Chongqing Rural Commercial Bank (3618.HK / 3618 HK)

Transcription

1 Asia Pacific/China Equity Research Regional Banks Rating UNDERPERFORM* [V] Price (21 Jan 11, HK$) 5.58 Target price (HK$) 4.56¹ Chg to TP (%) Market cap. (Rmb mn) 43,91 (US$ 6,667) Enterprise value (Rmb mn) 43,91 Number of shares (mn) 9,3. Free float (%) week price range *Stock ratings are relative to the relevant country benchmark. ¹Target price is for 12 months. [V] = Stock considered volatile (see Disclosure Appendix). Share price performance De c-1 Price (LHS) Research Analysts Daisy Wu daisy.wu@credit-suisse.com Sanjay Jain sanjay.jain@credit-suisse.com Rebased Rel (RHS) The price relative chart measures performance against the MSCI China Free index which closed at on 21/1/11 On 21/1/11 the spot exchange rate was HK$7.77/US$ Performance Over 1M 3M 12M Absolute (%) 8.8 Relative (%) Chongqing Rural Commercial Bank (3618.HK / 3618 HK) INITIATION Challenges are not priced in Initiating coverage of CRCB with an UNDERPERFORM rating. Our 12- month target price of HK$4.56 for CRCB (post-shoes) implies around 18% potential downside. CRCB offers leverage to both western China and the rural financial segment growth through its 12% loan market share in Chongqing. However, we anticipate substantial mid-term challenges including risk control, competition and tightening monetary policy. These challenges are not priced in. Market may be too optimistic on risk control, margin and opex. Credit cost at CRCB post restructuring remains a wildcard given: (1) relatively weak asset quality (with the highest NPL ratio and SML ratio among peers) and higher exposure to risky sectors (e.g., property developers, construction and personal business loans including farmer loans) and (2) unproven risk management with limited track record. Our 211 and 212 earnings forecasts are 5% and 19% below consensus, primarily due to our assumption of a normalising credit cost (51 bp and 89 bp versus consensus 3 bp and 5 bp). Moreover, CRCB is facing increasing competition as it continues to push loan growth in urban areas and corporate loans, where bigger banks still dominate. This will put pressure on both margin and opex. Strong loan pricing, which was a key margin driver, has lost some ground. Catalysts. Key catalysts are: (1) lower-than-expected volume growth, (2) credit quality deterioration amid tighter monetary policy and (3) LGFV resolution may trigger additional provisioning. Timing will be in 1Q11. Potential downside to our fair value. We adopt the Gordon Growth Model to derive the fair value for Chinese banks. Our 12-month target price of HK$4.56 for CRCB was derived from 1.4x forward P/B. We used a mid-term ROE of 14.1% and COE of 11.5% (beta of 1.25) and LT growth of 5%. Financial and valuation metrics Year 12/9A 12/1E 12/11E 12/12E Pre-prov Op profit (Rmb mn) 2, ,68.7 5, ,766. Pre -tax profit (Rmb mn) 2, ,95. 4, ,187.4 Net attributable profit (Rmb mn) 1, ,41.7 3, ,844.5 EPS (CS adj.) (Rmb) Change from previous EPS (%) n.a. Consensus EPS (Rmb) n.a EPS growth (%) P/E (x) Dividend yield (%) CS adj. BVPS (Rmb) P/B (x) ROE ROA (%) Tier 1 Ratio (%) Source: Company data, Thomson Reuters, Credit Suisse estimates. DISCLOSURE APPENDIX CONTAINS ANALYST CERTIFICATIONS AND THE STATUS OF NON-US ANALYSTS. U.S. Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, 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.

2 Focus charts Figure 1: Loan book exposure to risky sectors (1H1) (%) n.a Real estate Construction Mortgage loans Personal business loans Loan to farmers -n.a n.a ICBC CCB BOC ABC BCOM CMB CITIC CMBC CRCB Figure 3: Loan growth breakdown at CRCB Figure 2: CRCB showing the highest NPLs ratio, SML ratio, overdue ratio and borrower concentration (1H1) (%) (NPLs+ SMLs)/ Loans (%) Ov erdue/ Total loans (%) Top 1 borrowers as of total loans ICBC CCB BOC ABC BCOM CMB CITIC CMBC CRCB Figure 4: Large corporate loans (where CRCB competes with large banks) has grown rapidly (1.) (2.) (3.) (4.) (5.) 44. Corporate loans Loan growth (27-1H1 CAGR) 224 Loan-to-GDP (34.8) Retail loans Discounted County area Urban area Ov eral loans bills loans loans H1 <Rmb 5mn Rmb 5mn-1mn Rmb 1mn-5mn Rmb 5mn-1mn Rmb 1mn-5mn >Rmb 5mn Figure 5: Corporate loan pricing heading the downhill 1.% 9.% 8.% 7.% 6.% 5.% 4.% 3.% 2.% 1.%.% H9 2H9 29 1H1 Overal loans Corporate loans Retail loans Company data, Credit Suisse estimates Figure 6: Margin impact for every 25 bp time deposit hike (bp) ICBC CCB BOC ABC BCOM CMB CITIC CMBC CRCB Chongqing Rural Commercial Bank (3618.HK / 3618 HK) 2

