closing price. Though we do not expect all cornerstone investors to unload their shares after unlocking, we expect pressure on the stock in the short term. After the unlocking of these shares in mid-July, there will be no more ABC H shares subject to restrictions on sales. We recommend investors accumulate on any share price weakness.
52
June 24, 2011
Fig. 70: The trading date of shares subject to restrictions on sales

Number of new shares for trading upon the expiry of the restrictions Date 15-Oct-10 16-Jan-11 15-Jul-11 16-Jul-11 15-Jan-12 15-Jul-13 15-May-15 on sales 5,032,028,000 912,960,000 5,114,117,500 12,355,402,000 5,114,117,500 258,592,941,197 9,891,764,707 The remaining subject to the restrictions on sales 291,981,302,904 291,068,342,904 285,954,225,404 273,598,823,404 268,484,705,904 9,891,764,707 0 The remaining not subject to the restrictions on sales 32,812,814,096 33,725,774,096 38,839,891,596 51,195,293,596 56,309,411,096 314,902,352,293 324,794,117,000 Description Allottees of A shares under off-line placement Cornerstone investors of H shares Strategic investors of A shares Cornerstone investors of H shares Strategic investors of A shares A shares held by the MOF and Huijin, and A shares transferred to the SSF from the MOF A shares held by the SSF, and A shares transferred to the SSF by itself
Note: A shares held by the MOF and Huijin are not subject to the above lock-up period of 36 months after the approval of conversion to H shares by the relevant authority. Source: ABC FY10 results and Nomura Research.
number of shares number of shares
53
ICBC
BANKS
1398.HK 1398 HK
EQUITY RESEARCH
Top pick among H-share Chinese banks
June 24, 2011 Rating Remains Target price Reduced from 7.60 Closing price June 21, 2011 Potential upside
Most resilient player in a slowing economy; top BUY with TP of HKD7.50

Action: Reiterate BUY while slightly lowering TP to HKD7.50 We have fine-tuned our FY11F earnings to CNY196bn from CNY200bn with NPAT growth of 18.7% y-y, mainly due to our more cautious view on overall economic growth and potential asymmetric rate hikes. We now expect NIM to expand by 10bps and gross loans to grow by 14.5% y-y in FY11. Consequently, we have slightly cut our TP to HKD7.50 from HKD7.60. That said, we continue to view ICBC as the most resilient Hshare Chinese bank, able to withstand all the current headwinds from the policy front given its adequate liquidity (LDR stood at 60.04% as of 1Q11), diversified business growth model which makes it least reliant on expansion of assets and loans in our coverage and stable capital adequacy ratio. ICBC remains our top pick and we reiterate BUY. Least exposure to non-commercial LGFV loans Chinas regulators reportedly shifted as much as CNY3tn of debt away from the local government. If this is true, it should be a positive for ICBC given it would reduce concerns on default risks of lower grade LGFV loans which would be fully bailed out by the government. Catalysts: Better-than-expected 2Q11 results Better-than-expected 2Q11 results could trigger a re-rating near term. Valuation: Approaching a good entry point Trading at 1.69x FY11F P/B and 8.25x FY11F P/E after a 9% drop in share price over the past month, we consider the valuation attractive and believe the stock is approaching a good entry point for a potential rebound.
Buy
HKD 7.50 HKD 5.84 +28.4%
Anchor themes The operating environment remains favourable for Chinese banks in 2011F, but negative sentiment from uncertainties over policies and asset quality continues to weigh on valuations. Better visibility on regulatory policies (capital and provisioning) could trigger a rerating in the near term. Nomura vs consensus Our FY12F NPAT forecast is 1% above consensus estimates due to our higher NIM and lower credit cost assumptions.
Research analysts
Nomura | ASIA ICBC
June 24, 2011
Key data on ICBC

FY09 405,878 -160,057 245,821 55,147 7,135 1,308 63,590 309,411 0 -120,819 188,592 -21,682 -1,603 165,307 0 1,987 167,294 -37,898 129,396 -751 0 0 128,645 0 128,645 -56,783 71,862 FY10 462,762 -159,013 303,749 72,840 316 3,843 76,999 380,748 0 -139,480 241,268 -27,888 -100 213,280 0 2,146 215,426 -49,401 166,025 -869 0 0 165,156 0 165,156 -64,219 100,937 FY11F 594,112 -233,212 360,900 87,623 146 3,920 91,688 452,588 0 -161,092 291,497 -34,959 0 256,537 0 2,361 258,898 -60,841 198,057 -956 0 0 197,101 0 197,101 -89,126 107,975 FY12F 710,577 -286,249 424,328 105,796 24 3,998 109,818 534,146 0 -189,346 344,800 -33,416 0 311,384 0 2,597 313,981 -73,785 240,195 -1,051 0 0 239,144 0 239,144 -108,088 131,056 FY13F 838,302 -345,832 492,471 130,369 -103 4,078 134,345 626,815 0 -224,195 402,621 -38,178 0 364,442 0 2,856 367,299 -91,825 275,474 -1,157 0 0 274,317 0 274,317 -123,963 150,354 Notes
13.2 17.3 13.2 3.3 2.5 2.5 2.26 3.74 1.58 2.16 20.6 39.0 22.7 44.1 20.2 1.19 25.9 1.53
10.3 13.5 10.3 3.7 2.1 2.1 2.44 3.72 1.37 2.35 20.2 36.6 22.9 38.9 22.1 1.31 28.5 1.69
8.5 11.1 8.5 5.3 1.7 1.7 2.55 4.19 1.75 2.44 20.3 35.6 23.5 45.2 22.1 1.35 28.8 1.75
6.6 8.6 6.6 6.9 1.4 1.4 2.63 4.40 1.87 2.53 20.6 35.4 23.5 45.2 23.1 1.39 30.1 1.80
5.6 7.3 5.6 8.1 1.2 1.2 2.67 4.55 1.96 2.59 21.4 35.8 25.0 45.2 23.0 1.38 30.5 1.84
(HKD) 6.8 6.6 6.4 6.2 6 5.8 5.6 5.4 N ov 10 D ec 10 A ug 10 S ep 10 O c t 10 J an 11 F eb 11 M ar 11 A pr 11 J ul 10 M ay 11 J un 11 Price Rel MSCI China 104 102 100 98 96 94 92 90
1M -7.8 -8.0 -1.8 248,967.3 62.0 6.77/5.43 205.04
3M -3.3 -3.2 -1.8
12M 3.2 3.1 -1.3
-6.5 34.8 8.5 -5.2 16.1 16.1 16.1
23.6 21.1 15.4 27.9 28.4 25.6 25.6
18.8 19.1 15.5 20.8 19.3 16.8 16.8
17.6 19.8 17.5 18.3 21.3 21.3 21.3
16.1 22.3 18.4 16.8 14.7 14.7 14.7
Estimated free float (%) 52-week range (HKD) 3-mth avg daily turnover (USDmn) Major shareholders (%) Huijin MOF
35.4 35.3
55
Nomura | ASIA ICBC
June 24, 2011
BalanceSheet(CNYmn)
FY09 0 235,301 1,693,048 3,579,026 408,826 5,728,626 -145,452 5,583,174 36,278 95,684 0 18,696 135,020 11,785,053 9,771,277 1,003,106 111,060 10,885,443 220,676 11,106,119 5,041 334,019 FY10 0 248,860 2,282,999 3,719,282 262,227 6,790,506 -167,134 6,623,372 40,325 103,412 0 21,712 156,433 13,458,622 11,145,557 1,059,170 185,298 12,390,025 246,889 12,636,914 1,227 349,019 FY11F 0 278,723 3,218,770 4,155,562 288,450 7,775,769 -197,061 7,578,708 40,325 105,480 0 19,541 157,997 15,843,556 13,251,509 1,182,697 193,787 14,627,993 254,553 14,882,546 1,239 349,019 FY12F 0 312,170 4,360,014 4,643,192 317,295 8,932,091 -224,725 8,707,367 40,325 107,590 0 17,587 159,577 18,665,116 15,765,490 1,321,761 203,124 17,290,375 262,643 17,553,018 1,252 349,019 FY13F 0 349,630 4,908,318 5,188,233 349,024 10,157,074 -256,361 9,900,712 40,325 109,742 0 15,828 161,173 21,022,986 17,955,961 1,321,761 203,124 19,480,846 262,643 19,743,489 1,264 349,019 Notes
Benign asset quality
61,977 137,767 246,360 378,468 529,979 56,783 64,219 89,126 108,088 123,963 221,114 269,476 275,266 275,272 275,272 673,893 820,481 959,771 1,110,847 1,278,233 11,785,053 13,458,622 15,843,556 18,665,117 21,022,986 88,467 73,241 72,629 76,146 85,151
58.6 5.7
60.9 6.1
58.7 6.1
56.7 6.0
56.6 6.1
1.5 0.38 1.23 164.4 9.9 12.4
1.1 0.41 1.24 228.2 10.0 12.3
0.9 0.45 1.24 271.3 9.8 12.1
0.9 0.37 1.20 295.1 9.7 11.7
0.8 0.38 1.22 301.1 9.6 11.4
25.9 21.4 22.2 20.8 18.8
18.6 14.2 13.8 14.2 14.1
14.4 18.1 18.1 17.7 18.9
14.9 18.2 18.2 17.8 19.0
13.7 12.8 12.7 12.6 13.9
0.39 0.39 0.39 0.17 0.56 2.02 2.02 1.96
0.48 0.48 0.48 0.18 0.71 2.35 2.35 2.29
0.56 0.56 0.56 0.26 0.84 2.75 2.75 2.69
0.69 0.69 0.69 0.31 0.99 3.18 3.18 3.13
0.79 0.79 0.79 0.36 1.15 3.66 3.66 3.62
56
Nomura | ASIA ICBC
June 24, 2011
Most resilient player to outperform amid tightened policy and slowing economy
We have fine-tuned our FY11F earnings to CNY196bn from CNY200bn with NPAT growth of 18.7% y-y. However, we continue to view ICBC as the most resilient H-share Chinese bank given its adequate liquidity, diversified business growth model and stable capital adequacy ratio.
Cutting TP slightly to HKD7.50; maintain BUY, top pick status

We have fine-tuned our FY11F earnings to CNY196bn from CNY200bn with NPAT growth of 18.7% y-y, mainly due to our more cautious view on overall economic growth and potential asymmetric rate hikes. We now expect NIM to expand by 10bps and gross loans to grow by 14.5% y-y in FY11. Consequently, we have slightly cut our TP to HKD7.50 from HKD7.60. That said, we continue to view ICBC as the most resilient Hshare Chinese bank, able to withstand all the current headwinds from the policy front given its adequate liquidity (LDR stood at 60.04% as of 1Q11), diversified business growth model which makes it least reliant on expansion of assets and loans in our coverage and stable capital adequacy ratio. ICBC remains our top pick and we reiterate BUY.
Least exposure to non-commercial LGFV loans

According to a Reuters news report dated 1 June 2011, Chinas regulators plan to shift as much as CNY3tn (USD463bn) of debt away from the local government. If this is true, we believe it would be positive for ICBC given it would reduce concerns on default risks of lower grade LGFV loans which would be fully bailed out by the government and thus relieve pressures on higher provisioning. Assuming a 28% bail-out from government on ICBCs LGFV loans with a 20% hair cut on the bail-out plan, we estimate that all of its lower grade LGFV loans would be removed and the plan would reduce its FY11F profit before tax by 14%, which is the least among all the H-share banks we cover.
Fig. 71: Sensitivity analysis on potential bail-out plan on LGFV loans
RMB'mn ABC ICBC CCB BOC BCOM CMB Citic Minsheng CRCB
Base case: we assume Chinese banks write off 20% of LGFV loans (RMB2.5trn) sold to government in the bail-out plan as a haircut total LGFV as of Dec 2010 total LGFV as % of total loan 30% of LGFV loan spin off 20% write-off on the spin off haircut as % of LGFV haircut as % of total loans 2011F pre tax profit write off as % of 2011F PBT 395,300 8.0% 108,718 21,744 6% 0.44% 167,064 13.0% 649,600 9.6% 178,658 35,732 6% 0.53% 263,222 13.6% 540,000 9.5% 148,515 29,703 6% 0.52% 214,915 13.8% 380,000 6.7% 104,510 20,902 6% 0.37% 163,658 12.8% 177,400 7.9% 48,790 9,758 6% 0.44% 59,829 16.3% 135,100 9.4% 37,156 7,431 6% 0.52% 45,178 16.4% 118,400 9.4% 32,563 6,513 6% 0.52% 34,383 18.9% 197,200 18.6% 54,235 10,847 6% 1.03% 28,445 38.1% 18,500 15.1% 5,088 1,018 6% 0.83% 5,291 19.2%
Worse case: in addition to the write-off, Chinese banks take 50% loss provisioning on lower grade of LGFV loans not taken up by government total lower grade LGFV loans remaining lower grade LGFV loans not spin off 50% provision on remaining lower grade LGFV to 2011F PBT Total impact on 2011F PBT
Source: Reuters, Company data, Nomura estimates
162,073 53,355 16% 29%
162,400 0 0% 14%
234,681 86,166 20% 34%
190,000 85,490 26% 39%
75,395 26,605 22% 39%
14,402 0 0% 16%
710 0 0% 19%
59,160 4,925 9% 47%
37 0 0% 19%
57
Nomura | ASIA ICBC
June 24, 2011
Smaller capital risks from new capital framework

According to a report by Century News dated 9 June, the CBRC has proposed new capital rules with higher risk weightings for certain assets, such as infrastructure loan, property loans and LGFV loans, etc, while lowering the risk weighting for SME loans and retail loans. We estimate ICBCs tier 1 ratio would drop by 127bp if the new CAR rule is implemented, incorporating the operating risk into risk weighted assets (81bp) and raising the risk weighting for property loans (35bp) and corporate loans (25bp). On the other hand, ICBC tier 1 ratio could see a 31bp increase on the reduced risk weighting for retail loans (excluding personal mortgage) and small enterprise loans. On a net basis, we forecast a 127bp drop on tier 1 ratio, which may force the bank to raise CNY54bn in equity to replenish its tier 1 ratio to meet CBRCs requirement of 9.5%. That said, we believe the capital risks lies in interbank assets; corporate loans should be much smaller than it appears given that the bank can at least shift them into much shorter durations to absorb the negative impact from the new capital framework. If the extra incremental RWA potentially to be charged on interbank assets and corporate loans would be fully relieved, we estimate 43bp of Tier 1 CAR would be released. By contrast, it is toughest to absorb the capital risks associated with LGFV and property related loans as these are rather organic and there is little that banks can do to adapt to the new rules.
Fig. 72: Impact of new CAR rule on ICBCs tier 1 ratio
Retail claims excluding Operating Property Interbank mortgage risk 512,018 256,009 3.6% -35 511,087 111,519 1.6% -15 543,097 -135,774 -1.9% 19 Corporate loan over 5 years 1,361,018 204,153 976,246 2.9% -28 13.7% -127
2010 (RMB'mn) Total exposure Incremental RWA % to RWA Tier 1 impact (bps)
SME
Total
50,018 339,525 625,221 8.8% -81 -84,881 -1.2% 12
Source: Company data and Nomura estimates
Robust net fee income growth

ICBC booked robust net fee income growth of 42% y-y in 1Q11. Investment banking, wealth management, bank cards and settlement and clearing accounted for a total of 80%. In view of the flourishing corporate wealth management product sales in April and May, we believe fee growth momentum is likely to continue in 2Q, which is in line with the companys preliminary guidance. ICBC has one of the most diversified business growth models among its peers, which makes it the least reliant on NIM expansion. We believe ICBC should be better prepared for the interest rate deregulation, which we believe will be a medium-term theme. With rapidly growing fee income, we believe ICBCs earnings growth has been conservative with potential upside in the coming years. Although the PBOC has decided to accelerate the interest rate liberalisation process, we remain positive on ICBC delivering strong net profit growth with support from fee incomes.
58
Nomura | ASIA ICBC
June 24, 2011
Asset quality and credit cost most resilient to macro weakening

In terms of asset quality, the company expects stable NPL balance and ratio in 2Q11. Weaker economic data plus surging loan yields have probably increased the markets concern on the business outlook and repayment capacity of corporates, and accordingly the asset quality of Chinese banks. In our view, ICBC is likely to be more resilient in the event of the soft landing of the economy owing to its lower exposure to risky sectors (see figure titled Sensitivity analysis on potential bail-out plan on LGFV loans), benign asset quality on LGFV loans (0.3% in 2010), higher loan-to-provision ratio (see figure titled Impact of new CAR rule on ICBCs tier 1 ratio), and lower earnings sensitivity to credit cost changes among Chinese banks (see figure titled 2010 Chinese banks exposure to risk sectors). Every 10bp increase in credit cost would lower our net profit forecast for ICBC by 2.8% in 2011F, while it would lower our sector average by 3.4%.
Fig. 73: 2010 Chinese banks exposure to risk sectors
2010 Property Mortgage Manufacturing Risk Sectors ABC 11% 15% 21% 46.7% ICBC 8% 16% 14% 37.4% CCB 7% 19% 17% 43.6% BOC 8% 19% 21% 47.8% BOCOM 6% 12% 20% 38.0% CMB 8% 21% 18% 46.5% CITIC 6% 13% 21% 39.0% Minsheng 12% 9% 14% 35.0% CRCB 10% 20% 18% 47.9%
Fig. 74: 2010 loan provision ratio

4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0%
Bocom Minsheng CMB BOC ICBC CRCB CCB Citic ABC
Fig. 75: 2011F net profit sensitivity to credit cost

Net profit change for each 10bp change in credit cost
2010 loan provision ratio
4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0%
2011F net profit sensitivity to credit cost
Minsheng
Bocom
Our target price of HKD7.50 (previously HKD7.60) is based on 2.2x P/BV multiplier and FY11F BVPS of CNY2.75. Our sustainable ROE assumption is 15.8%. We use the Gordon Growth Model [target P/BV = (sustainable ROE - long-term growth)/(cost of equity - long-term growth)] to derive our fair P/BV range, assuming a cost of equity of 11.5% and a terminal growth rate of 7.9%. We derive our terminal growth figure by applying a 50% payout ratio to our long-term sustainable ROE. Our valuation methodology remains unchanged. Downside risks: As the largest bank in China, ICBC and its performance remain closely tied to the Chinese economy. Hence, we believe that a more severe-than-expected macro tightening could result in a sharp rise in bad debt costs. In addition, a slowing economy would have negative implications for loan growth, in our view. The concept of market and operation-related risks has only been introduced to the bank over the past few years. Moreover, fewer rate hikes than expected in 2011F is likely to pose a downward risk to our NIM assumption.
CRCB
CCB
ICBC
CMB
BOC
ABC
Citic
59
China Construction Bank-H

