Summary

Benefited from the “V”-shaped recovery of China's economy and significant increase of loans in 2009, the performance of domestic banking sector were satisfied. In the first half year of 2010, the profits of the banks still maintained stable growth, and most of financial data were in line with our expectation.

In 2010 the banks are facing the pressures of financing due to the requirement of increasing the capital adequacy ratio (CAR) released by the regulatory authorities, and we believe the non-performing loans (NPLs) ratio would be rise in the near future due to the sharp increase of total loans in recent years, which will be the main risk that domestic banks are going to face.

Importantly, we should note that Agricultural Bank of China (ABC) was listed in both A and H Shares in July, which was the milestone for China's banking sector. After ABC's listing, as the final large state-owned bank, it represented that China's wholly state-owned bank become the history, and the shareholding reform of Chinese banks has achieved the initial success. Under the restructure of China's economy, the deeper reformation of China's financial system and banking sector now is beginning, and we will face a new financing era.

However, because this report is written for the first half year of 2010, therefore we will mention ABC's listing in details in 2010 Annual Report.

In all, we believe the profits of listed banks will continue to increase stably if there are not any large changes of China's macro economy. Therefore, we still hold an optimistic view on domestic banking sector in the near future, and maintain the sector on “outperforming” rating.

Strong recovery of China's economy

Benefited from several economic stimulus plans released and implemented by Chinese government, China's economy experienced strong recovery in 2009. On these bases, China's economy continued to increase stably in 2010H1. As at the end of 2010Q1 and 2010Q2, China's quarter GDP increased by 11.9% and 11.1% yoy respectively.

As at the end of June 2010, China's monitoring signals of macroeconomic climate index was 106.7, 4.3 points lower than 110 of May, and still located in “stable” area.

In 2009 the People's Bank of China (PBOC) made the easing monetary policy to stimulate the economy, the money supply increased significantly. However, in 2010H1, both the increase of M1 and M2 were slowing down. As at the end of June, both M2 and M1 increased by 18.46% and 24.56% respectively, 2.54 and 5.34 percentage points lower than last month.

Although the growth of money supply was slow-down, the growth rate of M1 was still faster than M2, representing quite high liquidity in the market.

Meanwhile, the loans and deposits of domestic banks also decreased, especially for the loans.

As at the end of 2010H1, monthly newly added loans of China amounted to RMB603.4 billion, decreased significantly by 61% yoy. Total deposits of residents and loans increase by 15.54% and 18.18% yoy respectively.

We noted the proportion of notes of enterprises have continued to down, the proportion of medium and long term loans have maintained stable, and residents loans have decreased. As at the end of June, residents loans amounted to RMB234.23 billion, decreased by 22.86% yoy sharply, and 10.6 percentage points lower than last month.

The growth of newly added loans slowed down obviously

In 2009, loans of the listed banks increased significantly due to the expansionary fiscal policy released by the government, the hot money then increased sharply in the market, therefore, the growth of the banks` loans had slowed down in 2010H1 to reduce the liquidity. As at the end of 2010Q1, CMBC gained the largest decrease rate of newly added loans among the peers compared with 2009Q4, which was -527%, and BoCom achieved the highest one as 445%. Generally speaking , the growth rates of newly added loans of state-owned banks were faster than joint-stock commercial banks.

However, the growth of net loans of joint-stock commercial banks were faster in 2010H1 due to the low base. In 2010Q1, the growth rate of net loans and advances to customers of BoCom was the highest as 8.83%, and the second one was BOC, recorded 8.26%. Meanwhile, CCB gained the lowest growth rate as 5.11%.

We estimate the growth of loans of domestic financial institutions will decrease yoy but sill continue to increase stably in 2010, which may achieve to RMB7-8 trillion.

Profits rebound significantly

Due to the effects of global economic crisis in 2008, the profits of listed banks appeared large decreased in 2009H1, and considering such low base and the strong recovery of China's economy in 2009H2, the growth of the listed banks` profits were rebound significantly.

As at the end of 2010Q1, ICBC gained the most net interest incomes as RMB68.401 billion, but its growth rate was lower than the peers due to its large size, and CMBC recorded the highest growth rate of net interest incomes among 7 domestic listed banks, increased by 47.86% yoy.