3 Challenges are not priced in We are initiating coverage of Chongqing Rural Commercial Bank (CRCB, 3618.HK) with an UNDERPERFORM rating and a target price of HK$4.56. We believe CRCB will stand out as a proxy for western China s economic growth on the back of its 12% loan market share in Chongqing. CRCB offers leverage to both western China and the rural financial segment (through its 12% loan market share in Chongqing). However, we anticipate substantial mid-term challenges including risk control, competition and tightening monetary policy. These challenges are not priced in. Credit cost could surprise the market Credit cost at CRCB post its restructuring (in 27-8) remains a wildcard. CRCB s exposure to risky sectors are relatively high: property developers (13.9% of total loans), construction loans (4.5%), personal business loans (11.1%, including loans to farmers) at end-1h1. We believe credit cost could surprise the market. Both regional peers experience and adjusted credit cost (by excluding strong recoveries during 27-29) at the bank itself pointed to around 9-12 bp normalised credit cost versus 32 bp and 13 bp reported in 28 and 29. On top of a 3% NPL ratio and 13.6% special mentioned loan book (the highest among peers), we estimate that every 1% of new NPL formation will lead to around 25 bp credit cost hike at the bank. Margin upside reduced by loan mix changes Higher margin performance at CRCB in the past was primarily driven by strong loan yield over peers, thanks to its higher SME and rural exposure. However, relative pricing power was weakened by its aggressive loan growth in both urban areas (44% CAGR) and corporate loan space (31% CAGR) during 27-1H1 where bigger banks are usually dominant. Corporate loan pricing premuim over its H-share peers fell to around 1% above the average level in 1H1 from more than 4% in 27 on top of its 6% share in the loan book. Other than this, asymmetric rate hikes (if more on deposit side) and/or rate liberalisation, if it comes in the mid term, will pose another risk to the bank s relative margin performance despite a rising rate environment given that CRCB has the lowest net loan versus time deposit exposure as of interest yielding assets. Cost efficiency may not materialise so soon Operating expenses at CRCB may continue to rise, driven by investments to improve competitiveness. It will be a few years before economies of scale through branding, management, marketing and technology start having a positive effect, in our view. CRCB runs the majority of its banking outlets located in the county areas of Chongqing (1,457 out of 1,763 in 1H1), albeit staff per outlet is merely seven, which suggests fairly low cost efficiency. Nevertheless, cutting down the operating cost in rural areas seems difficult as its rural franchise contributed 7% of the deposits (with a very low LDR of 43%). CRCB s staff costs are currently at 1% of its average assets, the highest among H-share banks. However, staff cost per head at end-29 was at the low end. Valuation and risks We have adopted the Gordon Growth Model to derive the fair value for Chinese banks. Our 12-month target price of HK$4.56 for CRCB is based on 1.4x forward P/B or 1.x forward P/E. We have used a mid-term ROE of 14.1% and cost of equity of 11.5% (beta of 1.25, the highest in the peer group given its relatively higher rural and SME exposure) and a long-term growth of 5%. Regulation/policy, extent and pattern of interest rate moves, risk management and county business profitability are the major risks to our call. Initiating with an UNDERPERFORM rating Risk control the biggest challenge; CS estimated a normalising credit cost of 9 bp Competition will reduce margin upside Opex to spend up for staffing and networks Target price of HK$4.56 is based on 1.4x forward P/B against sustainable ROE of 14.1% Chongqing Rural Commercial Bank (3618.HK / 3618 HK) 3

4 Chongqing Rural Commercial Bank (3618.HK / 3618 HK) 4 Figure 7: Chinese banks Dupont analysis and normalised ROA and ROE ICBC CCB BOC Group ABC BCOM % 9 1E 11E 12E Norm.* 9 1E 11E 12E Norm.* 9 1E 11E 12E Norm.* 9 1E 11E 12E Norm.* 9 1E 11E 12E Norm.* Net interest inc Net fees Other income Non-interest inc Op. income Opex PPOP Impairment Operating profits PBT Income tax PAT (ROAA) Leverage** ROAE Margin Fees/revenue Credit cost CMB CITIC Minsheng CRBC % 9 1E 11E 12E Norm.* 9 1E 11E 12E Norm.* 9 1E 11E 12E Norm.* 9 1E 11E 12E Norm.* Net interest inc Net fees Other income Non-interest inc Op. income Opex PPOP Impairment Operating profit PBT Income tax PAT (ROAA) Leverage** ROAE Margin Fees/revenue Credit cost *Normalised. ** Assumed minimum core tier 1 of 1% for big 5 banks, 9% for JSBs and 12% for CRCB. 24 January 211