BANKS
0939.HK 939 HK
EQUITY RESEARCH
Downgrade to NEUTRAL, valuation protective
June 24, 2011 Rating Down from Buy Target price Reduced from 8.60 Closing price June 21, 2011 Potential upside
Material exposure to shadow credit (entrusted loans), risk yet to be priced in

Action: Downgrading to NEUTRAL on shadow credit concerns If the PBOC tightens its regulations on shadow credit, requiring 50% risk weighting to entrusted loans (14% of CCBs total loan in 2010), then CCBs Tier-1 CAR could be cut by 63bps one of the most among Hshare banks. In addition, we expect the new capital framework, if implemented, to lower CCBs 2010 Tier-1 ratio by 131bps. Again, the negative impact on CCB would be one of the largest among peers, given that 14% of its total loans are exposed to the longer-maturity infrastructure, construction and property sectors. BOA sale inevitable given its systematic importance We estimate BoA can retrieve US$21bn in proceeds, realising a gain of US$13bn, if it sells its 25.6bn CCB-H shares (>100x daily turnover) once the lockup expires on 29 August. On our calculation, this could boost BoAs Tier-1 CAR by 70bps to 9.3%. BoA is enlisted as a systematically important bank with potentially more strict capital requirements ahead; this, combined with an increasingly circumspect capital market could mean proceeds from CCB are the best way to raise capital. Earnings revised down by 3-7%; fairly valued Following our 3% and 7% revision to 2011F and 2012F earnings on the back of tighter margins and higher provisions to entrusted loans, we view CCB as fairly valued at 1.6x 2011F P/B with an implied ROE of 14.8%. We see better opportunities within the sector, given that China is increasingly moving away from a fixed asset investment-driven economy to a consumer one, which could lead to a longer term de-rating for CCB.
Neutral
HKD 7.02 HKD 6.44 +9%
Anchor themes The operating environment remains favourable for Chinese banks in 2011F, but negative sentiment from uncertainties over policies and asset quality continues to weigh on valuations. Better visibility on regulatory policies (capital and provisioning) could trigger a rerating in the near term. Nomura vs consensus Our net profit forecast is 2.6% below consensus estimates due to our higher NIM and higher credit cost assumptions.
Research analysts
Nomura | ASIA China Construction Bank-H
June 24, 2011
Key data on China Construction Bank-H

FY09 339,463 -127,578 211,885 48,059 6,704 2,666 57,429 269,314 0 0 -105,146 0 164,168 -24,256 -1,204 138,708 0 17 138,725 -31,889 106,836 -80 0 0 106,756 0 106,756 -47,205 59,551 FY10 377,783 -126,283 251,500 66,132 5,412 2,736 74,280 325,780 0 0 -121,366 0 204,414 -25,641 -3,651 175,122 0 34 175,156 -40,125 135,031 -187 0 0 134,844 0 134,844 -53,052 81,792 FY11F 470,321 -171,096 299,225 81,787 4,330 2,886 89,003 388,228 0 0 -145,003 0 243,225 -35,021 0 208,204 0 37 208,242 -47,896 160,346 -206 0 0 160,141 0 160,141 -72,063 88,077 FY12F 558,696 -208,357 350,338 104,688 3,464 3,043 111,194 461,533 0 0 -173,109 0 288,424 -42,620 0 245,804 0 41 245,845 -56,544 189,301 -249 0 0 189,052 0 189,052 -85,084 103,968 FY13F 649,464 -242,919 406,545 130,860 2,771 3,209 136,839 543,384 0 0 -206,690 0 336,694 -53,997 0 282,697 0 45 282,742 -66,444 216,298 -249 0 0 216,049 0 216,049 -97,222 118,827 Notes
12.7 17.6 12.7 3.5 2.4 2.4 2.41 3.85 1.55 2.30 21.3 39.0 23.0 44.2 20.9 1.24 27.2 1.61
10.2 14.2 10.2 3.7 2.0 2.0 2.49 3.74 1.34 2.40 22.8 37.3 22.9 39.3 21.5 1.32 28.0 1.71
8.5 11.8 8.5 5.3 1.6 1.6 2.60 4.09 1.60 2.49 22.9 37.3 23.0 45.0 21.3 1.36 27.7 1.77
6.8 9.5 6.8 6.6 1.4 1.4 2.67 4.25 1.73 2.52 24.1 37.5 23.0 45.0 21.9 1.38 28.5 1.79
5.8 8.1 5.8 7.7 1.2 1.2 2.72 4.34 1.81 2.53 25.2 38.0 23.5 45.0 21.9 1.35 28.6 1.77
(HKD) 8.5 8 7.5 7 6.5 6 5.5 N ov 10 M ar 11 A pr 11 M ay 11 A ug 10 S ep 10 J an 11 F eb 11 D ec 10 J un 11 O c t 10 J ul 10 Price Rel MSCI China 108 106 104 102 100 98 96 94
1M -6.7 -7.0 -0.7 199,068.0 31.8 8.22/5.92 231.12
3M -4.2 -4.1 -2.6
12M 8.3 8.2 3.8
-5.8 28.1 6.0 -3.7 15.3 15.3 15.3
18.7 29.3 15.4 24.5 26.3 22.0 22.0
19.0 19.8 19.5 19.0 18.8 14.9 14.9
17.1 24.9 19.4 18.6 18.1 18.1 18.1
16.0 23.1 19.4 16.7 14.3 14.3 14.3
Estimated free float (%) 52-week range (HKD) 3-mth avg daily turnover (USDmn) Major shareholders (%) Huijin Bank of America
57.1 10.2
61
June 24, 2011
BalanceSheet(CNYmn)
FY09 FY10 FY11F FY12F FY13F 29,173 36,961 50,257 63,022 80,965 123,380 142,280 170,736 204,883 245,860 1,429,475 1,811,068 2,462,600 3,088,084 3,967,298 2,578,799 2,904,994 3,340,743 3,841,855 4,418,133 0 0 0 0 0 4,819,773 5,669,128 6,407,031 7,341,372 8,310,064 -126,826 -143,102 -162,752 -199,499 -248,814 4,692,947 5,526,026 6,244,279 7,141,873 8,061,249 1,791 1,777 1,955 2,150 2,365 74,693 83,434 87,606 91,986 96,585 1,590 1,534 1,381 1,243 1,118 10,790 17,825 16,043 14,438 12,994 680,717 284,418 298,639 313,571 329,249 9,623,355 10,810,317 12,674,238 14,763,105 17,215,818 8,001,323 9,075,369 10,708,935 12,636,544 14,911,122 812,911 751,590 774,262 797,627 821,707 98,644 93,315 173,315 173,315 173,315 8,912,878 9,920,274 11,656,513 13,607,486 15,906,144 151,457 189,138 208,052 228,857 251,743 9,064,335 10,109,412 11,864,565 13,836,343 16,157,886 3,545 4,113 4,524 4,977 5,474 233,689 250,011 250,011 250,011 250,011 0 0 0 0 0 88,907 142,898 212,497 294,258 388,632 47,205 53,052 72,063 85,084 97,222 185,640 250,831 270,577 292,432 316,593 555,441 696,792 805,149 921,785 1,052,458 9,623,355 10,810,317 12,674,238 14,763,105 17,215,818 72,156 64,712 66,217 73,653 87,621 Notes
60.2 5.8
62.5 6.4
59.8 6.4
58.1 6.2
55.7 6.1
1.5 0.50 1.32 175.8 9.3 11.7
1.1 0.45 1.32 221.1 10.4 12.7
1.0 0.55 1.28 245.8 9.9 13.1
1.0 0.58 1.35 270.9 9.2 11.8
1.1 0.65 1.45 284.0 9.0 11.2
27.4 23.6 28.8 27.4 25.5
17.8 17.7 11.3 12.3 13.4
13.0 17.7 17.5 17.2 18.0
14.4 16.8 16.7 16.5 18.0
12.9 16.9 16.9 16.6 18.0
0.46 0.46 0.46 0.20 0.70 2.38 2.38 2.32
0.56 0.56 0.56 0.21 0.85 2.79 2.79 2.71
0.64 0.64 0.64 0.29 0.97 3.22 3.22 3.15
0.76 0.76 0.76 0.34 1.15 3.69 3.69 3.62
0.86 0.86 0.86 0.39 1.35 4.21 4.21 4.15
62
June 24, 2011
Asset mix restructuring required to reduce hidden risk on capital, cut to NEUTRAL
The shadow banking system is at risk of regulatory tightening given its credit supply to the system may discount the effectiveness of liquidity control by loan quota. Entrusted loans take up 43% of shadow loans. CCB's entrusted loan exposure is around 14% of its total loans, the highest proportion among all H-share listed banks.
LGFV loans higher proportion from lower grade

The unconfirmed government bailout plan to carve out RMB2-3tn LGFV loans and PBOCs financial report that total LGFV loans may reach as much as RMB14tn (instead of RMB9tn as suggested by the CBRC) shadowed the markets confidence on the LGFV loan quality of Chinese banks, albeit with healthy NPL ratios. While Chinese banks, including CCB, are reporting declining LGFV loans, with managements efforts at recycling and restructuring into commercial loans, we believe risks still exist as 50% of the LGFV loans only mature in 2012-2014, approximately 20% are backed by land use rights and more than 20% of the local governments disposable income is from land sales. In a worst case scenario, if Chinese banks are required to write off and charge higher provisions on lower-grade LGFV loans (those with basic, partial and no coverage), CCB would see a 34% reduction in PBT for 2011F, the highest among Chinese banks, owing to its higher proportion of lower-grade LGFV loans to total loans.
Fig. 76: Lower-grade LGFV loans to total loans Fig. 77: Impact on 2011F PBT in our worse case on LGFV loans
50% 40% 30% 20%
6% 5% 4% 3% 2% 1% 0%
10% 0%
Minsheng
CMB
BOC
BCOM
BCOM
Source: Nomura research, company report
Minsheng
CRCB
New CAR rule penalised by its bias towards long-term and corporate loans
We estimate CCBs Tier-1 ratio in 2010 will be mostly negatively impacted by the requirement to include operating risk in risk weighted assets (86bps), followed by the upward revision of risk weighting for property loans (34bps) and corporate loans over five years (25bps). On the other hand, CCBs Tier-1 ratio can increase by 24bps with the reduced risk weighting on retail loans (excluding personal mortgages) and small enterprise loans. In all, we forecast a 131bps drop in the Tier-1 ratio if the new CAR rule is implemented. The unfavourable change for CCB is the highest among H-share listed banks.
CRCB
63
ICBC
CCB
ICBC
CMB
BOC
ABC
Citic
CCB
Citic
ABC
June 24, 2011
CCB has been traditionally positioned to finance infrastructure projects in China. As at end-2010, property and infrastructure loans reached 30.3% of its total loans. Since most loans have a long maturity period, we believe it will take longer for CCB to improve its asset mix to reduce the negative impact from the new CAR rule.
Fig. 78: Impact on 2010 RWA and Tier-1 ratio by new CAR rule
Retail claims excluding Operating mortgage risk 277,695 -69,424 -1.2% 12
2010 (RMB mn) Total exposure Incremental RWA % to RWA Tier 1 impact (bps)
Property Interbank 402,922 201,461 3.3% -34 323,355 67,206 1.1% -11
Corporate loan over 5 years SME 976,838
Total
43,242 283,456 540,526 -70,864 9.0% -86 -1.2% 12
146,526 815,431 2.4% -25 13.6% -131
Source: Company report, Nomura research
Entrusted loans risk from tightened regulations on shadow bank loans

Entrusted loans are deemed as one of the shadow banks, in a sense that it is the credit supply outside the banking system. (Banks do not assume guarantee / credit risk in the contractual agreement.) Entrusted loans account for a significant share of the total shadow banking system, given its estimated loan size reached 43% of shadow loans in 2010. Recent news (Chinese-language report in 21st Century Business Herald dated 9 June) on the new capital framework has triggered market concerns on a stricter regulatory framework. If PBOC moves liquidity control from bank loans to total social financing (including some shadow banks like entrusted loans), we believe CCB may be the largest sufferer, given that total entrusted loans accounted for around 14% of its total loans in 2010. If entrusted loans are charged 50% risk weighting to calculate the RWA (from the current 0%), CCBs Tier-1 ratio would be reduced by approximately 60bps, more than double that of Citic Bank which has the second highest Tier-1 ratio.
Fig. 79: Entrusted loans as % of total loans (2010)
ABC, CRCB, BOC did not release the data
Fig. 80: Tier-1 impact on risk weighting charged at 50%

(bps) 70 60 50 40 30 20 10 0
16% 14% 12% 10% 8% 6% 4% 2% 0% ICBC CCB CMB Bocom Citic Minsheng
ICBC
CCB
CMB
Bocom
Citic
Minsheng
64
June 24, 2011
Moderate net interest margin expansion

We expect the net interest margin of Chinese banks to peak in 2Q11. We believe CCBs pressure of rising costs mainly stems from deposit re-pricing. The daily monitor of LDR, starting from June, is likely to have a limited impact on CCB given that the LDR ratio of the big four banks is only 59% as at end-April, compared with an average 81.5% for the medium and small state-owned banks. CCB also stands to benefit from the rise in the inter-bank rate, given that it is one of the largest money market maker and net lender in the inter-bank market. Nevertheless, the net interest margin in April declined marginally, which can be attributed to a 14bps hike in demand deposits and the progressive re-pricing of savings deposit after the first interest rate hike in last October. While NIM may have recovered in May and June, we expect only a moderate expansion in 2Q11. Our FY11F NIM forecast for CCB is 2.60% more conservative than managements guidance of 2.69% as we factor in an asymmetric interest rate increase given the stretched RRR ratio and market expectations of an elevated inflation level.
BOA unlock to expire soon

As of 31 Mar, 2011, Bank of America (BOA) holds 25.6bn H-shares of CCB, representing 10.2% of the total number of H-shares. Those shares will be unlocked on 29 August, 2011. Based on the closing price of 21 June, the total amount equals 103x the threemonth average daily trading turnover. We estimate a capital shortfall US$25bn by BOA, if it is required to raise its Tier-1 common equity ratio to 10% (for a global systematically important bank) immediately. The disposal of 25.6bn shares, if completed, would reward BOA investment gains and incremental equity of approximately US$13bn, on our reading. Valuation methodology and investment risks Our target price of HKD7.02 (previously HK$8.60) is based on 1.75x P/BV multiplier and FY11F BVPS of CNY3.22. Our sustainable ROE assumption is 15.5%. We use the Gordon Growth Model [target P/BV = (sustainable ROE - long-term growth)/(cost of equity - long-term growth)] to derive our fair P/BV range, assuming a cost of equity of 12.7% and a terminal growth rate of 7.8%. We derive our terminal growth figure by applying a 50% payout ratio to our long-term sustainable ROE. Downside risks: We believe that more severe-than-expected macro tightening could result in a sharp increase in bad debt costs. In addition, a slowing economy would have negative implications for loan growth and could lead to a significant rise in NPLs, in our view. Upside risks: a peak and reversing CPI is likely to reduce the possibility of asymmetric interest rate hike.
65
Bank of China (H-share)

BANKS
3988.HK 3988 HK
EQUITY RESEARCH
Mild NIM expansion expected in 2Q11F
Reiterate BUY on current dips
Buy
HKD 5.20 HKD 3.77 +37.9%
Action: Mild NIM rebound in 2Q11F; reiterate BUY with TP at HKD5.20 For 1Q11, BOC reported 3bp q-q NIM contraction. Per management, NIM continued to narrow in April by 1bp on a 10bp increase in demand deposits, but started to rebound in May. For 2Q11F, management guided for 1-2bp q-q NIM expansion. We, therefore, lower our FY11F NIM expansion forecast by 1bp to 7bps y-y, bringing our earnings forecast down by 2%. Currently trading at 1.2x FY11F P/BV, the lowest among the Big 4, BOC offers an undemanding valuation, in our view. Reiterate BUY. Catalysts Further rounds of rate hikes (if symmetric) to boost NIM in FY11F. Potentially slower growth in offshore RMB business Total RMB deposits in Hong Kong reached RMB511bn as at end-April 2011, accounting for 8.0% of total deposits in Hong Kong (up from 5.2% as at end-2010). However, we note the slower monthly growth pace of 1017% m-m this year, versus 13-45% m-m in 2H10, which may signal slower offshore RMB business in Hong Kong. However, given the PBOC is planning to expand the cross-border RMB settlement plan, we think the overall impact will be neutral. RMB32bn subordinated bonds issuance completed As of 31 March, 2011, BOCs CAR stood at 12.4%. In May, the bank completed the issuance of RMB32bn in subordinated bonds to strengthen its supplementary capital. According to our estimates, BOCs CAR will climb by 0.5pp and reach 12.8% by end-FY11.
Anchor themes The operating environment remains favourable for Chinese banks in 2011F, but negative sentiment from uncertainties over policies and asset quality continues to weigh on valuations. Better visibility on regulatory policies (capital and provisioning) could trigger a rerating in the near term. Nomura vs consensus Our net profit forecast is 2% above consensus estimates due to our higher NIM and lower credit cost assumptions.
Research analysts
31 Dec Currency (CNY)
FY10 Actual Old
FY11F New Old
FY12F New Old
FY13F New
Nomura | ASIA Bank of China (H-share)
June 24, 2011
Key data on Bank of China (H-share)