Moreover, compared with the same growth rate in 2009Q1, we noted the change of the growth rate of CITIC's net interest incomes was the highest, increased sharply by 55.31 percentage points to 41.06% in 2010Q1 from -14.25% in 2009Q1.

In addition, because of the market recovery in 2009, listed banks` intermediary business began to increase. Benefited from the huge assets scale and distribution channel of sales, commission incomes of the state-owned commercial banks occupy the most market shares, and joint-stock commercial banks got higher growth rate during the same period of time because of their flexible business structure and the lower base of assets scale.

As at the end of 2010Q1, CMBC gained the highest growth rate of net fee and commission incomes among the peers, increased significantly by 125.03% yoy, 157 percentage points higher than -31.97% in 2009Q1. ICBC still recorded the largest of net fee and commission incomes as RMB18.256 billion during the same period of time.

The profits of listed banks increased significantly due to the large increase of interest incomes and commission fees.

Net profits of CMBC recorded the highest increase among the peers. As at the end of 2010Q1, its net profits increased sharply by 70.83% yoy, 69.20 percentage higher than such rate in 2009Q1. We also noted the changes of the growth rate of CMB's net profits gained the highest as 74 percentage points from 2009Q1 to 2010Q1.

In all, we note the profits of domestic listed banks increased sharply from 2009H1 to 2010H1, we estimate that the average growth rate of net profits of listed banks would be around 40% in 2010H1.

Growth rate of assets dropped

Loans of the listed banks increased sharply in 2009 due to the implementation of 4 trillion economic stimulus plans, which caused the assets of listed banks to increase largely, and the growth rates of joint-stock commercial banks` assets were faster than such rate of state-owned banks.

However, in order to avoid some overheating in economy, the government begun to control the growth of loans, therefore the growth of the assets of listed banks slowed down.

As at the end of 2010Q1, CITIC recorded the fastest decrease of its total assets growth, dropped 1.25% compared with the end of 2009, which was the only one got the negative growth rate of total assets among domestic listed banks.

BOC's total assets maintained strong increase relatively due to the stable growth of its loans. As at the end of 2010Q1, BOC's total assets increased by 11.09% compared with the end of 2009.

In addition, although the growth rate of assets decreased, the quality of listed banks` assets have continued to improve obviously. As at the end of 2010Q1, the non-performing loans (NPL ) ratio of all domestic listed banks decreased compared with 2009.

ICBC and CCB had the highest ratios among the peers as the same as 1.35%, dropped 0.19 and 0.15 percentage points compared with the end of 2009, and CMB got the lowest one as 0.74% at the same period.

Expect for getting the lowest NPL ratio, CMB also owned the highest covered ratio, as at the end of 2010Q1, it achieved to 272.26%, much higher than the peers.

Pressures of financing increasing

Currently, the main risk listed banks face is still the deterioration of asset's quality due to the significant increase of loans in 2009. The capital adequacy ratio (CAR) of the most listed banks were down obviously at the beginning of 2010.

As at the end of 2010Q1, only CMB's CAR increased slightly by 1.08 percentage points to 11.53% from the end of 2009, and CITIC's CAR decreased mostly by 0.8 percentage points to 9.34% during the same period of time.

Therefore, the listed banks still face quite large financing pressures in 2010, and the banks announced several financing plans to ease the capital pressures.

Currently, except the listing of ABC in both A and H Shares in July, there was only CMB completed its right issues of A and H Shares in March, others should be finished in 2010H2 or 2011.

Recommendation and valuation

In all, we think domestic listed banks` profits keeping strong increase and the quality of assets continue to improve, therefore their performance would be outperforming. CMB owns the better quality of assets, and both profits and assets of BOC maintain stronger growth than others.

The stock price of CITIC dropped mostly as 23.23% in 2010H1, but increased largely by 98.80% compared with the lowest price in 2009, which was only lower than BOC.

According to our previous annual sector report, we concerned about the banks such as BOC, CMBC, CMB and CITIC, the performance of the most banks were in line with our expectation.

Due to the decrease of prices in 2010H1, we find the valuation of domestic listed banks in HK are quite reasonable now, and considering the anticipation of stable increase of banks` profits in 2010, we still hold an optimistic view on listed banks` performance in 2010, and maintain the sector on “Outperforming” rating, especially, we pay close attention to BOC, ABC, CMB and CMBC.

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