5 Credit cost could surprise the market After restructuring and incorporating 39 local rural credit unions into Chongqing Rural Credit Union (CRCU, the predecessor of CRCB) during 24-28, CRCB is now one of the 43 rural commercial banks (transformed from rural credit unions) across the country with assets amounting to Rmb262 bn as of 1H1 (Figure 8). Figure 8: A snapshot of China s financial institutions (27-29) Assets Equity PAT ROAA* ROAE* # of inst. # of staff (Rmb bn); % Policy banks 4,278 5,645 6, ,673 State-owned banks 28,7 31,836 4,89 1,574 1,957 2, ,56,424 JSBs 7,249 8,89 11, ,657 City commercial banks 3,34 4,132 5, ,765 City credit unions ,956 Rural credit unions 4,343 5,211 5, ,56 57,366 Rural commercial banks , ,317 Rural cooperative banks 646 1,3 1, ,776 Township banks n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a ,586 Non-bank Fis 972 1,18 1, ,145 Postal savings bank 1,769 2,216 2, ,536 Foreign bank 1,252 1,345 1, ,52 Total 52,598 62,388 78,769 3,31 3,786 4, ,857 2,844,73 *CS calculated. Source: CBRC, Credit Suisse CRCB had the highest NPL ratio (at 2.99%) and a relatively low NPL coverage ratio (at 148.8%) at end-1h1 across the H-share-listed Chinese banks. Further, its high specialmentioned loan ratio (at 13.6%, almost doubled ABC s 6.8%) is also of concern to us. Chongqing Rural Commercial Bank (3618.HK / 3618 HK) 5

6 Figure 9: China banks asset quality snapshot 1H1 (Rmb bn) ICBC CCB BOC ABC BCOM CMB CITIC CMBC CRCB Normal loans (A) 6,41 5,75 5,181 4,25 1,996 1,38 1, Special mention (B) Sub-standard (C ) Doubtful (D) Loss (E) Total loans 6,354 5,349 5,392 4,624 2,71 1,331 1, NPLs day overdue loans * 5.6 Loan loss reserves (LLRs) Shareholders equity ** Composition (%) Normal loans Special mention Sub-standard Doubtful Loss NPLs/ total loans (%) Special mention/ Loans (%) (NPLs+ Spl Men)/ Loans (%) Overdue/ total loans (%) * 4.86 LLRs/ NPLs (%) LLRs/ (NPL + Spl Men)(%) LLRs/ overdue loans (%) LLRs/ total loans (%) * Overdue for 1 day or above; ** IPO proceeds of Rmb1.6 bn, net of costs, were received in Dec. Company data, Credit Suisse Risk management remains unproven Incorporated from 39 local rural credit unions into Chongqing Rural Credit Union (CRCU, the predecessor of CRCB) in June 28, CRCB has only recently developed its risk management framework since its incorporation at that time (it started CBRC s five category loan classification in 26). Before that, the risk management functions were carried out by various credit unions and risk management capabilities were limited (CRCB prospectus). The bank established a centralised corporate loan approval system in April 21, only eight months before its IPO. Risk management over the old 39 credit unions remains unproven, in our view. Figure 1: Corporate loan customer rating breakdown (1H1) Corporate loan customers Jun-1 (%) Notes AAA AA A B C Unrated Source: Company data, Credit Suisse 1.46 "Key supported" customer with strong repayment ability and excellent credit worthiness "Proactively supported", good reputation and low risks; strong capital resources "Cautiously supported", average reputation an no major risks; above average performance indicators 2.14 "Restrictively supported" 1)below average reputation belonging to a restricted industry 2) weak recent repayment ability 13.6 "non-supported" 1) failed to repay loan or interest when due, is closed or suspended in operation or making loss for three consecutive years; on regulator's blacklist 2) whose technology and products are disallowed to be developed by government ) has been in operation for less than one year; 2)Operation for more than 1 year but unable to reach the scale of production as planned and unable to provide financial data; 3) project company under planning or construction; 4) the transaction undertook seen to be "low risk" at the bank Chongqing Rural Commercial Bank (3618.HK / 3618 HK) 6