FY09 261,424 -102,543 158,881 46,013 5,849 21,827 73,689 232,570 FY10 313,533 -119,571 193,962 54,483 3,491 24,582 82,556 276,518 FY11F 409,293 -182,259 227,033 78,440 4,740 16,217 99,397 326,430 FY12F 495,549 -228,682 266,867 98,498 6,760 17,565 122,823 389,690 FY13F 572,611 -265,518 307,093 122,533 8,893 19,028 150,454 457,547 Notes
Enhancing ROE
-107,307 125,263 -14,987 110,276 821 111,097 -25,748 85,349 -4,530
-122,409 154,109 -12,993 141,116 1,029 142,145 -32,454 109,691 -5,273
-135,928 190,502 -31,502 159,001 1,132 160,133 -36,387 123,746 -5,800
-160,913 228,777 -36,686 192,092 1,245 193,337 -44,356 148,981 -6,380
-193,308 264,240 -44,197 220,042 1,307 221,350 -51,079 170,271 -7,018
80,819 80,819 -35,537 45,282
104,418 104,418 -40,755 63,663
117,945 117,945 -53,075 64,870
142,600 142,600 -64,170 78,430
163,252 163,252 -73,464 89,789
10.4 17.6 10.4 4.2 1.6 1.6 2.04 3.36 1.41 1.94 31.7 46.1 23.2 44.0 16.5 1.03 22.5 1.40
8.3 14.1 8.3 4.5 1.4 1.4 2.07 3.34 1.37 1.97 29.9 44.3 22.8 39.0 18.0 1.09 24.3 1.47
7.3 12.4 7.3 6.1 1.2 1.2 2.14 3.87 1.81 2.06 30.4 41.6 22.7 45.0 17.4 1.05 23.5 1.42
5.7 9.7 5.7 7.8 1.0 1.0 2.23 4.14 1.98 2.16 31.5 41.3 22.9 45.0 19.1 1.11 25.7 1.49
4.9 8.3 4.9 9.2 0.9 0.9 2.27 4.23 2.01 2.22 32.9 42.2 23.1 45.0 19.6 1.09 26.4 1.48
(HKD) 5.2 5 4.8 4.6 4.4 4.2 4 3.8 3.6 N ov 10 M ar 11 A pr 11 M ay 11 A ug 10 S ep 10 J an 11 F eb 11 D ec 10 J un 11 O c t 10 J ul 10 Price Rel MSCI China 108 106 104 102 100 98 96 94 92 90
1M -11.7 -11.9 -4.4 122,835.4 67.3 4.88/3.69 152.29
3M -8.0 -8.0 -4.2
12M -7.8 -8.0 -7.9
-2.5 11.7 10.2 -4.7 25.6 25.6 25.6
22.1 12.0 14.1 23.0 29.2 23.1 23.1
17.1 20.4 11.0 23.6 13.0 7.8 7.8
17.5 23.6 18.4 20.1 20.9 20.9 20.9
15.1 22.5 20.1 15.5 14.5 14.5 14.5
Estimated free float (%) 52-week range (HKD) 3-mth avg daily turnover (USDmn) Major shareholders (%) Huijin HKSCC Nominees
67.5 21.8
67
June 24, 2011
BalanceSheet(CNYmn)
FY09 434,351 223,444 1,111,351 1,816,679 36,099 4,910,358 -112,950 4,797,408 10,668 109,954 FY10 636,126 213,716 1,573,922 2,055,324 42,469 5,668,478 -130,713 5,537,765 12,631 123,568 FY11F 1,147,608 213,716 1,762,793 2,160,527 42,469 6,326,213 -147,408 6,178,805 14,147 129,746 FY12F 1,842,813 213,716 1,974,328 2,271,186 42,469 7,217,779 -170,776 7,047,003 15,844 136,234 FY13F 2,643,804 213,716 2,211,247 2,387,588 42,469 8,136,415 -183,633 7,952,782 17,746 143,045 Notes
211,989 264,344 291,018 320,488 8,751,943 10,459,865 11,940,829 13,864,081 6,620,552 7,483,254 8,582,500 10,103,239 1,126,963 1,549,126 1,780,220 2,045,824 175,599 247,922 304,605 332,225 7,923,114 9,280,302 10,667,324 12,481,288 283,435 503,413 530,304 558,763 8,206,549 9,783,715 11,197,628 13,040,051 30,402 31,985 34,166 36,565 253,839 279,147 279,147 279,147
353,059 15,965,456 11,745,637 2,351,098 363,368 14,460,104 588,895 15,048,998 39,204 279,147
65,221 107,600 160,150 227,485 307,980 35,537 40,755 53,075 64,170 73,464 160,395 216,663 216,663 216,663 216,663 514,992 644,165 709,035 787,465 877,254 8,751,943 10,459,865 11,940,829 13,864,081 15,965,456 76,006 63,965 62,319 69,707 73,926
74.2 5.9
75.7 6.2
73.7 5.9
71.4 5.7
69.3 5.5
1.5 0.31 1.29 148.6 9.1 11.1
1.1 0.23 1.25 204.4 10.1 12.6
1.0 0.50 1.23 236.5 9.7 12.8
1.0 0.51 1.23 245.0 9.4 12.2
0.9 0.54 1.15 248.4 9.1 11.7
50.4 21.6 29.8 25.9 29.8
15.4 18.0 17.1 19.5 13.0
11.6 9.9 14.9 14.2 14.7
14.1 11.5 17.0 16.1 17.7
12.9 10.9 15.9 15.2 16.3
0.32 0.32 0.32 0.14 0.49 2.03 2.03 2.03
0.39 0.39 0.39 0.15 0.58 2.31 2.31 2.31
0.42 0.42 0.42 0.19 0.68 2.54 2.54 2.54
0.51 0.51 0.51 0.23 0.82 2.82 2.82 2.82
0.58 0.58 0.58 0.26 0.95 3.14 3.14 3.14
68
June 24, 2011
Mild NIM expansion expected in 2Q11F

Given higher funding costs, we expect BOC to see mild sequential NIM expansion in 2Q11F (management guided for 1-2bp q-q expansion). We, therefore, lower our NIM expansion forecast for FY11F by 1bp to 7bps y-y, bringing our earnings forecast down by 2%. Currently trading at 1.2x FY11F P/BV, the lowest among the Big 4, BOC offers an undemanding valuation, in our view. Reiterate BUY.
Mild NIM rebound in 2Q11F; reiterate BUY with TP at HKD5.20

For 1Q11, BOC reported 3bp q-q NIM contraction, partly due to lower margins in overseas business. Per management, NIM continued to narrow in April by 1bp on a 10bp increase in demand deposits, but started to rebound in May. For 2Q11F, management guided for 1-2bp q-q NIM expansion. We, therefore, lower our FY11F NIM expansion forecast by 1bp to 7bps y-y, bringing our earnings forecast down by 2%. Currently trading at 1.2x FY11F P/BV, the lowest among the Big 4, BOC offers undemanding valuation, in our view. Reiterate BUY.
Fig. 81: BOC: earnings revisions
Revised 2012F 266,867 98,498 122,823 389,690 (160,913) 228,777 (36,686) 1,245 193,337 (44,356) (6,380) 142,600 Previous 2012F 268,816 98,498 122,823 391,639 (161,014) 230,625 (36,686) 1,245 195,185 (44,799) (6,380) 144,005 Change (%) 2012F (0.7) 0.0 0.0 (0.5) (0.1) (0.8) 0.0 0.0 (0.9) (1.0) 0.0 (1.0)
Profit & Loss (RMBmn, except %) Net interest income Fee income Non-interest income Operating Income Operating Expenses PPOP Provisions Associated Companies Operating pre-tax Profit tax Minority Interest Profits attributable to equity holders
2011F 227,033 78,440 99,397 326,430 (135,928) 190,502 (31,502) 1,132 160,133 (36,387) (5,800) 117,945
2013F 307,093 122,533 150,454 457,547 (193,308) 264,240 (44,197) 1,307 221,350 (51,079) (7,018) 163,252
2011F 227,567 78,440 99,397 326,964 (135,955) 191,008 (28,482) 1,132 163,658 (37,233) (5,800) 120,625
2013F 309,176 122,533 150,454 459,631 (193,416) 266,215 (44,197) 1,307 223,325 (51,553) (7,018) 164,753
2011F (0.2) 0.0 0.0 (0.2) (0.0) (0.3) 10.6 0.0 (2.2) (2.3) 0.0 (2.2)
2013F (0.7) 0.0 0.0 (0.5) (0.1) (0.7) 0.0 0.0 (0.9) (0.9) 0.0 (0.9)
Potentially slower growth in offshore RMB business

Total RMB deposits in Hong Kong reached RMB511bn as at end-April 2011, accounting for 8.0% of total deposits in Hong Kong (up from 5.2% as at end-2010). However, we note the slower monthly growth pace of 10-17% m-m this year, versus 13-45% m-m in 2H10, which may signal slower offshore RMB business in Hong Kong. However, given the PBOC is planning to expand the cross-border RMB settlement plan, we think the overall impact will be neutral.
69
June 24, 2011
Fig. 82: RMB deposits in Hong Kong

(RMBmn) 600,000 500,000 400,000 300,000 200,000 100,000 0 Total deposit m-m growth (%) (%) 50 40 30 20 10 0 (10)
Fig. 83: RMB settlement for cross-border trade

(RMBbn) 400 350 300 250 200 150 100 50 0 1Q10 2Q10 3Q10 4Q10 1Q11 RMB Settlement for Cross Border Trade
Source: HKMA, Nomura research
Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11
RMB32bn subordinated bonds issuance completed

As of 31 March, 2011, BOCs CAR stood at 12.4%. The bank obtained approval by CBRC and PBOC on 9 May 2011 and completed the issuance of RMB32bn in subordinated bonds on 19 May 2011. According to our estimates, BOCs CAR will climb by 0.5pp and reach 12.8% by end-FY11, a level that will better prepare the bank for potentially tighter requirements under the new capital rules.
Valuation methodology and risks

We derive our target price of HKD5.20 by applying a target P/BV of 1.64x to our FY11F BVPS forecast of CNY2.54. Our sustainable ROE assumption is 14.9%. We use the Gordon Growth Model [target P/BV= (sustainable ROE - long-term growth)/(cost of equity - long-term growth)] to derive our fair P/BV range, assuming a cost of equity of 12.0% and a terminal growth rate of 7.4%. We derive our terminal growth rate by applying a 50% payout ratio to our long-term sustainable ROE. Downside risks. We believe that more-severe-than-expected macro tightening could result in a sharp rise in bad debt costs. Any downturn in the global economy, and especially Hong Kongs economy, could also weigh on the banks earnings performance given its bigger foreign exposure relative to that of peers.
70
Bank of Communications
BANKS
3328.HK 3328 HK
EQUITY RESEARCH
No surprise expected in 2Q11F; remain Neutral
No upside surprise expected in NIM expansion; NEUTRAL maintained

Action & Valuation: No surprise expected in 2Q11F; lower NIM forecast with TP reduced to HKD8.30; maintain NEUTRAL In 1Q11, BOCOM suffered from rising funding costs, which led to a q-q flattish NIM of 2.51% and a marginal increase (+1% q-q) in net interest income. Though the lending rate in 2Q11 continued its upward trend given recent rate hikes and improving pricing power, the positive impacts are largely offset by rapidly rising funding costs, especially after 3 RRR hikes in 2Q11. Meanwhile, a 10bp increase in the demand deposit rate in the latest rate hike in April and potential asymmetric rate hike (if any in 2H) could also weigh on NIM gains. We therefore bring down our FY11F NIM expansion forecast by 3bp to 6bp y-y and earnings by 5%. As a result, we lower our target price by 7.8% to HKD8.30. NEUTRAL maintained. Impact of new rules on risk weighting The CBRC introduced 10 new measures to enhance financing services to small enterprises in early June, including lowering the risk weighting of loans to small enterprises (100% 75% under internal approach). Meanwhile, the CBRC is also drafting the new capital rules. Based on our analysis, BOCOM may need to replenish RMB22bn of its T1 capital in order to reach the new requirement of 9.5%. Overall, we view the new capital rules to be slightly negative to BOCOM, as a RMB22bn capital raising represents potential 3.3% dilution on FY11F and FY12F EPS and 0.8ppt dilution on FY11F and FY12F ROE, respectively. Catalysts Further rounds of rate hikes (if symmetric) could boost NIM in FY11F.
Neutral
HKD 8.30 HKD 7.24 +14.6%
Anchor themes The operating environment remains favourable for Chinese banks in 2011F, but negative sentiment from uncertainties over policies and asset quality continues to weigh on valuations. Better visibility on regulatory policies (capital and provisioning) could trigger a rerating in the near term. Nomura vs consensus Our FY12F NPAT forecast is 10% lower than consensus due to lower NIM and higher credit cost assumptions.
Research analysts
62,200 39,042 39,042 0.74 20.7 8.4 1.5 1.5 3.0 20.2 1.1
75,552 46,225 46,225 0.78 5.5 N/A N/A N/A N/A 19.4 1.1
73,768 43,931 43,931 0.74 0.2 8.0 1.4 1.4 4.8 18.5 1.0
89,326 54,413 54,413 0.88 12.4 N/A N/A N/A N/A 20.4 1.1
85,334 104,117 50,523 50,523 0.82 9.8 6.9 1.2 1.2 5.8 19.1 1.0 62,647 62,647 1.01 15.1 N/A N/A N/A N/A 20.9 1.0
97,462 57,098 57,098 0.92 13.0 5.9 1.1 1.1 6.8 19.4 0.9
Nomura | ASIA Bank of Communications
June 24, 2011
Key data on Bank of Communications

FY09 116,743 -50,075 66,668 11,399 2,126 1,385 14,910 81,578 0 -32,022 0 49,556 -11,255 0 38,301 0 0 38,301 -8,047 30,254 -136 0 0 30,118 0 30,118 -9,799 20,319 FY10 141,905 -56,910 84,995 14,479 1,245 3,425 19,149 104,144 0 -41,944 0 62,200 -12,246 0 49,954 0 0 49,954 -10,782 39,172 -130 0 0 39,042 0 39,042 -10,525 28,517 FY11F 174,584 -74,159 100,425 18,488 1,121 3,599 23,208 123,633 0 -49,865 0 73,768 -16,898 0 56,870 0 0 56,870 -12,796 44,074 -143 0 0 43,931 0 43,931 -17,630 26,301 FY12F 207,241 -90,359 116,883 23,539 1,008 3,783 28,330 145,212 0 -59,878 0 85,334 -19,940 0 65,394 0 0 65,394 -14,714 50,680 -157 0 0 50,523 0 50,523 -20,272 30,251 FY13F 239,903 -105,813 134,091 29,895 908 3,975 34,778 168,868 0 -71,407 97,462 -23,564 0 73,898 0 0 73,898 -16,627 57,271 -173 0 0 57,098 0 57,098 -22,908 34,189 Notes
We expect a moderate expansion of 9bp in FY11F NIM.
10.3 12.7 10.3 3.2 1.9 1.9 2.26 3.96 1.78 2.18 18.3 39.3 21.0 32.5 19.2 1.01 24.4 1.28
8.4 10.3 8.4 3.0 1.5 1.5 2.46 4.11 1.72 2.38 18.4 40.3 21.6 27.0 20.2 1.08 25.8 1.38
8.0 9.8 8.0 4.8 1.4 1.4 2.51 4.37 1.97 2.40 18.8 40.3 22.5 40.1 18.5 1.02 24.0 1.32
6.9 8.5 6.9 5.8 1.2 1.2 2.57 4.55 2.13 2.42 19.5 41.2 22.5 40.1 19.1 0.99 24.7 1.29
5.9 7.3 5.9 6.8 1.1 1.1 2.60 4.65 2.20 2.45 20.6 42.3 22.5 40.1 19.4 0.95 25.1 1.23
(HKD) 9.5 9 8.5 8 7.5 7 N ov 10 M ar 11 A pr 11 M ay 11 A ug 10 S ep 10 J an 11 F eb 11 D ec 10 J un 11 O c t 10 J ul 10 Price Rel MSCI China 105 100 95 90 85 80 75
(%) Absolute (HKD) Absolute (USD) Relative to index Market cap (USDmn) Estimated free float (%) 52-week range (HKD) 3-mth avg daily turnover (USDmn) Major shareholders (%) MOF HSBC
1M -9.5 -9.7 -2.2 45,538.3 62.9 9.53/7.18 33.45
3M -8.4 -8.3 -4.5
12M -18.6 -18.7 -18.6
1.2 30.6 3.7 6.8 6.1 6.1 6.1
27.5 28.4 31.0 25.5 29.6 20.7 20.7
18.2 21.2 18.9 18.6 12.5 0.2 0.2
16.4 22.1 20.1 15.7 15.0 9.8 9.8
14.7 22.8 19.3 14.2 13.0 13.0 13.0
26.5 18.6
72
June 24, 2011
BalanceSheet(CNYmn)
FY09 13,050 222,671 421,946 778,131 0 1,839,314 -37,776 1,801,538 0 29,878 0 5,821 36,102 3,309,137 2,372,055 715,547 0 3,087,602 57,110 3,144,712 577 48,994 0 16,247 9,799 88,808 163,848 3,309,137 25,009 FY10 17,597 262,976 568,957 814,551 0 2,236,927 -46,437 2,190,490 0 33,911 0 7,341 55,770 3,951,593 2,867,847 783,411 0 3,651,258 76,678 3,727,936 884 56,260 0 19,416 10,525 136,572 222,773 3,951,593 24,988 FY11F 24,828 302,422 802,780 898,308 0 2,591,009 -59,522 2,531,487 0 35,607 0 6,607 58,559 4,660,598 3,498,773 840,701 0 4,339,474 69,874 4,409,348 0 61,886 0 38,613 17,630 133,122 251,251 4,660,598 26,195 FY12F 33,455 347,786 1,081,711 990,787 0 3,025,925 -73,846 2,952,079 0 37,387 0 5,946 61,486 5,510,638 4,268,503 899,926 0 5,168,430 63,902 5,232,332 0 61,886 0 66,221 20,272 129,927 278,306 5,510,638 29,003 FY13F 44,535 399,954 1,439,965 1,092,910 0 3,519,603 -89,227 3,430,375 0 39,256 0 5,352 64,561 6,516,907 5,207,574 941,193 0 6,148,767 58,628 6,207,395 0 61,886 0 97,775 22,908 126,943 309,512 6,516,907 33,913 Notes
Benign asset quality.
77.5 5.0
78.0 5.6
74.1 5.4
70.9 5.1
67.6 4.7
1.4 0.61 1.14 151.0 8.2 12.0
1.1 0.55 1.18 185.8 9.4 12.4
1.0 0.65 1.28 227.2 8.9 12.0
1.0 0.66 1.34 254.6 8.7 11.7
1.0 0.67 1.37 263.1 8.5 11.2
38.7 23.6 24.2 23.3 27.1
21.6 19.0 18.3 19.4 20.9
15.6 18.2 18.8 17.9 22.0
16.6 18.5 19.1 18.2 22.0
16.2 18.4 19.0 18.3 22.0
0.61 0.61 0.61 0.20 1.01 3.34 3.34 3.23
0.74 0.74 0.74 0.19 1.18 3.96 3.96 3.83
0.74 0.74 0.74 0.28 1.25 4.06 4.06 3.95
0.82 0.82 0.82 0.33 1.38 4.50 4.50 4.40
0.92 0.92 0.92 0.37 1.57 5.00 5.00 4.91
73
June 24, 2011
No upside surprise expected in NIM expansion

