Key highlights from dbAccess China Conference and the financial tour

Deutsche Bank Markets Research Asia China Banking / Finance Banks Industry Chinese Banks Date 21 January 2016 Industry Update Key highlights from dbAccess China Conference and the financial tour Cheap valuation to offset challenges and risks ________________________________________________________________________________________________________________ Deutsche Bank AG/Hong Kong Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 124/04/2015. Hans Fan, CFA Research Analyst (+852) 2203 6353 hans.fan@db.com Vincent Gu Research Associate (+852) 2203 6185 vincent.gu@db.com Jacky Zuo Research Associate (+852) 2203 6255 jacky.zuo@db.com Top picks China Construction Bank (0939.HK),HKD4.58 Buy Bank of China (3988.HK),HKD2.98 Buy Source: Deutsche Bank Companies Featured ICBC (1398.HK),HKD3.92 Buy China Construction Bank (0939.HK),HKD4.58 Buy Agri. Bank of China (1288.HK),HKD2.74 Buy Bank of China (3988.HK),HKD2.98 Buy Bank of Communications (3328.HK),HKD4.59 Buy China Merchants Bank (3968.HK),HKD14.62 Buy China CITIC Bank (0998.HK),HKD4.32 Buy China Minsheng Bank (1988.HK),HKD6.53 Buy Chongqing Rural Bank (3618.HK),HKD3.74 Buy Huishang Bank (3698.HK),HKD3.39 Hold Bank of Chongqing (1963.HK),HKD5.96 Hold Shanghai Pudong Bank (600000.SS),CNY17.23 Hold Industrial Bank (601166.SS),CNY15.15 Hold China Everbright Bank (601818.SS),CNY3.70 Hold Ping An Bank (000001.SZ),CNY10.54 Buy Bank of Beijing (601169.SS),CNY9.88 Buy Bank of Nanjing (601009.SS),CNY15.73 Hold Bank of Ningbo (002142.SZ),CNY13.25 Hold Source: Deutsche Bank Valuation and Risks: We value Chinese banks using a three-stage Gordon Growth Model (PV= (ROE-g)/(COE-g)), with PTs based on 2016E book values. Downside risks incl. slower-than-expected economic growth leading to lower loan demand. Upside risks incl. policy easing including interest rate and RRR cuts. See p. 18 Managements from 13 banks, three brokers and two diversified financial companies participated in our Access China Conference to meet investors. The event was held on 11-13 January 2016 in Beijing, and was followed up with a financial tour to Chengdu, Sichuan on 14-15 January to meet local governments and financial institutions. This report consolidates the key takeaways from meetings with the managements of listed financial institutions and the highlights of the two-day Chengdu financial tour. Trading at 0.6x 2016 PB, which implies 8%+ NPL ratio, we stay positive on Chinese banks. Banks’ fundamentals remain challenging on NIM squeeze and asset quality Banks’ managements, in general, are optimistic on PPOP growth in 2016, mainly driven by stable loan growth, still-decent fee income growth and tight cost control (Figure 1). Nevertheless, this is partly offset by NIM compression due to rate cuts. Banks expect continued asset quality pressure, with modestly higher or flattish NPL formation rates in 2016. With rising write-offs or transfers-out, the NPL ratio should increase modestly in 2016 (2% we estimate). As such, the provision coverage ratio (3Q15: 183%) may continue to fall and we expect the CBRC to relax the 150% provision requirement in 2016 in order to help the sector achieve flat or positive profit growth. Banks are increasingly differentiated by their strategies to tackle challenges Among the listed banks, we see BOC, CCB and CRCB as having the most differentiated strategies. Running a unique rural banking model, CRCB has set up 600 self-service rural banking terminals (aside from its 1,700 outlets) in new rural communities and enjoys a solid deposit market share in Chongqing (~20% market share). With a focus on its overseas business, BOC should benefit from China’s “One Belt One Road” policy and RMB internationalisation. Owning a strong competitive edge in financing infrastructure projects, CCB should benefit from accelerating infrastructure spending. De-capacity should have limited impact on banks, but the process may be slow Listed banks have been scaling back exposure to overcapacity sectors in previous years; they currently account for 2% of total loans (vs. 5% for the banking sector as a whole). In addition, big banks expanded their credit allocation to leading corporates in overcapacity sectors, which should benefit from the de-capacity process with better margin and stronger market share. Nevertheless, our conversations with provincial officials suggest t