7 Figure 11: Retail loan customer rating breakdown (1H1) Retail customers Jun-1 (%) Notes Level One Level Two Level Three Level Four Unrated Source: Company data, Credit Suisse "Key supported" customer with good creditworthiness "Proactively supported" with relatively good creditworthiness "Cautiously supported" with fair creditworthiness 6.59 "Restrictively supported" with poor creditworthiness Other than applying for credit or guaranteed loans are usually not rated Compared to its large cap peer ABC s business/networks geographical diversifcation throughout China, CRBC had almost all of its business concentrated in Chongqing, whose GDP per capita was slightly below the country s average in 29 (Figure 12). This is also a challenge to the bank s management in managing the credit quality, in our view. Figure 12: Loan breakdown in terms of geographic regions (29) 1% 8% 6% 4% 2% % ICBC CCB BOC ABC BCOM CMB CITIC Minsheng Eastern China Southern and Central China Northeastern China Bohai Rim and Northern China Western China Ov erseas and other assets Risky sector exposures The bank had a relatively higher exposure to property developers (13.9%), construction loans (4.5%) and personal business loans (11.1%, including loans to farmers) at end- 1H1. Chongqing Rural Commercial Bank (3618.HK / 3618 HK) 7

8 Figure 13: Loan breakdown by industry sector at Chinese banks in 1H1 (Rmb mn) ICBC CCB BOC ABC BCOM CMB CITIC Minsheng CRCB Manufacturing 886,63 931,77 1,52,31 1,11, , ,554 25,41 122,711 19,333 Transportation, logistics, storage 94, ,86 448,58 343, ,1 12, ,345 65,9 n.a Power generation and supply 565,547 5, ,65 369, ,221 63,528 82,387 35,388 4,49 Water, environment and public utility 554, , ,457 25,737 19,167 31,474 9,242 57,565 8,824 Real estate 565, , ,91 536, ,72 111,62 6, ,917 15,889 Leasing and commercial services 351, ,65 69, ,615 12,963 51,47 47,149 12,963 1,998 Retail, wholesale and catering 354,17 188,14 na 272, ,496 18,6 116,2 52,66 4,152 Construction 78, ,67 59, ,784 65,966 3,84 43,83 26,149 5,2 Others 87, , , ,57 113,23 66,53 15,38 145,345 14,554 Total corporate loans 4,384,464 3,737,338 3,263,12 3,411,287 1,627, ,21 956, ,77 74,441 Discounted bills 193,9 194, ,85 146,14 71,155 71,37 46,131 15,63 6,472 Mortgage loans 1,37,764 1,2, ,1 641, ,971 33, ,1 16,94 Personal business loans 158, , ,726 87,268 8,92 Consumer loans and card loans 261, ,88 37, ,585 14,572 13,21 3,835 Loan to farmers 113,359 3,824 Others 13,679 22,485 5,778 34,755 99,59 4,246 3,57 Total personal loans 1,457,898 1,247,78 1,122,857 1,2, ,49 446,437 19,572 21,76 33,61 Overseas loans 272, , ,115 46,14 81,12 Gross loans 6,354,384 5,349,382 5,391,879 4,623,983 2,7,568 1,411,885 1,192, , ,513 Composition (%) Manufacturing 14.% 17.4% 19.5% 21.9% 2.% 16.3% 21.% 12.9% 16.9% Transportation, logistics, storage 14.8% 11.1% 8.3% 7.4% 13.4% 8.5% 9.7% 6.8% n.a Power generation and supply 8.9% 9.3% 6.5% 8.% 5.6% 4.5% 6.9% 3.7% 3.9% Water, environment and public utility 8.7% 4.% 4.9% 4.4% 9.2% 2.2% 7.6% 6.% 7.7% Real estate 8.9% 7.1% 5.4% 11.6% 7.6% 7.9% 5.1% 12.8% 13.9% Leasing and commercial services 5.5% 6.5% 11.3% 4.3% 5.% 3.6% 4.% 1.8% 1.7% Retail, wholesale and catering 5.6% 3.5% na 5.9% 9.2% 7.7% 9.7% 5.5% 3.6% Construction 1.2% 2.5% 1.1% 2.9% 3.2% 2.2% 3.7% 2.7% 4.5% Others 1.4% 8.4% 3.5% 7.3% 5.5% 4.7% 12.6% 15.2% 12.7% Total corporate loans 69.% 69.9% 6.5% 73.8% 78.6% 57.6% 8.2% 76.4% 65.% Discounted bills 3.1% 3.6% 3.% 3.2% 3.4% 5.1% 3.9% 1.6% 5.7% Mortgage loans 16.3% 18.7% 16.% 13.9% 11.7% 21.5% 11.4% 11.1% 14.8% Personal business loans 2.5% n.a n.a 2.6% 2.7% n.a.9% 9.1%^ 7.8% Consumer loans and card loans 4.1% 2.1%.7% 3.% 1.8% 3.1% 1.2% 1.4% 3.3% Loan to farmers n.a n.a n.a 2.5% n.a n.a n.a n.a 3.3% Others.% 2.4% 4.1%.1% 1.7% 7.1% 3.4%.4%.% Total personal loans 22.9% 23.3% 2.8% 22.1% 18.% 31.6% 16.% 22.% 29.3% Overseas loans 4.3% 3.2% 15.7% 1.% n.a 5.7% n.a n.a n.a Gross loans 1.% 1.% 1.% 1.% 1.% 1.% 1.% 1.% 1.% ^ Referring to ShangDaiTong loans at Minsheng.Source: Company data, Credit Suisse Borrower concentration was high On a separate note, the bank demonstrated very high borrower concentration, as its topten largest single borrowers have made up more than 7% of its total loan book, or 56% of its regulatory capital by 1H1. Loans made to the largest single borrower (of water, environment and public utility management) reached 9.13% of regulatory capital, almost reaching the 1% regulatory ceiling. Chongqing Rural Commercial Bank (3618.HK / 3618 HK) 8