Given the positive impact from improving pricing power largely offset by rising funding costs, we do not expect any upside surprise in BOCOMs NIM expansion in 2Q11F. We expect a rise in the demand deposit rate and a potential asymmetric rate hike later in the year could continue to be a drag BOCOMs NIM expansion. We have lowered our NIM and earnings forecast, and have reduced our target price to HKD8.30.
Lower NIM forecast with PT reduced to HKD8.30; maintain NEUTRAL

No surprise expected in 2Q11F; NEUTRAL maintained In 1Q11, BOCOM suffered from rising funding costs which led to a q-q flattish NIM of 2.51% and a marginal increase (+1% q-q) in net interest income. Though lending rate in 2Q11 continued its upward trend given recent rate hikes and improving pricing power, the positive impact are largely offset by rapidly rising funding costs especially after 3 RRR hikes in 2Q11. Meanwhile, a 10bp increase in demand deposit rate in the latest rate hike in April and potential asymmetric rate hike later in the year would also drag NIM expansion. We therefore brought down our FY11F NIM forecast by 3bp to 6bp y-y and earnings by 5%. As a result, we lowered our PT by 7.8% to HKD8.30. NEUTRAL maintained.
Fig. 84: BOCOM: earnings revision
Lower NIM forecasts
Profit & Loss (RMBmn, except %) Net interest income Fee income Non-interest income Operating Income Operating Expenses PPOP Provisions Operating pre-tax Profit tax Minority Interest Profits attributable to equity holders
2011F 100,425 18,488 23,208 123,633 (49,865) 73,768 (16,898) 56,870 (12,796) (143) 43,931
Revised 2012F 116,883 23,539 28,330 145,212 (59,878) 85,334 (19,940) 65,394 (14,714) (157) 50,523
2013F 134,091 29,895 34,778 168,868 (71,407) 97,462 (23,564) 73,898 (16,627) (173) 57,098
2011F 101,745 18,488 23,208 124,953 (49,400) 75,552 (15,723) 59,829 (13,462) (143) 46,225
Previous 2012F 119,746 23,539 28,330 148,075 (58,749) 89,326 (18,913) 70,413 (15,843) (157) 54,413
2013F 138,611 29,895 34,778 173,388 (69,272) 104,117 (23,059) 81,057 (18,238) (173) 62,647
2011F (1.3) 0.0 0.0 (1.1) 0.9 (2.4) 7.5 (4.9) (4.9) 0.0 (5.0)
Change (%) 2012F (2.4) 0.0 0.0 (1.9) 1.9 (4.5) 5.4 (7.1) (7.1) 0.0 (7.1)
2013F (3.3) 0.0 0.0 (2.6) 3.1 (6.4) 2.2 (8.8) (8.8) 0.0 (8.9)
Pricing level of new loans We understand that in 2Q11 there are 7% new domestic RMB loans priced below benchmark, 38% at benchmark and 55% above benchmark. The figures show an obvious improvement in pricing power, as the proportion in 1Q11 was 20%, 34% and 46%, respectively. The percentage of new loans priced at and above benchmark further increased to 93%, up from 80% in 1Q11.
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June 24, 2011
Fig. 85: BOCOM: quarterly NIM

NIM remained flattish q-q in 1Q11
Fig. 86: BOCOM: % of new RMB loans at benchmark interest rates and above benchmark interest rates
Improving pricing power
(%) 2.52 2.50 2.48 2.46 2.44 2.42 2.40 2.38 2.36 1Q10 2Q10 3Q10 4Q10 1Q11
(%) 100 90 80 70 60 50 40 30 20 10 0 FY10

1Q11
2Q11
Impact of new rules on risk weighting

The CBRC introduced 10 new measures to enhance financing services to small enterprises in early June, including lowering the risk weighting of loans to small enterprises (from 100% to 75% under an internal approach). Based on our analysis, we believe the new measure could raise BOCOMs CAR by around 13bp, assuming the internal approach is applied in FY10. Meanwhile, the CBRC is also drafting the new capital rules. Overall, we view the new capital rules to be slightly negative to BOCOM, as a RMB22bn capital raising represents potential 3.3% dilution on FY11F and FY12F EPS and 0.8ppt on FY11F and FY12F ROE, respectively.
More emphasis on small and micro enterprises

Total loans and deposits at end 1Q11 grew by 17.2% y-y and 18.5% y-y, respectively. Management did not disclose a specific loan target for this year, but said the growth rate would remain largely the same through the year with more emphasis on small and micro enterprises. According to management, new domestic RMB loans extended to small and micro enterprises surged by 17.8% q-q, 13.0pp higher than that of overall loan growth (+4.8% q-q). Management expects the trend to continue for the remainder of FY11F. We think this is positive for BOCOMs NIM, as loans to small businesses generally have higher lending rates. According to the management, loan yields to small and micro enterprises are on average 70bp higher than the banks overall loan yields.
Limited pressure from loan-related financial products

CBRC released further rules on trust loans in January 2011 and required commercial banks to move the off-balance sheet credit-related bank-trust corporation products to their books by the end of 2011. We understand that BOCOM has relatively less exposure to such products. At the end of 1Q11, the total amount was RMB17.3bn, equal to 0.74% of total loans. We think the bank could continue to compress the size of these products as required by CBRC (according to the requirement released earlier in last August), and the exposure is not substantial. According to management, BOCOM is not going to move the amount to the balance sheet until 4Q11F. By then, they will do a one-off adjustment to the balance sheet. In our view, the impact on the banks provision, RWA and overall loan growth would be limited
75
June 24, 2011
given the amount of these products is not substantial. Besides, one-off adjustment by year-end could avoid potential pressure on quarterly results, in our view. Assuming the amount of credit-related bank-trust corporation products remain the same until the end of the year (which is a conservative assumption), we estimate the impact would be 0.7% on FY11F NPAT (assuming 2% provision), 0.6% on FY11F RWA (assuming 100% risk weight) and 4.8% on net new loans in FY11F.
76
China Merchants Bank

BANKS
3968.HK 3968 HK
EQUITY RESEARCH
Robust fee income growth to continue in 2Q11
Margin expansion facing headwinds from potential asymmetric rate hikes

Action: Downgrade FY11F NPAT and cut TP to HKD24.82 We revise lower our FY11F NPAT by 4.5% to CNY33bn (up by 28.1% y-y) to reflect our more cautious view on NIM expansion in FY11F we expect 12bps versus 20bps previously given that our economics team now sees more asymmetric rate hikes going forward. Consequently, we cut our TP from HKD26.86 to HKD24.82. We expect margin expansion to be constrained by potential asymmetric rate hikes, given CMBs assetsensitive balance sheet, especially with rates in time deposits rising, and could attract depositors to shift funds from demand deposits to time deposits. While we expect NIM to peak in 2Q11F, we believe fee income growth should remain strong throughout the quarter, due mainly to rapid growth in the wealth management business. We believe the SME business is likely to continue to grow rapidly given strong lending demand and higher loan yields. Thus, we maintain our BUY rating on the stock. Catalysts Announcement of a capital-raising plan could ease market concerns and trigger a re-rating in the near term. Valuation The stock is underperforming peers, having dropped 8.2% YTD vs the sectors decline of 4.1%, due largely to the overhang of capital raising. We believe a realistic size for its capital raising plan is around CNY40bn in the form of A+H share rights issues, which we estimate would have a dilution effect of 2.8pp on FY11F ROE and 11.5% on FY11F EPS. The share price is currently at a four-month trough. We reiterate our BUY rating.
Buy
HKD 24.82 HKD 18.08 +37.3%
Anchor themes The operating environment remains favorable for Chinese banks in 2011F, but negative sentiment from uncertainties over policies and asset quality continues to weigh on valuations. Better visibility on capital raising plan could trigger a re-rating in the near term. Nomura vs consensus Our FY12F net profit forecast is 3% above consensus estimates due to our higher NIM and lower credit cost assumptions.
Research analysts
38,780 25,769 25,769 1.19 33.3 13.0 2.5 2.5 1.9 22.7 1.2
52,125 34,561 34,561 1.60 34.1 N/A N/A N/A N/A 23.4 1.3
49,908 33,007 33,007 1.53 28.1 9.7 1.9 1.9 3.1 22.5 1.2
65,559 43,127 43,127 2.00 24.8 N/A N/A N/A N/A 24.2 1.3
63,763 4 ,089 42,089 1.95 27.5 7.2 1.5 1.5 4.2 23.9 1.3
81,176 52,905 52,905 2.45 22.7 N/A N/A N/A N/A 24.6 1.4
78,961 51,281 51,281 2.38 21.8 5.8 1.3 1.3 5.2 24.1 1.3
Nomura | ASIA China Merchants Bank
June 24, 2011
Key data on China Merchants Bank

FY09 65,838 -25,474 40,364 7,993 1,318 2,173 11,484 51,848 0 -26,562 25,286 -3,073 102 22,315 0 69 22,384 -4,149 18,235 0 0 0 18,235 0 18,235 -4,015 14,220 FY10 84,513 -27,437 57,076 11,330 1,947 1,339 14,616 71,692 0 -32,912 38,780 -5,570 69 33,279 0 64 33,343 -7,574 25,769 0 0 0 25,769 0 25,769 -6,257 19,512 FY11F 109,289 -39,440 69,848 14,291 2,171 1,540 18,002 87,851 0 -37,943 49,908 -6,838 0 43,070 0 77 43,147 -10,139 33,007 0 0 0 33,007 0 33,007 -9,902 23,105 FY12F 137,328 -51,305 86,023 18,040 2,422 1,771 22,234 108,256 0 -44,493 63,763 -8,837 0 54,927 0 92 55,019 -12,929 42,089 0 0 0 42,089 0 42,089 -12,627 29,463 FY13F 165,996 -62,074 103,922 22,831 2,704 2,036 27,571 131,493 0 -52,532 78,961 -12,037 0 66,924 0 111 67,035 -15,753 51,281 0 0 0 51,281 0 51,281 -15,384 35,897 Notes
18.7 27.0 17.7 1.3 3.3 3.3 2.23 3.65 1.50 2.14 22.1 51.2 18.5 22.0 21.2 1.00 25.9 1.23
13.0 18.8 13.0 1.9 2.5 2.5 2.65 3.93 1.37 2.56 20.4 45.9 22.7 24.3 22.7 1.15 29.3 1.49
9.7 14.0 9.7 3.1 1.9 1.9 2.77 4.34 1.71 2.63 20.5 43.2 23.5 30.0 22.5 1.24 29.3 1.62
7.2 10.4 7.2 4.2 1.5 1.5 2.86 4.56 1.83 2.72 20.5 41.1 23.5 30.0 23.9 1.31 31.2 1.71
5.8 8.3 5.8 5.2 1.3 1.3 2.92 4.66 1.85 2.81 21.0 40.0 23.5 30.0 24.1 1.33 31.5 1.74
(HKD) 24 22 20 95 18 16 N ov 10 M ar 11 A pr 11 M ay 11 A ug 10 S ep 10 J an 11 F eb 11 D ec 10 J un 11 O c t 10 J ul 10 90 85 Price Rel MSCI China 110 105 100
1M -8.8 -9.0 -1.5 44,381.2
3M -11.8 -11.7 -7.9
12M -8.4 -8.6 -8.5
-13.9 31.1 11.9 -20.7 -13.5 -28.1 -18.4
41.4 27.3 23.9 53.4 41.3 33.3 41.3
22.4 23.2 15.3 28.7 28.1 28.1 28.1
23.2 23.5 17.3 27.8 27.5 27.5 27.5
20.8 24.0 18.1 23.8 21.8 21.8 21.8
Estimated free float 100.0 (%) 52-week range (HKD) 23.9/17.62 3-mth avg daily turnover (USDmn) Major shareholders (%) China Merchants Steam Navigation China Ocean Shipping 57.21
12.4 6.4
78
June 24, 2011
BalanceSheet(CNYmn)
FY09 8,342 277,738 200,212 377,072 0 1,185,859 -24,042 1,161,817 466 16,008 0 2,786 23,500 2,067,941 1,608,146 307,023 0 1,915,169 59,989 1,975,158 0 19,119 0 27,592 6,296 39,776 92,783 2,067,941 9,732 FY10 11,428 273,675 274,277 394,176 0 1,431,495 -29,335 1,402,160 443 18,397 0 3,706 24,245 2,402,507 1,897,178 319,473 0 2,216,651 51,850 2,268,501 0 21,577 0 42,806 8,719 60,904 134,006 2,402,507 9,686 FY11F 14,970 324,589 359,276 498,810 0 1,676,881 -34,805 1,642,076 532 22,076 0 4,818 36,368 2,903,514 2,314,557 361,893 0 2,676,450 67,405 2,743,855 0 21,577 0 62,911 9,902 65,269 159,659 2,903,514 11,240 FY12F 17,880 385,303 429,127 631,430 0 2,005,105 -41,961 1,963,144 638 26,492 0 6,263 54,551 3,514,828 2,823,760 410,670 0 3,234,430 87,627 3,322,056 0 21,577 0 89,374 12,627 69,195 192,772 3,514,828 13,633 FY13F 20,282 457,741 486,762 799,580 0 2,371,917 -51,916 2,320,001 766 31,790 0 8,142 68,189 4,193,253 3,388,512 466,757 0 3,855,269 105,538 3,960,807 0 21,577 0 122,271 15,384 73,213 232,445 4,193,253 16,916 Notes
73.7 4.5
75.5 5.6
72.4 5.5
71.0 5.5
70.0 5.5
0.8 0.26 1.16 247.0 6.6 10.4
0.7 0.39 1.22 302.9 8.0 11.5
0.7 0.41 1.20 309.6 8.5 11.3
0.7 0.44 1.19 307.8 8.6 10.9
0.7 0.51 1.24 306.9 8.8 10.7
36.2 32.3 31.1 31.6 28.6
20.7 16.2 15.7 16.2 18.0
17.1 20.5 20.7 20.9 22.0
19.6 20.7 20.8 21.1 22.0
18.2 19.2 19.2 19.3 20.0
0.90 0.90 0.85 0.21 1.24 4.85 4.85 4.71
1.19 1.19 1.19 0.29 1.80 6.21 6.21 6.04
1.53 1.53 1.53 0.46 2.31 7.40 7.40 7.18
1.95 1.95 1.95 0.59 2.96 8.93 8.93 8.64
2.38 2.38 2.38 0.71 3.66 10.77 10.77 10.40
79
June 24, 2011
Margin expansion facing headwinds from potential asymmetric rate hikes

We now expect FY11F NIM expansion of 12bps vs 20bps previously, due to rising risks of asymmetric rate hikes in 2H11F. However, we expect fee income to maintain its growth momentum and make a larger contribution to operating income, supporting our revised forecast earnings growth forecast of 28.1% y-y for FY11F.
Lower FY11F NPAT forecast; cut TP to HKD24.82

We revise lower our FY11F NPAT by 4.5% to CNY33bn (up by 28.1% y-y) to reflect our more cautious view on NIM expansion in FY11F we expect 12bps versus 20bps previously given that our economics team now sees more asymmetric rate hikes going forward. Consequently, we cut our TP from HKD26.86 to HKD24.82 to reflect our lowered earnings forecasts. We expect margin expansion to be constrained by potential asymmetric rate hikes in 2H11F, given CMBs asset sensitive balance sheet, especially with rates in time deposits rising and could attract depositors to shift funds from demand deposits. While we expect NIM to likely peak in 2Q11F, we believe fee income growth should remain strong throughout the quarter, due mainly to rapid growth in the wealth management business. After witnessing a strong grow rate of 62.3% y-y in 1Q11, fee income continued to grow by around 59% y-y in April, due mainly to rapid growth in the sales of wealth management products in the month. For instance, revenues from selling wealth management products invested in trust companies surged by 3,000% y-y in April 2011. We expect fee income growth to remain brisk in 2Q11F, supporting our forecast of 34% y-y earnings growth for 2011F. We maintain our BUY rating on the stock.
Fig. 87: Fee income
(% y-y) 80 68 56 44 32 20 1Q10 2Q10 3Q10 4Q10 1Q11 Fee income as % share of total income (RHS) Net fee income growth (LHS) (% share) 20 18 16 14 12 10
Source: Company data and Nomura research
Potential risks from shadow banking business

CMB has been one of the most active banks engaging in shadow banking business, as indicated by the percentage share of its entrusted loans in total loans, which reached 8% on average between 2006 and 2010. However, in our view, with more stringent regulations on the shadow banking business, including higher risk weightings for these assets as well as tightened liquidity, we see rising risks related to its asset quality and capital adequacy ratio in this area.
80
June 24, 2011
Fig. 88: Entrusted loan as % of total loans

2006 3% 11% 9% NA 5% 4% 2007 4% 12% 10% 10% 4% 4% 2008 5% 12% 9% 9% 5% 4% 2009 5% 13% 6% 6% 5% 4% 2010 6% 14% 7% 6% 8% 4%
ICBC CCB CMB Bocom Citic Minsheng
SME business continues to grow rapidly

SME loans continued to grow rapidly in April with its percentage share in total loans increasing to 50% compared with 47% as of end-2010. Under tightened credit, yields on SME loans rose further in April compared with that in 1Q11, with most of SME loans charging a premium of 10-20% over general corporate loans. We believe this should more than offset the rise in funding costs, resulting in a stable NIM in 2Q11F on a q-q basis.
Asset quality should remain benign in 2Q11F

Despite uncertainties over Chinas property market, we understand from management that a moderate decline (10-30%) in property prices would only have a limited impact on CMBs asset quality based on a stress test conducted by the bank. CMBs total NPL balance further decreased to CNY8.8bn as of April 2011 and the NPL ratio declined to 0.62% from 0.68% at the end of 2010. We think the banks asset quality should remain stable in 2011F with risks on the downside.
Fig. 89: NPL balance and NPL ratio
(RMb mn) 10,000 9,700 9,400 9,100 8,800 8,500 1Q10 2Q10 3Q10 4Q10 1Q11 NPL ratio (RHS) NPL balance (LHS) (% ratio) 0.8 0.7 0.6 0.5 0.4 0.3
Likely least affected H-share banks by new rules on RWA

The CBRC has proposed new capital rules with higher risk weighting for certain assets, such as infrastructure loans, property loans and LGFV loans, among others. It also lowered the risk weighting for SME loans and retail loans, as reported by 21st Century News on 9 June. Based on our estimates, the new rule would lift CMBs risk-weighted assets by 11% and have a negative impact of 80bps on its Tier 1 CAR on a net basis. Among all the H-share banks we cover, CMB should be the one least affected by the new rules on RWA, mainly due to its relatively greater exposure to SME loans and retail loans and smaller exposure to property loans.
81
June 24, 2011
Fig. 90: Estimated impact on new rules on RWA

2010 (RMBmn) Incremetnal RWA as % of total RWA Total tier 1 impact
Source: Company data and Nomura estimates
ABC 15% (136)
ICBC 14% (127)
CCB 14% (131)
BOC 14% (135)
BOCOM 11% (95)
CMB 11% (80)
CITIC 11% (88)
Minsheng 11% (84)
CRCB 17% (234)
Capital-raising plan in FY11F

Caixin reported on 21 June 2011 that CMB may raise CNY60bn in view of its low capital ratio of 7.66% for Tier 1 CAR at end-1Q11. We believe the realistic size of the banks capital-raising plan is around CNY40bn, in the form of A+H share rights issues. In our view, the release of a capital-raising plan could ease market concerns and potentially lead to a share-price rebound. Sensitivity analysis We conduct a sensitivity test to determine the potential extent of enhancement on capital and dilution effect with different capital-raising amounts. Assuming that CMB would raise CNY40bn, we estimate that its FY11F Tier-1 CAR and total CAR would be boosted by 2.1-2.2pp to 10.65% and 13.46%, respectively. However, our sensitivity analysis also suggests that capital raising would have a dilution effect of 2.7pp on FY11F ROE and 13.3% on FY11F EPS.
Fig. 91: Sensitivity analysis on the potential capital-raising plan
Baseline forecast FY11F T1 CAR (%) CAR (%) ROE (%) EPS (RMB) BVPS (RMB) P/B (using 21 June closing price at HK$ 18.08) P/E (using 21 June closing price at HK$ 18.08) 8.5 11.34 22.5 1.53 7.40 2.00 9.69 FY12F 8.59 10.94 23.9 1.95 8.93 1.66 7.60 Scenario (RMB40bn raised) Post-money financials FY11F FY12F 10.65 13.46 19.8 1.33 8.02 1.85 11.18 10.37 12.69 19.5 1.69 9.35 1.59 8.77 Impact FY11F 2.2pp 2.1pp -2.7pp -13.3% 8.4% FY12F 1.8pp 1.8pp -4.4pp -13.3% 4.7%
Note: (1) assuming new shares are issued at a 85% discount to CMB's average closing price over the last 90 trading days (equivalent to HKD19.75 for H shares and CNY13.83 for A shares); (2) assuming the proportion of the A-share rights issue and the H-share rights issue equals the proportion of existing A shares & H shares to total number of shares. Source: Bloomberg, Nomura estimates

Our price target of HKD24.82 is based on 2.69x P/BV applied to our FY11F BVPS forecast of CNY7.4. Our sustainable ROE is 16.8%. We use the Gordon Growth Model [target P/BV = (sustainable ROE - long-term growth) / (cost of equity - long-term growth)] to derive our fair P/BV range, assuming a cost of equity of 11.5% and a terminal growth rate of 8.4%. We derive our terminal growth rate by applying a 50% payout ratio to our long-term sustainable ROE. Our valuation methodology is unchanged. Downside risks: We believe that more severe-than-expected macro tightening could result in a sharp rise in bad debt costs. In addition, a slowing economy would have negative implications for loan growth.
82
China CITIC Bank

BANKS
0998.HK 998 HK
EQUITY RESEARCH
A+H rights issues soon be completed
CNY26bn capital-raising plan soon be completed; reaffirm BUY

Action and Valuation: Lower FY11F NIM forecast by 1bp; marginal earnings reduction; reaffirm BUY In view of the 10bp interest rate hike in demand deposits in April and three more potential RRR hikes in 2Q11, we believe funding costs should continue to rise. Although supported by stronger pricing power, we believe more moderate NIM expansion in 2Q11F and a potential asymmetric rate hike will likely place downside pressure on the banks NIM in FY11F. We lower our forecast FY11F NIM expansion by 1bp to 8bp y-y. The stock is trading at 1.2x FY11F P/B. With a marginal reduction (0.5%) in our earnings forecasts, we reaffirm our BUY rating with a TP of HKD6.50. Limited impact from new rules on risk weighting The CBRC introduced 10 new measures to enhance financing services to small enterprises in early June, including lowering the risk weighting of loans to small enterprises (from 100% to 75% under internal approach). We believe the new measures could raise Citics CAR by around 15bp, assuming the internal approach is applied for FY10. Meanwhile, the CBRC is also drafting new capital rules with revised risk weighting calculations on loans to certain sectors and interbank assets. We believe the overall impact will be slightly negative. Based on our analysis, Citic may need CNY13bn more for its T1 capital if the new capital rules are implemented. Given the soon-be-completed CNY26bn A+H rights issues, we estimate Citics T1 CAR will stand at 9.5% at end-FY11F and we think it is not likely to trigger further capital raising in the near term. Catalysts Further rounds of rate hikes (if symmetric) to boost NIM in FY11F.
Buy
HKD 6.50 HKD 4.97 +30.8%
Anchor themes The operating environment remains favourable for Chinese banks in 2011F, but negative sentiment from uncertainties over policies and asset quality continues to weigh on valuations. Better visibility on regulatory policies (capital and provisioning) could trigger a rerating in the near term. Nomura vs consensus Our net profit forecast is 2% above consensus estimates due to our higher NIM and lower credit cost assumptions.
Research analysts
33,718 21,509 21,509 0.55 50.2 7.8 1.4 1.4 na 19.3 1.1
43,974 25,959 25,959 0.60 8.7 N/A N/A N/A N/A 18.3 1.1
43,813 25,837 25,837 0.60 8.2 6.8 1.2 1.2 4.6 18.3 1.1
53,140 31,029 31,029 0.65 8.8 N/A N/A N/A N/A 17.9 1.1
52,951 30,887 30,887 0.65 8.8 6.0 1.0 1.0 5.9 17.9 1.1
62,863 36,092 36,092 0.76 16.3 N/A N/A N/A N/A 18.5 1.1
62,642 35,925 35,925 0.75 16.3 5.0 0.9 0.9 7.0 18.4 1.1
Nomura | ASIA China CITIC Bank
June 24, 2011
Key data on China CITIC Bank

FY09 56,131 -20,147 35,984 4,220 383 396 4,999 40,983 0 -19,132 21,851 -2,446 -173 19,232 32 0 19,264 -4,705 14,559 -240 0 0 14,319 0 14,319 -3,435 10,884 FY10 72,460 -24,325 48,135 5,696 1,431 1,094 8,221 56,356 0 -22,638 33,718 -4,238 -1,011 28,469 226 0 28,695 -6,916 21,779 -270 0 0 21,509 0 21,509 0 21,509 FY11F 95,990 -36,423 59,567 7,990 1,416 1,313 10,720 70,286 0 -26,474 43,813 -9,591 0 34,221 0 0 34,221 -8,384 25,837 0 0 0 25,837 0 25,837 -9,043 16,794 FY12F 118,014 -46,699 71,315 10,521 1,084 1,510 13,115 84,430 0 -31,479 52,951 -12,042 0 40,909 0 0 40,909 -10,023 30,887 0 0 0 30,887 0 30,887 -10,810 20,076 FY13F 140,556 -56,025 84,531 13,261 878 1,736 15,876 100,406 0 -37,765 62,642 -15,059 0 47,582 0 0 47,582 -11,658 35,925 0 0 0 35,925 0 35,925 -12,574 23,351 Notes
Continued NIM expansion.
11.9 21.2 11.9 2.0 1.7 1.7 2.39 3.73 1.53 2.20 12.2 46.7 24.4 24.0 14.4 0.98 19.4 1.30
7.8 13.9 7.8 na 1.4 1.4 2.63 3.96 1.42 2.54 14.6 40.2 24.1 0.0 19.3 1.13 25.5 1.48
6.8 12.3 6.8 4.6 1.2 1.2 2.71 4.37 1.77 2.60 15.3 37.7 24.5 35.0 18.3 1.12 24.2 1.49
6.0 10.7 6.0 5.9 1.0 1.0 2.76 4.58 1.94 2.64 15.5 37.3 24.5 35.0 17.9 1.12 23.6 1.48
5.0 8.9 5.0 7.0 0.9 0.9 2.81 4.68 1.99 2.68 15.8 37.6 24.5 35.0 18.4 1.11 24.4 1.47
(HKD) 6.4 6.2 6 5.8 5.6 5.4 5.2 5 4.8 4.6 N ov 10 M ar 11 A pr 11 M ay 11 A ug 10 S ep 10 J an 11 F eb 11 D ec 10 J un 11 O c t 10 J ul 10 Price Rel MSCI HK 105 100 95 90 85 80 75
(%) Absolute (HKD) Absolute (USD) Relative to index Market cap (USDmn) Estimated free float (%) 52-week range (HKD) 3-mth avg daily turnover (USDmn) Major shareholders (%) Citic Group BBVA 1M -8.5 -8.7 -1.5 24,907.1 51.1 6.26/4.7 25.57 3M -4.1 -3.9 -1.0 12M -5.2 -5.3 -19.2
-0.3 16.8 18.5 -9.8 7.2 7.2 7.2
33.8 64.5 18.3 54.3 50.2 50.2 50.2
23.7 30.4 16.9 29.9 20.1 8.2 8.2
19.7 22.3 18.9 20.9 19.5 8.8 8.8
18.5 21.0 20.0 18.3 16.3 16.3 16.3
62.3 15.0
84
June 24, 2011
BalanceSheet(CNYmn)
FY09 4,480 81,808 219,523 206,260 0 1,065,649 -15,170 1,050,479 0 10,482 0 2,095 199,904 1,775,031 1,341,927 298,024 0 1,639,951 28,072 1,668,023 4,210 39,033 0 14,286 3,435 46,044 102,798 1,775,031 10,157 FY10 5,126 130,588 251,197 269,005 0 1,264,245 -18,219 1,246,026 0 10,222 0 2,565 166,585 2,081,314 1,730,816 183,650 0 1,914,466 42,310 1,956,776 4,363 39,033 0 30,576 0 50,566 120,175 2,081,314 8,533 FY11F 8,857 146,259 434,006 301,229 0 1,476,113 -20,826 1,455,287 0 10,426 0 0 168,251 2,524,315 2,111,596 202,774 0 2,314,369 42,570 2,356,939 4,407 47,620 0 38,327 9,043 67,979 162,969 2,524,315 9,218 FY12F 11,914 163,810 583,780 337,313 0 1,734,973 -24,707 1,710,266 0 10,635 0 0 169,933 2,987,651 2,533,915 223,384 0 2,757,299 42,856 2,800,155 4,451 47,620 0 56,636 10,810 67,979 183,046 2,987,651 10,824 FY13F 14,928 183,467 731,452 377,722 0 2,029,886 -30,222 1,999,664 0 10,848 0 0 171,633 3,489,712 2,990,019 245,631 0 3,235,651 43,170 3,278,820 4,495 47,620 0 78,224 12,574 67,979 206,397 3,489,712 13,647 Notes
Lowering LDR.
79.4 5.8
73.0 5.8
69.9 6.5
68.5 6.1
67.9 5.9
1.0 0.23 0.85 149.4 9.2 10.7
0.7 0.34 0.88 213.5 8.4 11.3
0.6 0.65 0.83 225.9 10.3 12.4
0.6 0.69 0.83 228.3 9.9 11.9
0.7 0.74 0.87 221.4 9.5 11.5
61.3 41.2 53.5 49.4 41.9
18.6 21.7 16.7 17.3 29.0
16.8 23.2 20.9 21.3 22.0
17.5 19.6 19.1 18.4 20.0
16.9 17.8 17.3 16.8 18.0
0.37 0.37 0.37 0.09 0.56 2.63 2.63 2.58
0.55 0.55 0.55 0.00 0.86 3.08 3.08 3.01
0.60 0.60 0.60 0.19 1.01 3.42 3.42 3.42
0.65 0.65 0.65 0.23 1.11 3.84 3.84 3.84
0.75 0.75 0.75 0.26 1.32 4.33 4.33 4.33
85
June 24, 2011
CNY26bn capital raising plan soon be completed

On 21 June, 2011, the bank announced the receipt of approval by the CSRC on the A+H share rights issues. Upon completion of the rights issues, we expect the banks T1 CAR and CAR to reach 10.32% and 12.45% respectively. We reiterate our BUY rating with a TP of HKD6.50.
Lower FY11F NIM forecast by 1bp; marginal earnings reduction; reiterate BUY
In view of the 10bp interest rate hike in demand deposits in April and three more potential RRR hikes in 2Q11, we believe funding costs should continue to rise. Although supported by stronger pricing power, we expect more moderate NIM expansion in 2Q11F and a potential asymmetric rate hike will likely place downside pressure on the banks NIM in FY11F. We lower our forecast FY11F NIM expansion by 1bp to 8bp y-y. The stock is trading at 1.2x FY11F P/B. the lowest among H-share banks. With a marginal reduction (0.5%) in our earnings forecasts, we reiterate our BUY rating with a PT of HKD6.50.
Fig. 92: Citic Bank: earnings revisions
Marginal earnings reduction
Profit & Loss (RMBmn, except %) Net interest income Fee income Non-interest income Operating Income Operating Expenses PPOP Provisions Operating pre-tax Profit tax Profits attributable to equity holders
2011F 59,567 7,990 10,720 70,286 (26,474) 43,813 (9,591) 34,221 (8,384) 25,837
Revised 2012F 71,315 10,521 13,115 84,430 (31,479) 52,951 (12,042) 40,909 (10,023) 30,887
2013F 84,531 13,261 15,876 100,406 (37,765) 62,642 (15,059) 47,582 (11,658) 35,925
2011F 59,738 7,990 10,720 70,457 (26,484) 43,974 (9,591) 34,383 (8,424) 25,959
Previous 2012F 71,516 10,521 13,115 84,631 (31,491) 53,140 (12,042) 41,098 (10,069) 31,029
2013F 84,766 13,261 15,876 100,642 (37,778) 62,863 (15,059) 47,804 (11,712) 36,092
2011F (0.3) 0.0 0.0 (0.2) (0.0) (0.4) 0.0 (0.5) (0.5) (0.5)
Change (%) 2012F (0.3) 0.0 0.0 (0.2) (0.0) (0.4) 0.0 (0.5) (0.5) (0.5)
2013F (0.3) 0.0 0.0 (0.2) (0.0) (0.4) 0.0 (0.5) (0.5) (0.5)
Limited impact of new rules on risk weighting

The CBRC introduced 10 new measures to enhance financing services to small enterprises in early June, including lowering the risk weighting of loans to small enterprises (from 100% to 75% under internal approach). Based on our estimates, we believe the new measure could raise Citics CAR by around 15bp, assuming the internal approach is applied for FY10. Meanwhile, the CBRC is also drafting new capital rules with revised risk weighting calculations on loans to certain sectors and interbank assets. We believe the overall impact will be slightly negative. Based on our analysis, Citic may need CNY13bn more for its T1 capital if the new capital rules are implemented. Given the soon-be-completed CNY26bn A+H rights issues, we estimate Citics T1 CAR will stand at 9.5% at end-FY11F and we think it is not likely to trigger further capital raising in the near term.
Rights issues to be completed soon

A-share rights issue approved by the CSRC CITIC Bank announced on 11 August 2010 that it aimed to raise CNY26bn through an Hshare and A-share rights issue of 2.2 rights for every 10 existing shares. The proposal was approved by the Ministry of Finance and the CBRC in October 2010. On 21 June, 2011, the bank announced the receipt of approval by the CSRC on the A+H share rights issues. We expect the rights issues to be completed in 3Q11F.
86
June 24, 2011
CAR & T1 CAR to be boosted by 1.5pp After the CNY26bn A+H shares rights issues, we estimate Citics CAR and T1 CAR will be boosted by 1.5pp each. We expect both ratios to reach 12.45% and 10.32% at the end of FY11F, respectively.
Fig. 93: Citic: quarterly T1 CAR
(%) 11.0 10.5 10.0 9.5 9.0 8.5 8.0 7.5 7.0 6.5 6.0
2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11
Fig. 94: Citic: quarterly CAR

(%) 13 12 11 10 9 8 7 6
2Q09
3Q09
4Q09
1Q10
2Q10
3Q10
4Q10
Valuation methodology and investment risk Our target price of HKD6.50 is based on 1.5x P/BV applied to our FY11F BVPS forecast of CNY3.42, assuming sustainable ROE of 14.5% in order to reflect our positive view on Citics improvement in LDR. We use the Gordon Growth Model [target P/BV = (sustainable ROE - long-term growth)/(cost of equity - long-term growth)] to derive our fair P/BV, assuming a cost of equity of 12% and a terminal growth rate of 7.2%. We derive our terminal growth rate by applying a 50% payout ratio to our long-term sustainable ROE. Downside risks: more severe-than-expected macro tightening could result in a sharp rise in bad debt costs. In addition, a slowing economy would have negative implications for loan growth.
1Q11
87
China Minsheng Bank - H