9 Figure 14: Loan concentration at Chinese banks (1H1) (Rmb mn) Regulation ICBC CCB BOC ABC* BCOM CMB CITIC CMBC CRCB Loans to ten largest borrowers 173, 111,93 n.a. 98,93 61,634 33,42 42,657 37,271 8,63 As % of total loans n.a As % of regulatory capital n.a n.a Single largest borrower to regulatory capital (%) *As end of 29A. Source: Company data, Credit Suisse Sensitivity analysis on LGFV related loans n.a n.a CRCB had reported total exposure of Rmb194 bn LGFV loans (or 17% of total loans versus peers average at ~14%) by 1H1. Although CRCB claimed 99.11% of the total amount of the loans (totalling Rmb19.22 bn) would be regarded and regulated as normal corporate loans, their credit quality remains a concern, given that MT/LT loans had doubled during 28-1H1 with a net increase of Rmb32 bn (or 28% of its total loan book). On 21 December, China Business Network reported that CBRC may require banks to reclassify LGFV loans to substandard category if cash flow and collateral coverage are less than 12% or to doubtful category if cash flow and collateral coverage are less than 8%. If we assume that of its real LGFV lending out of which 2.5-1% is potentially problematic, then an additional credit cost will be 1-4 bp (if downgraded to substandard loans with 25% provisioning) or bp (if downgraded to doubtful loans with 59% provisioning). Figure 15: Sensitivity analysis of LGFV loan exposure Problematic loan % 2.5% 5.% 7.5% 1.% 12.5% LGFV loans 19,22 19,22 19,22 19,22 19,22 Problematic loans ,442 1,922 2,43 (a) 25% provisioning coverage Additional credit cost E earnings impact (%) (b) 5% provisioning coverage ,141 Additional credit cost E earnings impact (%) From another perspective, very high exposure to special-mention loans will naturally lead to question the downward migration pressure. We estimate every 1% special mentioned loans downgrade to sub-standard loans will increase credit cost by 3 bp, or reduce earnings by close to 1%. Figure 16: Every 1% downward migration of special-mention loans will lead to around 1% negative earnings impact SML downward migration 1.% 5.% 7.% 1.% 15.% 2.% 25.% 3.% 35.% New NPL formation ,93 1,561 2,342 3,123 3,93 4,684 5,464 NPL ratio increase () provisioning ,54 1,23 Credit cost (bp) E earnings impact () Sustainable credit cost? In the regional context, we found banks running at around above 3% margin (India, Korea, and Thailand), the credit costs ranged from 1-12 bp (or provisioning as % of interest yielding assets at.5-.6%). Chongqing Rural Commercial Bank (3618.HK / 3618 HK) 9