BANKS
1988.HK 1988 HK
EQUITY RESEARCH
Stretched loan yields capped NIM expansion
Asset quality could worsen as economic growth slows sharply; remain NEUTRAL
Action: Reaffirm NEUTRAL and TP of HK$7.40 We continue to expect FY11F NPAT to grow 21.3% y-y, underpinned by 5bp NIM expansion and 18.6% y-y gross loan growth. Nevertheless, with the rapid growth of the shadow banking business and a stretched loan yield, we see higher risks of worsening asset quality, especially if the overall economy slows sharply. Although a higher loan yield has boosted margin expansion and profitability in past quarters, we see very limited upside for further margin expansion, given that new SDT loan yield reached over 10% p.a. in 1Q11 vs 6.31% p.a. for the benchmark one-year lending rate, while funding costs should continue to rise significantly due to tight liquidity, severe competition for deposits (due to daily monitoring of LDR) and higher interest and interbank market rates. The stock has outperformed peers recently with the share price up 9.5% YTD vs. -4.1% for the sector; however, we believe the macro outlook could be crucial for the bank as a potential significant slowdown in economic growth could erode its asset quality substantially given that SME borrowers are usually very sensitive to economic conditions. We maintain our NEUTRAL rating. Catalysts Better-than-expected 2Q11 results could trigger a re-rating in the near term. Valuation The stock is trading at 7.7x FY11F P/E and 1.4x FY11F P/B. We believe ongoing capital-raising will continue to exert pressure on ROE and EPS; hence, we maintain our NEUTRAL rating and TP of HK$7.40.
Neutral
HKD 7.40 HKD 7.29 +1.5%
Anchor themes The operating environment remains favourable for Chinese banks in 2011F, but negative sentiment from uncertainties over policies and asset quality continues to weigh on valuations. Better visibility on regulatory policies (capital and provisioning) could trigger a rerating in the near term. Nomura vs consensus Our forecasts are 6.0% lower than consensus because of our lower loan yields and higher funding costs assumption.
Research analysts
28,480 17,581 17,581 0.72 21.8 8.7 1.6 1.6 1.6 18.3 1.1
35,190 21,334 21,334 0.77 7.9 N/A N/A N/A N/A 18.9 1.1
35,190 21,334 21,334 0.77 7.9 7.7 1.4 1.4 2.6 18.9 1.1
43,165 25,729 25,729 0.88 13.2 N/A N/A N/A N/A 19.5 1.0
43,165 25,729 25,729 0.88 13.2 6.5 1.2 1.2 3.1 19.5 1.0
52,931 31,037 31,037 1.02 16.7 N/A N/A N/A N/A 20.2 1.0
52,931 31,037 31,037 1.02 16.7 5.5 1.0 1.0 3.7 20.2 1.0
Nomura | ASIA China Minsheng Bank - H
June 24, 2011
Key data on China Minsheng Bank - H

FY09 53,441 -21,201 32,240 4,664 5,133 0 9,797 42,037 FY10 70,776 -24,903 45,873 8,289 505 0 8,794 54,667 FY11F 83,169 -30,411 52,759 10,822 600 0 11,422 64,181 FY12F 98,865 -36,767 62,098 14,124 714 0 14,838 76,936 FY13F 116,098 -43,128 72,970 18,429 849 0 19,277 92,247 Notes
-21,074 20,963 -5,307 15,656 0 15,656 -3,548 12,108 -4
-26,187 28,480 -5,504 22,976 0 22,976 -5,288 17,688 -107
-28,991 35,190 -6,745 28,445 0 28,445 -7,111 21,334 0
-33,772 43,165 -8,860 34,305 0 34,305 -8,576 25,729 0
-39,316 52,931 -11,547 41,383 0 41,383 -10,346 31,037 0
12,104 12,104 -1,113 10,991
17,581 17,581 -2,672 14,909
21,334 21,334 -4,395 16,939
25,729 25,729 -5,318 20,411
31,037 31,037 -6,306 24,731
10.8 11.0 10.8 0.8 1.6 1.6 2.59 4.29 1.80 2.49 23.3 50.1 22.7 9.2 17.1 0.98 22.1 1.26
8.7 8.9 8.7 1.6 1.6 1.6 2.94 4.54 1.72 2.82 16.1 47.9 23.0 15.2 18.3 1.08 23.9 1.41
7.7 7.9 7.7 2.6 1.4 1.4 2.99 4.72 1.83 2.89 17.8 45.2 25.0 20.6 18.9 1.05 25.2 1.40
6.5 6.6 6.5 3.1 1.2 1.2 3.06 4.86 1.94 2.93 19.3 43.9 25.0 20.7 19.5 1.04 26.0 1.39
5.5 5.6 5.4 3.7 1.0 1.0 3.12 4.97 2.00 2.97 20.9 42.6 25.0 20.3 20.2 1.03 26.9 1.37
(HKD) 7.8 7.6 7.4 7.2 7 6.8 6.6 6.4 6.2 N ov 10 M ar 11 A pr 11 M ay 11 A ug 10 S ep 10 J an 11 F eb 11 D ec 10 J un 11 O c t 10 J ul 10 Price Rel MSCI HK 105 100 95 90 85 80 75 70
1M -0.4 -0.6 6.5 20,831.1 26.0 7.75/6.3 29.89
3M 8.2 8.3 11.2
12M 4.6 4.4 -9.4
6.1 104.4 16.0 23.3 53.5 8.2 8.2
42.3 -10.2 24.3 35.9 45.2 21.8 21.8
15.0 29.9 10.7 23.6 21.3 7.9 7.9
17.7 29.9 16.5 22.7 20.6 13.2 13.2
17.5 29.9 16.4 22.6 20.6 16.7 14.9
Estimated free float (%) 52-week range (HKD) 3-mth avg daily turnover (USDmn) Major shareholders (%) New Hope China Life
5.0 4.0
89
June 24, 2011
BalanceSheet(CNYmn)
FY09 66,312 73,015 221,590 156,491 0 882,979 -15,241 867,738 0 8,068 FY10 130,059 149,385 262,238 180,943 0 1,057,571 -19,848 1,037,723 0 8,809 FY11F 281,514 156,854 288,462 207,241 0 1,254,020 -27,928 1,226,092 0 10,130 FY12F 453,330 164,697 317,308 237,475 0 1,496,787 -32,868 1,463,919 0 11,650 FY13F 687,776 172,932 349,039 272,236 0 1,777,032 -38,932 1,738,100 0 13,397 Notes
33,178 1,426,392 1,127,938 166,188 23,060 1,317,186 20,312 1,337,498 860 22,262 11,390 1,113 53,269 88,034 1,426,392 7,397
54,580 1,823,737 1,416,939 250,355 21,496 1,688,790 29,690 1,718,480 1,149 26,715 17,209 2,672 57,512 104,108 1,823,737 7,339
62,767 2,233,061 1,742,835 300,426 31,496 2,074,757 34,972 2,109,729 1,264 28,366 25,690 4,395 63,618 122,068 2,233,061 8,495
72,182 2,720,561 2,143,687 360,511 31,496 2,535,694 41,203 2,576,898 1,390 30,330 35,098 5,318 71,527 142,274 2,720,561 10,558
83,009 3,316,490 2,636,735 432,613 31,496 3,100,844 48,556 3,149,401 1,529 31,313 47,536 6,306 80,406 165,560 3,316,490 13,013
78.3 6.2
74.6 5.7
72.0 5.5
69.8 5.2
67.4 5.0
0.8 0.60 1.07 206.0 8.9 10.8
0.7 0.52 1.09 270.4 8.1 10.4
0.7 0.54 1.25 328.8 8.7 12.5
0.7 0.59 1.21 311.3 9.2 12.8
0.7 0.65 1.17 299.2 9.6 13.0
34.2 30.6 34.0 35.3 43.5
19.6 23.6 28.2 27.9 25.6
18.2 15.2 22.9 22.4 23.0
19.4 16.2 22.2 21.8 23.0
18.7 16.0 22.3 21.9 23.0
0.59 0.59 0.59 0.05 1.02 3.95 3.95 3.95
0.72 0.72 0.72 0.10 1.16 3.90 3.90 3.90
0.77 0.77 0.77 0.15 1.28 4.30 4.30 4.30
0.88 0.88 0.88 0.18 1.47 4.69 4.69 4.69
1.02 1.02 1.01 0.20 1.75 5.29 5.29 5.29
90
June 24, 2011
Asset quality could worsen as economic growth slows sharply

We expect FY11F NPAT to grow 21.3% y-y, underpinned by 5bp NIM expansion and 18.6%y-y gross loan growth. With rapid growth of the shadow banking business and a stretched loan yield, we see higher risk of worsening asset quality, especially if the overall economy slows sharply. We maintain our NEUTRAL rating on the stock.
Still decent earnings growth in FY11F; remain NEUTRAL

We continue to expect FY11F NPAT to grow 21.3% y-y, underpinned by 5bp NIM expansion and 18.6% y-y gross loan growth. Nevertheless, with rapid growth of the shadow banking business and a stretched loan yield, we see higher risk of worsening asset quality, especially if the overall economy slows sharply. Although a higher loan yield has boosted margin expansion and profitability in the past quarters, we see very limited upside for further margin expansion given that SDT loan yield reached 8.5% p.a. in 1Q11 vs. 6.31% p.a. for the benchmark 1-year lending rate, while funding costs should continue to rise significantly due to severe competition for deposits (due to daily monitoring of LDR) and higher interest and interbank market rates. We expect NIM will likely peak in 2Q11 and remain flattish in 3Q11 before a potential contraction in 4Q11. The stock has outperformed peers of late, with the share price up 9.5% YTD vs. -4.1% for the sector; however, we believe the macro outlook could be very crucial for the bank as a potential significant slowdown in economic growth could substantially erode its asset quality given that SME borrowers are usually very sensitive to economic conditions. We maintain our NEUTRAL stance and TP of HK$7.40.
New rules on RWA should have limited impact

The CBRC has proposed new capital rules with higher risk weighting for certain assets, such as infrastructure loans, property loans and LGFV loans, among others, while lowering the risk weighting for SME loans and retail loans, as reported by 21st Century News on 9 June. Based on our estimates, the new rule would lift Minshengs riskweighted assets by 11% and have a negative impact of 84bps on its Tier 1 CAR on a net basis. Minsheng would likely be among the least-affected H-share Chinese banks given its higher exposure to SME loans and retail loans. However, due to its lower-than-peers Tier 1 CAR level, we believe the new rule would likely to lead to further capital-raising plans for the bank in order to meet the higher regulation standard at the CAR level.
Fig. 95: Estimated impact on new rules on RWA
2010 (RMB mn) Incremetnal RWA as % of total RWA Total tier 1 impact ABC 15% (136) ICBC 14% (127) CCB 14% (131) BOC 14% (135) BOCOM 11% (95) CMB 11% (80) CITIC 11% (88) Minsheng 11% (84) CRCB 17% (234)
Shang Dai Tong loans continue to outpace other loans

This loan product grew 255% y-y in FY10. As at end-FY10, the total number of Shang Dai Tong customers grew to 110,000, more than 20% of which were VIP customers. The pricing of newly issued loans improved significantly in 2010, according to management, due to an improved loan interest rate structure, resulting in higher product profitability. The actual interest rate of newly issued loans increased by more than 1pp, compared with the previous year, with the average loan yield standing at above 8% in 1Q11. As at end-1Q11, the outstanding amount of Shang Dai Tong loans was RMB177bn, up 11.3% from end-FY10, still outpacing overall loan growth of 2.9%. This, we believe, is positive for the bank as the lending rate to SME borrowers is generally higher.
91
June 24, 2011

Our target price of HKD7.40 is based on 1.35x P/BV applied to our FY11F BVPS forecast of CNY4.39 as well as a sustainable ROE of 13.8%. We use the Gordon Growth Model [target P/BV = (sustainable ROE - long-term growth)/(cost of equity - long-term growth)] to derive our fair P/BV, assuming a cost of equity of 12.0% and a terminal growth rate of 6.9%. We derive our terminal growth rate by applying a 50% payout ratio to our long-term sustainable ROE. Risks to our target price include: Downside more sever-than-expected macro tightening could result in a sharp rise in bad debt costs. In addition, a slowing economy would have negative implications for loan growth. Upside a strong NIM rebound amid the interest rate hike cycle.
92
Chongqing Rural Commercial Bank

3618.HK 3618 HK FINANCIALS
EQUITY RESEARCH
At least 30% y-y NPAT growth in FY11F
Target 30% earnings growth in FY11F with potential upside; reaffirm BUY
Action and Valuation: targets 30% earnings growth in FY11 with potential upside; reaffirm BUY with TP slightly lowered to HKD6.52 According to management guidance, FY11F NPAT would be at least above CNY40bn, driven mainly by asset growth, further NIM expansion and strong fee income growth, as well as proactive cost control (target CIR of <40% in FY11F). We maintain our forecast that CRCBs NPAT will double in three years, but we slightly lower our TP by 2% to reflect our higher provision assumptions under tighter regulations. Trading at 1.3x FY11F P/B, we would recommend investors to accumulate the stock. Catalyst: 2Q11 results Stronger-than-expected results could trigger a share price re-rating. FY11F NIM will likely reach 3.30-3.50% According to management, CRCBs 1Q11 NIM was 3.17% (compared with 3.07% in FY10). Management has guided for a full-year FY11F NIM of 3.30-3.50%, to be driven mainly by higher investment yields, improving pricing power and availability of low-cost IPO funds. We expect this to bring 8-20% potential upside to our FY11F earnings estimate. 1Q11 operating data loan and deposit growth on track Total loans in 1Q11 grew 5.7% q-q to CNY129.1bn, with net new loans of CNY6,956mn equivalent to 34.8% of managements minimum loan growth target of CNY20bn for FY11F guided by management in an analyst briefing in late-March. Total deposits increased 4.3% q-q to CNY214.3bn. Given its relatively low LDR at 60%, we think the impact of monitoring the daily average LDR starting in June would not be significant to CRCB.
Buy
HKD 6.52 HKD 4.71 +38.4%
Anchor themes The operating environment remains favourable for Chinese banks in 2011F, but negative sentiment from uncertainties over policies and asset quality continues to weigh on valuations. Better visibility on regulatory policies (capital and provisioning) could trigger a rerating in the near term. Nomura vs consensus Our net profit forecast is above consensus estimates by 9% due to our higher NIM and lower credit cost assumptions.
Research analysts
3,835 3,064 3,064 0.41 29.8 9.9 1.6 1.6 1.1 19.3 1.3
5,591 4,011 4,011 0.44 7.3 N/A N/A N/A N/A 16.6 1.2
5,591 3,973 3,973 0.43 6.3 8.9 1.3 1.3 3.3 16.4 1.2
7,303 5,126 5,126 0.55 25.7 N/A N/A N/A N/A 18.2 1.3
7,303 5,126 5,126 0.55 26.9 6.6 1.1 1.1 5.3 18.3 1.3
9,036 6,302 6,302 0.68 22.9 N/A N/A N/A N/A 19.3 1.3
9,036 6,302 6,302 0.68 22.9 5.3 0.9 0.9 6.7 19.3 1.3
Nomura | ASIA Chongqing Rural Commercial Bank
June 24, 2011
Key data on Chongqing Rural Commercial Bank

FY09 8,703 -3,228 5,474 137 8 57 202 5,677 -331 0 -2,860 2,486 -118 -5 2,363 121 0 2,485 -596 1,888 0 0 0 1,888 0 1,888 -360 1,528 FY10 11,473 -3,972 7,502 286 -46 3 243 7,745 -331 0 -3,579 3,835 -5 50 3,880 106 0 3,986 -925 3,061 3 0 0 3,064 0 3,064 -404 2,661 FY11F 15,053 -5,012 10,042 384 23 4 410 10,452 -348 0 -4,513 5,591 -350 0 5,241 0 0 5,241 -1,271 3,970 3 0 0 3,973 0 3,973 -1,192 2,781 FY12F 18,983 -6,232 12,750 486 24 3 513 13,264 -365 0 -5,595 7,303 -540 0 6,763 0 0 6,763 -1,640 5,123 3 0 0 5,126 0 5,126 -1,793 3,333 FY13F 23,144 -7,427 15,717 618 25 4 648 16,365 -383 0 -6,945 9,036 -721 0 8,315 0 0 8,315 -2,016 6,299 3 0 0 6,302 0 6,302 -2,205 4,097 Notes
We expect NPAT to double in three years.
13.1 18.6 13.1 1.5 2.6 2.6 3.06 4.87 1.93 2.93 3.6 56.2 24.0 19.1 21.7 1.02 27.2 1.28
9.9 14.1 9.9 1.1 1.6 1.6 3.07 4.70 1.73 2.97 3.1 50.5 23.2 13.2 19.3 1.26 24.4 1.59
8.9 12.6 8.9 3.3 1.3 1.3 3.16 4.74 1.75 2.99 3.9 46.5 24.3 30.0 16.4 1.24 21.7 1.63
6.6 9.4 6.6 5.3 1.1 1.1 3.21 4.79 1.81 2.97 3.9 44.9 24.3 35.0 18.3 1.29 24.1 1.70
5.3 7.5 5.3 6.7 0.9 0.9 3.25 4.78 1.80 2.98 4.0 44.8 24.3 35.0 19.3 1.31 25.5 1.72
(HKD) 6.5 6 5.5 5 4.5 4 M ar 11 A pr 11 M ay 11 J an 11 F eb 11 J un 11 Price Rel MSCI China 120 115 110 105 100 95 90 85
(%) Absolute (HKD) Absolute (USD) Relative to index Market cap (USDmn) Estimated free float (%) 52-week range (HKD) 3-mth avg daily turnover (USDmn) Major shareholders (%) Chongqing Yufu Chongqing City Construction
1M -14.4 -14.5 -7.1 5,442.0 1.0 6.46/4.33 25.85
3M -20.3 -20.2 -16.4
12M
5.6 82.2 32.2 -11.9 -5.4 -39.7 -39.7
37.0 20.0 25.2 54.2 62.3 29.8 29.8
33.9 69.0 26.1 45.8 29.7 6.3 6.3
27.0 25.0 24.0 30.6 29.0 26.9 26.9
23.3 26.2 24.1 23.7 22.9 22.9 22.9
6.9 6.6
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BalanceSheet(CNYmn)
FY09 27,416 10,154 0 40,882 13,374 101,821 -5,005 96,816 0 2,117 0 1,264 9,338 201,361 153,776 4,136 28,806 186,718 5,166 191,883 0 6,000 1,710 360 1,408 9,477 201,361 3,946 FY10 37,322 19,220 0 59,373 37,158 122,145 -5,031 117,114 0 2,341 0 1,308 11,710 285,546 205,563 12,157 38,063 255,782 7,333 263,115 85 9,000 2,243 404 10,699 22,345 285,546 2,912 FY11F 75,555 21,527 0 66,074 40,874 142,210 -5,232 136,978 0 2,388 0 1,177 12,594 357,166 263,042 15,225 45,215 323,482 7,559 331,042 94 9,300 4,236 1,192 11,303 26,031 357,166 2,481 FY12F 118,787 24,110 0 73,536 44,961 166,425 -5,548 160,878 0 2,436 0 1,059 13,565 439,331 327,725 19,793 53,798 401,316 7,806 409,123 103 9,300 6,967 1,793 12,046 30,105 439,331 2,191 FY13F 161,074 27,003 0 81,846 49,457 194,072 -5,989 188,082 0 2,485 0 953 14,629 525,529 392,422 25,731 64,098 482,250 8,077 490,328 113 9,300 10,651 2,205 12,932 35,088 525,529 1,929 Notes
Lowering NPL ratio.
66.2 4.7
59.4 7.8
54.1 7.3
50.8 6.9
49.5 6.7
3.9 0.12 2.49 126.8 8.1 10.2
2.4 0.00 1.76 172.8 14.8 16.3
1.7 0.25 1.46 210.9 13.3 14.5
1.3 0.32 1.26 253.2 12.2 13.1
1.0 0.37 1.14 310.6 11.6 12.3
34.1 15.9 21.1 20.4 31.1
21.0 44.4 37.0 41.8 33.7
17.0 14.0 26.5 25.1 28.0
17.4 14.3 24.1 23.0 24.6
16.9 14.1 20.2 19.6 19.7
0.31 0.31 0.31 0.06 0.41 1.58 1.58 1.37
0.41 0.41 0.41 0.04 0.51 2.48 2.48 2.34
0.43 0.43 0.43 0.13 0.61 2.80 2.80 2.67
0.55 0.55 0.55 0.19 0.79 3.24 3.24 3.12
0.68 0.68 0.68 0.24 0.97 3.77 3.77 3.67
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At least 30% y-y NPAT growth in FY11F

Management has forecast that FY11F NPAT would be at least above CNY40bn (to at least increase by 30% y-y), driven mainly by asset growth, further NIM expansion and strong fee income growth. We maintain our forecast that CRCBs NPAT will double in three years.
Reiterate BUY with TP slightly lowered to HKD6.52

The stock is currently trading at 1.3x FY11F P/B. We think the valuation is at an attractive level and reaffirm our BUY rating. We lower our TP slightly by 2% to HKD6.52 (from HKD6.68) to reflect our higher provision assumptions given tighter regulations. As we still expect CRCB to have strong cash recoveries, we estimate credit costs in FY11F will be 0.26%, the lowest level among listed domestic peers.
Fig. 96: CRCB: earnings revisions
Higher provision forecasts
Profit & Loss (RMBmn, except %) Net interest income Fee income Non-interest income Operating Income Operating Expenses PPOP Provisions Operating pretax Profit tax Minority Interest Profits attributable to equity holders
2011F 10,042 384 410 10,452 (4,861) 5,591 (350) 5,241 (1,271) 3 3,973
Revised 2012F 12,750 486 513 13,264 (5,960) 7,303 (540) 6,763 (1,640) 3 5,126
2013F 15,717 618 648 16,365 (7,329) 9,036 (721) 8,315 (2,016) 3 6,302
2011F 10,042 384 410 10,452 (4,861) 5,591 (300) 5,291 (1,283) 3 4,011
Previous 2012F 12,750 486 513 13,264 (5,960) 7,303 (540) 6,763 (1,640) 3 5,126
2013F 15,717 618 648 16,365 (7,329) 9,036 (721) 8,315 (2,016) 3 6,302
2011F 0.0 0.0 0.0 0.0 0.0 0.0 16.7 (0.9) (0.9) 0.0 (0.9)
Change (%) 2012F 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
2013F 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
FY11F NIM will likely reach 3.30-3.50%

According to management, CRCBs 1Q11 NIM was 3.17% (compared with 3.07% in FY10). Management expects full-year FY11 NIM to reach 3.30-3.50%, driven mainly by the following factors: 1) Higher investment yield The banks average investment yield in 1Q11 stood at 4.5% (versus 4.19% in FY10), while the yield of new investment made this year has reached 6.1% so far. Management targets an average yield of 5% for the whole year of 2011. 2) Improving pricing power on the back of rate hikes According to estimates made by CRCB, NIM would be boosted by 15bp for every 100bp symmetric rate hike, based on the banks asset size at the beginning of the year. No new loans and loans being re-priced so far this year are offered with a discount to the benchmark lending rate, including loans to large enterprises. For SMEs and retail customers, loans are generally lent at a premium of 30-50% above benchmark. 3) Conversion of IPO funds into CNY According to management, over 90% (nearly CNY10bn) of IPO funds have been converted into CNY and reached the banks account in April. IPO funds provide the bank with capital at a low cost, enabling it to boost NIM by 10bp (assuming a return of 5%), according to CRCB. We expect this to bring 8-20% potential upside to our FY11F earnings estimate.
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Fast-growing intermediary business

On an unaudited basis, net fee income in 1Q11 ranged from CNY30mn-CNY40mn, with potential upside as some fee income might have not been included due to system issues (e.g. settlements for some categories are only done every semi-annually). Management aims to achieve 80% y-y growth in net fee income in FY11, with the total amount to account for 4-5% of total operating income in FY11F, up from 3.7% in FY10.
Fig. 97: CRCB: LDR
(%) 85 80 75 70 65 60 55 50 45 40 2007 2008 2009 2010 1Q11 2.0 1H09 2H09 1H10 2H10 1Q11 2.5 3.0 3.5
Fig. 98: CRCB: NIM

(%) 4.0
Targets 30% earnings growth with potential upside

According to management guidance, FY11F NPAT would be at least above CNY40bn (up by more than 30%), driven mainly by asset growth, further NIM expansion and strong fee income growth. Management has emphasised that it will keep track of operating costs. In FY11, it aims to keep operating expense increase to below 15%, leading to a CIR of no more than 40% (versus 50% in FY10), which would also contribute to the banks earnings growth. Management targets a CIR of around 35% from 2012F onwards.
1Q11 operating data loan and deposit growth on track

CRCB released its unaudited 1Q11 operating results on 1 June 2011, providing details mostly on deposits and loans. Total loans at the end of 1Q11 grew 5.7% q-q to CNY129.1bn. Net new loans of CNY6,956mn in the first quarter are equivalent to 34.8% of managements minimum loan growth target of CNY20bn for FY11F, announced during an analyst briefing in March. Total deposits increased to CNY214.3bn at the end of 1Q11, up by 4.3% q-q. The percentage of time deposits and demand deposits to total loans were 58% and 40%, respectively (versus 54% and 43% at end-FY10). Realizing that the proportion of time deposits is higher than peers, management is putting in efforts to adjust the structure of its liabilities. It targets a more ideal balance of a half-to-half ratio for demand and time deposits in future. LDR as of 31 March 2011 remained stable at 60%. Given its relatively low LDR, we think the impact of monitoring the daily average LDR starting in June would not be significant on CRCB.
No NPL in LGFV loans

According to management, the bank did not receive any official guidance, either verbally or in written format, from the regulator on shifting debts off the local governments, as reported by Reuters on 1 June 2011.
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As at the end of 1Q11, total outstanding amount of LGFV loans was CNY18.0bn, accounting for 15% of total loans. According to management, 99.98% of the loans can be classified as general corporate loans based on the regulators principles. As for the CNY30mn loans that are regarded as real LGFV loans, the bank has a detailed plan of recovering and clearing. So far, it has recovered several millions in renminbi and its NPL ratio on LGFV loans remains at 0%, according to management. Valuation methodology and risk Our revised target price of HKD6.52 (from HKD6.68) is based on 1.9x P/BV applied to our FY11F BVPS forecast of CNY2.80 as well as a sustainable ROE of 15.6%. We lower our TP in order to reflect our higher provision forecasts due to tighter regulations. We use the Gordon Growth Model [target P/BV = (sustainable ROE - long-term growth)/(cost of equity - long-term growth)] to derive our fair P/BV, assuming a cost of equity of 12.0% and a terminal growth rate of 7.8%. We derive our terminal growth rate by applying a 50% payout ratio to our long-term sustainable ROE. Downside risks: A more severe-than-expected macro tightening could result in a sharp rise in bad debt costs. In addition, a slowing economy would have negative implications for loan growth.
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Appendix A-1
Analyst Certification
I, Lucy Feng, hereby certify (1) that the views expressed in this Research report accurately reflect my personal views about any or all of the subject securities or issuers referred to in this Research report, (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of my compensation is tied to any specific investment banking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company.
Issuer Specific Regulatory Disclosures

Mentioned companies
Issuer name Agricultural Bank of China ICBC China Construction Bank-H Bank of Communications China Merchants Bank Chongqing Rural Commercial Bank China Minsheng Bank - H China CITIC Bank Bank of China (H-share) Ticker 1288 HK 1398 HK 939 HK 3328 HK 3968 HK 3618 HK 1988 HK 998 HK 3988 HK Price HKD 3.85 HKD 5.80 HKD 6.40 HKD 7.26 HKD 18.26 HKD 4.42 HKD 7.28 HKD 4.96 HKD 3.76 Price date 22-Jun-2011 22-Jun-2011 22-Jun-2011 22-Jun-2011 22-Jun-2011 22-Jun-2011 22-Jun-2011 22-Jun-2011 22-Jun-2011 Stock rating Buy Buy Neutral Neutral Buy Buy Neutral Buy Buy Sector rating Not rated Not rated Not rated Not rated Not rated Not rated Not rated Not rated Not rated Disclosures 3,4,8,47,48,55,58 4,8,12,48,50,55,58,61 4,58 24
8,47,48,55,61
4,58
Disclosures required in the U.S.

24 47 Disclosure of share ownership positions Nomura International plc holds a proprietory position in the issuer. Manager/Co-Manager in the past 12 months Nomura Securities International Inc. and /or its affiliates has managed or co-managed a public or Rule 144A offering of the company's securities in the past 12 months. IB related compensation in the past 12 months Nomura Securities International, Inc and/or its affiliates has received compensation for investment banking services from the company in the past 12 months. Nomura Beneficial Ownership of Securities Disclosures Nomura Securities International, Inc and /or its affiliates beneficially owns 1% or more of the common equity securities of the company.
48
50
Disclosures required in the European Union

3 Lead manager/co-lead manager of securities/related derivatives offering Nomura International plc or an affiliate in the global Nomura group has been lead manager or co-lead manager over the previous 12 months of a publicly disclosed offer of the issuer's securities or related derivatives Market maker Nomura International plc or an affiliate in the global Nomura group is a market maker or liquidity provider in the securities / related derivatives of the issuer. Investment banking services Nomura International plc or an affiliate in the global Nomura group is party to an agreement with the issuer relating to the provision of investment banking services which has been in effect over the past 12 months or has given rise during the same period to a payment or to the promise of payment. Nomura 1% shareholdings Nomura International plc and/or its affiliates in the global Nomura group have shareholdings exceeding 1% of the total issued share capital of the issuer.
12
Disclosures required in Hong Kong

55 Nomura financial interest/business relationships disclosures: Nomura International (Hong Kong) Limited has received compensation or mandate for investment banking services within the preceding 12 months from the issuer.
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58
Nomura financial interest/business relationships disclosures: Nomura International (Hong Kong) Limited or an affiliate in the global Nomura group is a market maker or liquidity provider in the securities / related derivatives of the issuer. Nomura financial interest/business relationships disclosures: Nomura International (Hong Kong) Limited and/or its group company which carries on a business in Hong Kong in proprietary trading or market making, in aggregate own/(s) 1% or more of the securities of the issuer as of the previous month-end.
61
Previous Rating
Issuer name Agricultural Bank of China ICBC China Construction Bank-H Bank of Communications China Merchants Bank Chongqing Rural Commercial Bank China Minsheng Bank - H China CITIC Bank Bank of China (H-share) Previous Rating Not Rated Strong Buy Buy Buy Neutral Not Rated Not Rated Reduce Neutral Date of change 26-Aug-2010 10-Dec-2008 23-Jun-2011 14-Jan-2011 03-Feb-2010 26-Jan-2011 03-Feb-2010 26-Jun-2009 12-Feb-2009
Rating and target price changes

Ticker Old stock rating New stock rating Old target price New target price
ICBC China Construction Bank-H Bank of Communications China Merchants Bank Chongqing Rural Commercial Bank
1398 HK 939 HK 3328 HK 3968 HK 3618 HK
Buy Buy Neutral Buy Buy
Buy Neutral Neutral Buy Buy
HKD 7.60 HKD 8.60 HKD 9.00 HKD 26.86 HKD 6.68
HKD 7.50 HKD 7.02 HKD 8.30 HKD 24.82 HKD 6.52
Agricultural Bank of China (1288 HK)

Rating and target price chart (three year history)
HKD 3.85 (22-Jun-2011) Buy (Sector rating: Not rated)

Date 05-May-2011 14-Jan-2011 22-Oct-2010 26-Aug-2010 26-Aug-2010 Rating Target price 5.20 4.80 4.70 4.30 Buy Closing price 4.48 3.97 4.07 3.53 3.53
For explanation of ratings refer to the stock rating keys located after chart(s)
Valuation Methodology Our target price of HKD5.20 is based on 2.1x P/BV applied to FY11F BVPS of CNY2.00. Our sustainable ROE assumption is 16.2% to reflect our positive view on ABCs LT ROE development given: 1) strong deposit franchise to be benefit from RRR hikes; 2) normalised credit costs to support future earnings. We use a Gordon Growth model (target P/BV= (sustainable ROE long-term growth) / (cost of equity long-term growth)) to derive our fair P/BV range, assuming a cost of equity of 12% and terminal growth rate of 8.1%. We derive our terminal growth rate assumption by applying a 50% payout ratio to our long-term sustainable ROE assumption. Risks that may impede the achievement of the target price Downside risks: Being one of the largest banks in China, ABC remains closely tied to the Chinese economy. We believe that a more severe-than-expected macro tightening could result in a sharp rise in bad debt costs. The government may implement certain policies specifically for ABC in county areas which might or might not be of benefit to ABC. A slowing economy would likely have negative implications for loan growth and asset quality. The concept of market and operations-related risks has only been introduced into Chinas banking system in recent years, and
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the system itself has yet to go through a full credit cycle. Therefore, there is no historical data showing how Chinese banks may perform under a more testing credit environment.
ICBC (1398 HK)
Rating and target price chart (three year history) Date 14-Jan-2011 22-Oct-2010 30-Jul-2010 13-May-2010 03-Feb-2010 18-Dec-2009 31-Aug-2009 26-Jun-2009 26-Mar-2009 10-Dec-2008 10-Dec-2008 Rating Target price 7.60 7.30 7.00 7.70 7.36 7.50 6.70 6.25 4.94 4.97 Buy Closing price 6.08 6.14 5.82 5.62 5.72 6.08 5.19 5.35 4.03 4.38 4.38
Valuation Methodology Our target price of HKD7.50 is based on 2.2x P/BV multiplier and FY11F BVPS of CNY2.75. Our sustainable ROE assumption is 15.8%. We use the Gordon Growth Model [target P/BV = (sustainable ROE - long-term growth)/(cost of equity - long-term growth)] to derive our fair P/BV range, assuming a cost of equity of 11.5% and a terminal growth rate of 7.9%. We derive our terminal growth figure by applying a 50% payout ratio to our long-term sustainable ROE. Risks that may impede the achievement of the target price Downside risks: As the largest bank in China, ICBC and its performance remain closely tied to the Chinese economy. Hence, we believe that a more severe-than-expected macro tightening could result in a sharp rise in bad debt costs. In addition, a slowing economy would have negative implications for loan growth, in our view. The concept of market and operation-related risks has only been introduced to the bank over the past few years. Moreover, fewer rate hikes than expected in 2011F is likely to pose a downward risk to our NIM assumption.
China Construction Bank-H (939 HK)
Rating and target price chart (three year history) Date 14-Jan-2011 22-Oct-2010 30-Jul-2010 13-May-2010 03-Feb-2010 18-Dec-2009 04-Sep-2009 18-Jun-2009 25-May-2009 30-Mar-2009 12-Feb-2009 12-Feb-2009 10-Dec-2008 10-Dec-2008 Rating Target price 8.60 8.50 7.60 7.90 7.48 8.50 7.80 7.30 5.65 4.95 4.99 Buy 5.05 Neutral Closing price 7.32 7.20 6.39 6.17 5.92 6.17 5.86 5.37 4.65 4.12 3.84 3.84 4.73 4.73
HKD 6.40 (22-Jun-2011) Neutral (Sector rating: Not rated)
Valuation Methodology Our target price of HKD7.02 is based on 1.75x P/BV multiplier and FY11F BVPS of CNY3.22. Our sustainable ROE assumption is 15.5%. We use the Gordon Growth Model [target P/BV = (sustainable ROE - long-term growth)/(cost of equity - long-term growth)] to derive our fair P/BV range, assuming a cost of equity of 12.7% and a terminal growth rate of 7.8%. We derive our terminal growth figure by applying a 50% payout ratio to our long-term sustainable ROE.
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Risks that may impede the achievement of the target price Downside risks: We believe that more severe-than-expected macro tightening could result in a sharp increase in bad debt costs. In addition, a slowing economy would have negative implications for loan growth and could lead to a significant rise in NPLs, in our view. Upside risks: a peak and reversing CPI is likely to reduce the possibility of asymmetric interest rate hike.
Bank of Communications (3328 HK)
Rating and target price chart (three year history) Date 14-Jan-2011 14-Jan-2011 22-Oct-2010 07-Jun-2010 13-May-2010 09-Mar-2010 09-Mar-2010 23-Feb-2010 03-Feb-2010 18-Dec-2009 04-Sep-2009 26-Jun-2009 26-Jun-2009 19-Mar-2009 10-Dec-2008 10-Dec-2008 Rating Target price 9.00 Neutral 11.00 10.00 10.20 10.00 Buy 9.09 8.81 10.00 9.80 8.65 Neutral 4.10 4.40 Reduce Closing price 8.00 8.00 9.28 7.71 7.92 8.19 8.19 7.58 7.63 8.28 9.00 7.99 7.99 4.91 5.50 5.50
Valuation Methodology Our target price of HKD8.30 is based on a P/BV multiple of 1.6x, which we apply to our FY11F BVPS forecast of CNY4.07. In deriving our target multiple, we assume a sustainable ROE of 15.7%. We use the Gordon Growth Model [target P/BV = (sustainable ROE - long-term growth)/(cost of equity - long-term growth)] to derive our fair P/BV range, assuming a cost of equity of 12.5% and a terminal growth rate of 7.9%. We derive our terminal growth by applying a 50% payout ratio to our long-term sustainable ROE. Risks that may impede the achievement of the target price Downside risks: We believe that severer-than-expected macro tightening could result in a sharp rise in bad debt costs. A sharper-than-expected fall in exports could hurt BCOM more than peers, given its exposure to Chinas coastal regions. Finally, a slowing economy would have negative implications for loan growth. Upside risks: A strong NIM rebound amid the interest rate hike cycle.
China Merchants Bank (3968 HK)