10 Figure 17: NIM versus provisioning as % of avg. IEAs across the region (212E) NIM Prov isioning as % of av g. IEAs CN IN KR TW ID TH MY SG HK CRCB reported muted credit cost at 32 bp and 13 bp, respectively, in 28 and 29, post its restructuring and a write-back of 23 bp (annualised) in 1H1. Strong recovery momentum had played an important role, which also distorted the long-term sustainable picture of credit cost trend. Figure 18: Bad loan allowances migration at CRCB E 211E 212E Beginning balance 1,121 6,315 5,641 5,5 5,54 5,789 Provision for the year - net ,699 Unwinding of interest on impaired loans (568) (395) (229) (166) (141) (138) Write-offs (4,238) (98) (1,322) (789) (573) (484) Recoveries of loans written off in previous yrs Ending balance 6,315 5,641 5,5 5,54 5,789 7,65 Coverage ratio (%) LLRs to total loans (%) Recoveries as % of average loans Credit cost (reported) (%) Credit cost (adjusted) (%) Figure 19: Credit cost vs GDP growth in China '92 '94 '96 '98 ' '2 '4 '6 '8 '1E CN real GDP grow th CN credit cost (RHS) (reverse) Figure 2: Margin vs credit cost at Chinese banks (212E) 4. (%) Margin Credit cost ICBC CCB BOC ABC BCOM CMB CITIC CMBC CRCB Chongqing Rural Commercial Bank (3618.HK / 3618 HK) 1

11 Margin upside reduced by loan mix changes We believe CRCB will stand out as a proxy of western China s economic growth. Commanding a 12% and 14% loan and deposit market share, respectively, in Chongqing (and 26% and 28% share of loans and deposits, respectively, in county areas), the bank has most of its banking business in Chongqing, the only municipality in west China with a 2% loan market share in the whole system. Along with this growth story to roll out, we foresee that the bank may face challenges similar to most Chinese banks as the macro/regulatory environment brings about more uncertainties going forward, i.e., potential credit cost hikes (as we discussed above) and a higher regulatory requirement (e.g., capital, provisioning bar). Specifically, achieving growth at CRCB (as a small regional bank) may involve more competition in both the county and urban areas of Chongqing, where the state banks still dominate with almost half of the market share. The bank has already lost 3% of the loan market share in Chongqing during the past three years. Competition will create some funding cost pressure (or operating expenses pressure), leaving improving loan pricing power the more likely driver to a better-than-expected margin results. Figure 21: CRCB loan market share breakdown in Chongqing City Figure 22: CRCB deposit market share breakdown in Chongqing City 65% 55% County areas Loans market share 5% 45% 4% County areas Deposit market share 45% 35% 25% 15% 5% 42% 35% 26% Urban areas 7.5% 6.8% 8.% Ov eral Chongqing 14.7% 12.3% 11.6% 35% 3% 25% 2% 15% 1% 5% % 3% 3% 28% Urban areas 6.% 5.9% 6.6% Ov eral Chongqing 14.6% 14.6% 14.1% -5% Source: Company data, Credit Suisse Source: Company data, Credit Suisse Chongqing Rural Commercial Bank (3618.HK / 3618 HK) 11

12 Figure 23: GDP per capita vs loan-to-gdp ratio in selected cities of China (29) 12, GDP per capita Suzhou 1, Shenzhen Guangzhou 8, Shanghai Hangzhou Dalian Ningbo Beijing 6, Tianjin Nanjing Qingdao 4, China Chongqing Chengdu 2, Loam-to-GDP Figure 24: Loan and deposit growth in selected cities during 23-9 (%) 3. Loan growth CAGR Deposit growth CAGR Beijing Shanghai Tianjin Chongqing Shenzhen Hangzhou Ningbo Dalian Nanjing Suzhou Chengdu Guangzhou Qingdao System *For Suzhou, Chengdu, Guangzhou, Qingdao we used 28 GDP per capital here. Source: CEIC, Credit Suisse Margin heavily relying on loan pricing power Source: Company data, Credit Suisse The bank had reported a higher-than-peers margin performance in the past. Its margin was the highest among H-share-listed Chinese banks. (Figure 25). Figure 25: Margin trend at H-share-listed banks % H9 2H9 1H1 ICBC CCB BOC ABC n.a. n.a. n.a. n.a BOCOM CMB CITIC n.a CMBC n.a. n.a. n.a CRCB n.a. n.a. n.a. n.a The higher margin performance was primarily driven by strong loan yield (i.e., pricing power) over peers. Figure 26: Overall loan yield at CRCB versus peers 9.5% 9.% 8.5% 8.% 7.5% 7.% 6.5% 6.% 5.5% 5.% 4.5% 4.% H share banks average CRCB ABC 8.% 5.48% 8.77% 7.15% 5.44% 5.99% 6.35% 6.2% 5.9% 5.16% H9 2H9 1H1 Figure 27: Overall deposit cost at CRCB versus peers 2.6% 2.4% 2.2% 2.% 1.8% 1.6% 1.4% 1.2% 1.% H share banks average CRCB ABC 1.89% 1.57% 2.43% 1.98% 1.62% 2.8% 1.37% 1.64% 1.47% 1.28% H9 2H9 1H1 Chongqing Rural Commercial Bank (3618.HK / 3618 HK) 12