Date 14-Jan-2011 22-Oct-2010 13-May-2010 14-Apr-2010 02-Mar-2010 03-Feb-2010 03-Feb-2010 18-Dec-2009 02-Sep-2009 25-Aug-2009 08-Jun-2009 10-Dec-2008 10-Dec-2008 Rating Target price 26.86 26.36 23.40 23.33 23.30 23.99 Buy 22.00 17.20 16.65 16.55 14.00 Neutral Closing price 20.25 22.70 18.16 20.70 19.09 18.29 18.29 18.40 15.50 17.02 15.14 11.61 11.61
Valuation Methodology Our target price of HKD24.82 is based on 2.69x P/BV applied to our FY11F BVPS forecast of CNY7.4. Our sustainable ROE is 16.8%. We use the Gordon Growth Model [target P/BV = (sustainable ROE - long-term growth) / (cost
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of equity - long-term growth)] to derive our fair P/BV range, assuming a cost of equity of 11.5% and a terminal growth rate of 8.4%. We derive our terminal growth rate by applying a 50% payout ratio to our long-term sustainable ROE. Risks that may impede the achievement of the target price Downside risks: We believe that severer-than-expected macro tightening could result in a sharp rise in bad debt costs. In addition, a slowing economy would have negative implications for loan growth.
Chongqing Rural Commercial Bank (3618 HK)
Rating and target price chart (three year history) Date 30-Mar-2011 26-Jan-2011 26-Jan-2011 Rating Target price 6.68 6.90 Buy Closing price 5.23 5.41 5.41
Valuation Methodology Our target price of HKD6.52 is based on 1.9x P/BV applied to our FY11F BVPS forecast of CNY2.80 as well as a sustainable ROE of 15.6%. We lower our TP in order to reflect our higher provision forecast due to tighter regulations. We use the Gordon Growth Model [target P/BV = (sustainable ROE - long-term growth)/(cost of equity - long-term growth)] to derive our fair P/BV, assuming a cost of equity of 12.0% and a terminal growth rate of 7.8%. We derive our terminal growth rate by applying a 50% payout ratio to our long-term sustainable ROE. Risks that may impede the achievement of the target price Downside risks: A more severe-than-expected macro tightening could result in a sharp rise in bad debt costs. In addition, a slowing economy would have negative implications for loan growth.
China Minsheng Bank - H (1988 HK)


Date 22-Oct-2010 30-Jul-2010 13-May-2010 03-Feb-2010 03-Feb-2010 Rating Target price 7.40 7.90 9.00 8.81 Neutral Closing price 7.22 7.25 6.61 6.62 6.62
Valuation Methodology Our target price of HKD7.40 is based on 1.35x P/BV applied to our FY11F BVPS forecast of CNY4.39 as well as a sustainable ROE of 13.8%. We use the Gordon Growth Model [target P/BV = (sustainable ROE - long-term
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growth)/(cost of equity - long-term growth)] to derive our fair P/BV, assuming a cost of equity of 12.0% and a terminal growth rate of 6.9%. We derive our terminal growth rate by applying a 50% payout ratio to our long-term sustainable ROE. Risks that may impede the achievement of the target price Downside risks: severer-than-expected macro tightening could result in a sharp rise in bad debt costs. In addition, a slowing economy would have negative implications for loan growth. Upside risks: A strong NIM rebound amid the interest rate hike cycle.
China CITIC Bank (998 HK)
Rating and target price chart (three year history) Date 05-May-2011 14-Jan-2011 22-Oct-2010 13-May-2010 03-Feb-2010 18-Dec-2009 04-Sep-2009 26-Jun-2009 26-Jun-2009 10-Dec-2008 10-Dec-2008 Rating Target price 6.50 6.30 6.60 5.80 6.57 8.25 6.10 5.85 Buy 2.40 Reduce Closing price 5.47 5.35 5.73 4.64 5.55 6.18 4.79 4.94 4.94 3.03 3.03
Valuation Methodology Our target price of HKD6.50 is based on 1.5x P/BV applied to our FY11F BVPS forecast of CNY3.42, assuming sustainable ROE of 14.5% in order to reflect our positive view on Citics improvement in LDR. We use the Gordon Growth Model [target P/BV = (sustainable ROE - long-term growth)/(cost of equity - long-term growth)] to derive our fair P/BV, assuming a cost of equity of 12% and a terminal growth rate of 7.2%. We derive our terminal growth rate by applying a 50% payout ratio to our long-term sustainable ROE. Risks that may impede the achievement of the target price Downside risks: more severe-than-expected macro tightening could result in a sharp rise in bad debt costs. In addition, a slowing economy would have negative implications for loan growth.
Bank of China (H-share) (3988 HK)


Date 14-Jan-2011 22-Oct-2010 30-Jul-2010 24-Jun-2010 13-May-2010 15-Mar-2010 03-Feb-2010 18-Dec-2009 04-Sep-2009 26-Jun-2009 20-Apr-2009 25-Mar-2009 12-Feb-2009 12-Feb-2009 10-Dec-2008 10-Dec-2008 Rating Target price 5.20 5.30 4.90 5.00 4.80 4.64 4.55 5.50 4.90 4.30 3.25 2.57 2.61 Buy 2.63 Neutral Closing price 4.30 4.32 3.93 3.91 3.84 3.75 3.68 3.86 3.79 3.51 2.83 2.32 2.02 2.02 2.49 2.49
Valuation Methodology We derive our target price of HKD5.20 by applying a target P/BV of 1.64x to our FY11F BVPS forecast of CNY2.54. Our sustainable ROE assumption is 14.9%. We use the Gordon Growth Model [target P/BV= (sustainable ROE long-term growth)/(cost of equity - long-term growth)] to derive our fair P/BV range, assuming a cost of equity of 12.0% and a
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terminal growth rate of 7.4%. We derive our terminal growth rate by applying a 50% payout ratio to our long-term sustainable ROE. Risks that may impede the achievement of the target price Downside risks: We believe that more-severe-than-expected macro tightening could result in a sharp rise in bad debt costs. Any downturn in the global economy, and especially Hong Kongs economy, could also weigh on the banks earnings performance given its bigger foreign exposure relative to that of peers.
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Distribution of ratings (US)

The distribution of all ratings published by Nomura US Equity Research is as follows: 38% have been assigned a Buy rating which, for purposes of mandatory disclosures, are classified as a Buy rating; 4% of companies with this rating are investment banking clients of the Nomura Group*. 55% have been assigned a Neutral rating which, for purposes of mandatory disclosures, is classified as a Hold rating; 1% of companies with this rating are investment banking clients of the Nomura Group*. 7% have been assigned a Reduce rating which, for purposes of mandatory disclosures, are classified as a Sell rating; 0% of companies with this rating are investment banking clients of the Nomura Group*. As at 31 March 2011. *The Nomura Group as defined in the Disclaimer section at the end of this report.
Distribution of ratings (Global)

The distribution of all ratings published by Nomura Global Equity Research is as follows: 49% have been assigned a Buy rating which, for purposes of mandatory disclosures, are classified as a Buy rating; 37% of companies with this rating are investment banking clients of the Nomura Group*. 40% have been assigned a Neutral rating which, for purposes of mandatory disclosures, is classified as a Hold rating; 46% of companies with this rating are investment banking clients of the Nomura Group*. 11% have been assigned a Reduce rating which, for purposes of mandatory disclosures, are classified as a Sell rating; 16% of companies with this rating are investment banking clients of the Nomura Group*. As at 31 March 2011. *The Nomura Group as defined in the Disclaimer section at the end of this report.
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June 24, 2011
Explanation of Nomura's equity research rating system in Europe, Middle East and Africa, US and Latin America for ratings published from 27 October 2008
The rating system is a relative system indicating expected performance against a specific benchmark identified for each individual stock. Analysts may also indicate absolute upside to target price defined as (fair value - current price)/current price, subject to limited management discretion. In most cases, the fair value will equal the analyst's assessment of the current intrinsic fair value of the stock using an appropriate valuation methodology such as discounted cash flow or multiple analysis, etc. STOCKS A rating of 'Buy', indicates that the analyst expects the stock to outperform the Benchmark over the next 12 months. A rating of 'Neutral', indicates that the analyst expects the stock to perform in line with the Benchmark over the next 12 months. A rating of 'Reduce', indicates that the analyst expects the stock to underperform the Benchmark over the next 12 months. A rating of 'Suspended', indicates that the rating and target price have been suspended temporarily to comply with applicable regulations and/or firm policies in certain circumstances including when Nomura is acting in an advisory capacity in a merger or strategic transaction involving the company. Benchmarks are as follows: United States/Europe: Please see valuation methodologies for explanations of relevant benchmarks for stocks (accessible through the left hand side of the Nomura Disclosure web page: http://www.nomura.com/research);Global Emerging Markets (exAsia): MSCI Emerging Markets ex-Asia, unless otherwise stated in the valuation methodology. SECTORS A 'Bullish' stance, indicates that the analyst expects the sector to outperform the Benchmark during the next 12 months. A 'Neutral' stance, indicates that the analyst expects the sector to perform in line with the Benchmark during the next 12 months. A 'Bearish' stance, indicates that the analyst expects the sector to underperform the Benchmark during the next 12 months. Benchmarks are as follows: United States: S&P 500; Europe: Dow Jones STOXX 600; Global Emerging Markets (ex-Asia): MSCI Emerging Markets ex-Asia.
Explanation of Nomura's equity research rating system for Asian companies under coverage ex Japan published from 30 October 2008 and in Japan from 6 January 2009
STOCKS Stock recommendations are based on absolute valuation upside (downside), which is defined as (Target Price - Current Price) / Current Price, subject to limited management discretion. In most cases, the Target Price will equal the analyst's 12-month intrinsic valuation of the stock, based on an appropriate valuation methodology such as discounted cash flow, multiple analysis, etc. A 'Buy' recommendation indicates that potential upside is 15% or more. A 'Neutral' recommendation indicates that potential upside is less than 15% or downside is less than 5%. A 'Reduce' recommendation indicates that potential downside is 5% or more. A rating of 'Suspended' indicates that the rating and target price have been suspended temporarily to comply with applicable regulations and/or firm policies in certain circumstances including when Nomura is acting in an advisory capacity in a merger or strategic transaction involving the subject company. Securities and/or companies that are labelled as 'Not rated' or shown as 'No rating' are not in regular research coverage of the Nomura entity identified in the top banner. Investors should not expect continuing or additional information from Nomura relating to such securities and/or companies. SECTORS A 'Bullish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a positive absolute recommendation. A 'Neutral' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a neutral absolute recommendation. A 'Bearish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a negative absolute recommendation.
Explanation of Nomura's equity research rating system in Japan published prior to 6 January 2009 (and ratings in Europe, Middle East and Africa, US and Latin America published prior to 27 October 2008)
STOCKS A rating of '1' or 'Strong buy', indicates that the analyst expects the stock to outperform the Benchmark by 15% or more over the next six months. A rating of '2' or 'Buy', indicates that the analyst expects the stock to outperform the Benchmark by 5% or more but less than 15% over the next six months. A rating of '3' or 'Neutral', indicates that the analyst expects the stock to either outperform or underperform the Benchmark by less than 5% over the next six months. A rating of '4' or 'Reduce', indicates that the analyst expects the stock to underperform the Benchmark by 5% or more but less than 15% over the next six months. A rating of '5' or 'Sell', indicates that the analyst expects the stock to underperform the Benchmark by 15% or more over the next six months. Stocks labeled 'Not rated' or shown as 'No rating' are not in Nomura's regular research coverage. Nomura might not publish additional research reports concerning this company, and it undertakes no obligation to update the analysis, estimates, projections, conclusions or other information contained herein. SECTORS A 'Bullish' stance, indicates that the analyst expects the sector to outperform the Benchmark during the next six months. A 'Neutral' stance, indicates that the analyst expects the sector to perform in line with the Benchmark during the next six months. A 'Bearish' stance, indicates that the analyst expects the sector to underperform the Benchmark during the next six months. Benchmarks are as follows: Japan: TOPIX; United States: S&P 500, MSCI World Technology Hardware & Equipment; Europe, by sector Hardware/Semiconductors: FTSE W Europe IT Hardware; Telecoms: FTSE W Europe Business Services; Business Services: FTSE W Europe; Auto & Components: FTSE W Europe Auto & Parts; Communications equipment: FTSE W Europe IT Hardware; Ecology Focus: Bloomberg World Energy Alternate Sources; Global Emerging Markets: MSCI Emerging Markets ex-Asia.
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June 24, 2011
Explanation of Nomura's equity research rating system for Asian companies under coverage ex Japan published prior to 30 October 2008
STOCKS Stock recommendations are based on absolute valuation upside (downside), which is defined as (Fair Value - Current Price)/Current Price, subject to limited management discretion. In most cases, the Fair Value will equal the analyst's assessment of the current intrinsic fair value of the stock using an appropriate valuation methodology such as Discounted Cash Flow or Multiple analysis etc. However, if the analyst doesn't think the market will revalue the stock over the specified time horizon due to a lack of events or catalysts, then the fair value may differ from the intrinsic fair value. In most cases, therefore, our recommendation is an assessment of the difference between current market price and our estimate of current intrinsic fair value. Recommendations are set with a 6-12 month horizon unless specified otherwise. Accordingly, within this horizon, price volatility may cause the actual upside or downside based on the prevailing market price to differ from the upside or downside implied by the recommendation. A 'Strong buy' recommendation indicates that upside is more than 20%. A 'Buy' recommendation indicates that upside is between 10% and 20%. A 'Neutral' recommendation indicates that upside or downside is less than 10%. A 'Reduce' recommendation indicates that downside is between 10% and 20%. A 'Sell' recommendation indicates that downside is more than 20%. SECTORS A 'Bullish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a positive absolute recommendation. A 'Neutral' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a neutral absolute recommendation. A 'Bearish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a negative absolute recommendation.
Target Price
A Target Price, if discussed, reflect in part the analyst's estimates for the company's earnings. The achievement of any target price may be impeded by general market and macroeconomic trends, and by other risks related to the company or the market, and may not occur if the company's earnings differ from estimates.
Disclaimers
This publication contains material that has been prepared by the Nomura entity identified at the top or bottom of page 1 herein, if any, and/or, with the sole or joint contributions of one or more Nomura entities whose employees and their respective affiliations are specified on page 1 herein or elsewhere identified in the publication. Affiliates and subsidiaries of Nomura Holdings, Inc. (collectively, the 'Nomura Group'), include: Nomura Securities Co., Ltd. ('NSC') Tokyo, Japan; Nomura International plc ('NIplc'), United Kingdom; Nomura Securities International, Inc. ('NSI'), New York, NY; Nomura International (Hong Kong) Ltd. (NIHK), Hong Kong; Nomura Financial Investment (Korea) Co., Ltd. (NFIK), Korea (Information on Nomura analysts registered with the Korea Financial Investment Association ('KOFIA') can be found on the KOFIA Intranet at http://dis.kofia.or.kr ); Nomura Singapore Ltd. 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Unmasking China&#39;s Shadow Banking System

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ANCHOR REPORT

Unmasking the shadow banking system

Unmasking the shadow banking system

June 24, 2011

Rating: See report end for details of Nomuras rating system.

Nomura | AEJ China banks

June 24, 2011

Monetary policy unlikely to be eased any time soon

Regulation of shadow banking system

Macro and monetary policy

Economic growth showing signs of slowdown

Monetary policy unlikely to ease any time soon

CBRC rolls out stricter regulatory rules for China banks

New regulations on cross-industry financial holding companies

Shadow Banking Business

Wiping off trust loans 1% of total bank loans

Entrusted loans RWA funding pressure

Two tales: wealth management products

SMEs who is borrowing at above 10% pa rate?

...due to higher lending rates...

... which is starting to erode the profit margin of SMEs

Case study SMEs in Wenzhou

Credit guarantee companies

Nomura | AEJ China banks

June 24, 2011

Public housing program in the spotlight

Public housing program smaller funding size for China banks

Public housing development plan for 12th Five Year Plan

Surging financing demand from public housing projects

Financing gap for the public housing program

Banks lack enthusiasm in this area

Multiple funding sources for the public housing program

How much of the CNY900bn needs to be financed by China banks?

Improvement of rural financing

Continuous development of new-type rural financial institutions

Rural financial institutions more important role

Historical burden on rural financial institutions

Still opportunities for other commercial banks

Nomura | AEJ China banks

June 24, 2011

Nomura | AEJ China banks

June 24, 2011

Net interest income

Non-interest income Revenue (%) SG&A PPOP (%)

0.49-0.86 2.87-3.31 (0.94)-(1.16) 1.75-2.25

Loan loss provision

15.5-18.7 18.0-24.1 1.02-1.38

Source: Company data, Nomura estimates

Nomura | AEJ China banks

June 24, 2011

2nd rate hike in 2011

Talk of government bail-out on LGFV loans

Talk of BOA selling part of CCB stake

Source: Bloomberg, Nomura research

Nomura | AEJ China banks

June 24, 2011

Fig. 5: H-share banks stock price performance YTD

Fig. 6: H-share banks stock price performance YTD

(%) 15 10 5 0 (5) (10) (15) (20)

Note: closing prices as of 21 June, 2011 Source: Bloomberg, Nomura research

Monetary policy unlikely to be eased any time soon

Fig. 8: Household inflation expectations

Source: Bloomberg, Nomura research

Unmasking China's Shadow Banking System

Unmasking China's Shadow Banking System