13 but loan pricing lost some ground We adopted the aggregated average loan yield breakdown by different loan types (i.e., corporate loans, retail loans and discounted bills) as a proxy to measure CRCB s pricing power over it. We found that a narrowing loan pricing premium can largely be explained by falling corporate loan pricing power it fell to around 1% above the average level in 1H1 from more than 4% in 27 (Figure 29), while corporate loans accounted for ~6% of the overall loan book. Meanwhile, retail loan pricing continued to remain high at 6-7% above average in 1H1, which saved overall loan pricing, we believe. Figure 28: Loan yield breakdown at CRCB Figure 29: Corporate loan pricing premium over peers heading the downhill 12.% 1.% 1.% 8.% 9.14% 8.85% 9.67% 9.33% 8.63% 7.79% 8.76% 7.39% 9.% 8.% 7.% 6.% 6.% 4.% 2.%.% 6.14% 5.97% 4.36% 4.96% 4.27% 4.18% 1.1% H9 2H9 1H1 Corporate loan Discounte bills Retail loans 5.% 4.% 3.% 2.% 1.%.% H9 2H9 29 1H1 Overal loans Corporate loans Retail loans * CRCB loan yield as % above average loan yield of H share listed banks(aggregated average of the nine banks). Source: Company data, Credit Suisse estimates It is worth noting that during the past two-and-a-half years (27-1H1), this 18.2% CAGR of loan growth was primarily driven by corporate loans (at 44% CAGR) and urban area loans (at 31% CAGR), albeit growth of retail loans and county area loans remained relatively weak at 9.8% and 7.9%. Figure 3: Loan growth during the past two-and-a-half years was primarily driven by corporate loans and urban area loans (1.) 44. Loan grow th (27-1H1 CAGR) Loan-to-GDP (2.) (3.) (4.) (34.8) -5 (5.) -1 Corporate loans Retail loans Discounted bills County area Urban area loans Ov eral loans loans Source: Company data, Credit Suisse We attributed this weakening corporate loan pricing power to the bank s more aggressive growth strategy in urban areas and corporate loans since end-28, when China s Rmb4 tn stimulus package was rolled out. More competition in urban areas and corporate loans in Chongqing (loan-to-gdp ratio was 49% in county areas versus 224% in urban Chongqing Rural Commercial Bank (3618.HK / 3618 HK) 13

14 areas) forced the bank to sacrifice some bargaining power for loan market share, in our view. This is further evident in: (1) a growing proportion of large corporate loans as a share of loans above Rmb1 mn jumped to about 7% of its total corporate loans from 43% in 27; and (2) longer loan portfolio duration with medium- to long-term loans also increased to over 85% of its corporate loan book. Figure 31: Large corporate loans were growing H1 <Rmb 5mn Rmb 5mn-1mn Rmb 1mn-5mn Rmb 5mn-1mn Rmb 1mn-5mn >Rmb 5mn Figure 32: and longer corporate loan portfolio duration 1 (%) 95 MT/LT loans as % of total corporate loans H1 Source: Company data, Credit Suisse Source: Company data, Credit Suisse CRBC s management has expressed its desire to expand its business into urban areas and economically developed regions outside Chongqing. It also said that the shift in retail banking business will be more towards large scale rural corporates in the county. We believe both shall lead to a weaker bargaining power on pricing given more competition. Figure 33: CRCB versus ABC on profitability of county business and urban business CRCB ABC CRCB ABC CRCB ABC % County County County County Urban Urban Urban Urban Group Group Group Group Dupont: Net interest income Fee income Other income (.28) (.16).8 Operating income Operating expenses (1.62) (1.13) (1.98) (1.58) (1.84) (2.45) (1.65) (1.24) (1.72) (1.73) (1.79) (1.38) Pre-provision optg profit Impairment losses (.55) (.59) (.99) (.45) (.2) (.7) (.84) (.51) Operating profits Profit before tax Tax (.1) (.8) (.2) (.13) (.37) (.32) (.1) (.11) Net profit Key ratios: Net II / assets Fee / assets CIR Credit cost Loan growth (21) (11) 33 Deposit growth LDR NPL ratio Special mentioned % NPL coverage LLRs to loans LLRs/ NPL+Spl Mn Source: Company data, Credit Suisse Chongqing Rural Commercial Bank (3618.HK / 3618 HK) 14

15 Asymmetric rate hikes and/or rate liberalisation, another risk to margin Owing to a relatively low LDR (62% in 1H1) but a highest time deposit share (54% in 1H1 versus its closest large peer ABC at merely 41%) in the mix, CRCB saw a lowest net loan versus time deposit exposure as of interest yielding assets. Figure 34: Deposit breakdown at Chinese banks (1H1) ICBC CCB BOC ABC BCOM CMB CITIC Minsheng CRCB Corporate deposits 5,362,883 4,675,679 3,337,413 3,293,861 1,831,993 1,77,237 1,349,58 1,1,31 46,313 Demand deposits 3,448,278 3,145,48 2,55,842 2,434, ,74 63, , ,74 42,649 Time deposits 1,914,65 1,53,199 1,281, ,867 84, , , ,57 3,664 Individual deposits 5,92,99 3,916,22 3,42,585 4,83, , , , , ,178 Demand deposits 2,54,883 1,575,95 1,281,411 2,216, , ,186 79,117 65,538 37,459 Time deposits 3,38,17 2,34,927 2,139,174 2,586, ,68 292,977 2, ,41 96,719 Other deposits 376, , ,694 4,472 2,671 4,911 Total deposits 1,832,789 8,591,71 7,219,334 8,348,82 2,72,931 1,752,4 1,629,32 1,319,56 185,42 Composition (%) Corporate deposits Demand deposits Time deposits Individual deposits Demand deposits Time deposits Other deposits Source: Company data, Credit Suisse Figure 35: CRCB highest time deposits share (1H1) ICBC CCB BOC ABC BCOM CMB CITIC Minsheng Demand Time deposit Other deposit CRCB Figure 36: CRCB lowest net loan minus time deposit to interest yielding assets (IYA) exposure (29) 4 (%) ICBC CCB BOC ABC BCOM CMB CITIC CMBC CRCB Net interbank assets Net loans - time deposits Investment Source: Company data *Net loans excluding discounted bills. Source: Company data, Credit Suisse This largely explains that the bank is very sensitive to asymmetric rate hikes (every 25 bp time deposit rate hike would arrive to around 1 bp of margin contraction, Figure 37), while a symmetric rate hike (of 25 bp on both loans and time deposits) would only translate to a 4 bp margin gain, short of ABC s (despite ABC s LDR at merely 54%!) and JSB s at 6-7 bp. Chongqing Rural Commercial Bank (3618.HK / 3618 HK) 15

16 Figure 37: Margin impact for every 25 bp time deposit rate hike in 12 months (no change of loan rate) (bp) ICBC CCB BOC ABC BCOM CMB CITIC CMBC CRCB Figure 38: Margin impact for every 25 bp loan rate and time deposit rate hike in 12 months (bp) ICBC CCB BOC ABC BCOM CMB CITIC CMBC CRCB Rate liberalisation on deposit side (as currently banks have a fair bit of flexibility in lending rates) posed another risk to the bank s margin through its funding cost (or operating cost spent on network and staff to maintain its rural retail deposit customers). Chongqing Rural Commercial Bank (3618.HK / 3618 HK) 16

17 Cost efficiency may not materialise so soon Opex may spend up for talents and networks We expect that continued investment in networks, IT infrastructure and staff at CRCB alongside its strategy to expand business in urban areas and other economically developed regions out of Chongqing will link to fast-growing operating expenses in the next few years. 24 January 211 Figure 39: Operating cost breakdown of Chinese banks (29) (%) ICBC CCB BOC ABC BCOM CMB CITIC Minsheng CRCB Staff costs YoY change Y CAGR n.a n.a. % of revenue % of avg assets Business tax YoY change Y CAGR n.a n.a. % of revenue % of avg assets Other costs YoY change Y CAGR n.a n.a. % of revenue % of avg assets Total opex YoY change Y CAGR n.a n.a. % of revenue % of avg assets Source: Company data, Credit Suisse Staff compensation, the biggest chunk (around 5%) in Chinese banks operating costs, will probably have to remain competitive given more competitive marketplace in urban areas. Currently, CRCB s staff cost is at 1% of its average assets, the highest among H share banks. However, staff cost per head by end-29 was at Rmb144,, the low end among the peers. Figure 4: Staff cost per head (in Rmb ) Figure 41: Operating cost per head (in Rmn ) Rmb ' ICBC CCB BOC ABC BCOM CMB CITIC Minsheng CRCB Rmb ' ICBC CCB BOC ABC BCOM CMB CITIC Minsheng CRCB 253 Chongqing Rural Commercial Bank (3618.HK / 3618 HK) 17

18 Meanwhile, the bank is running the majority of its banking outlets located in the county areas of Chongqing (1,457 out of 1,763 in 1H1) albeit staff per outlet is merely 7, which suggests low cost efficiency. Operating profitability will be very sensitive to additional fixed costs of network expansion.moreover, since its rural franchise contributed 7% of the deposits (albeit a very low LDR of 43%), which has made stable funding possible for the bank in the past, cutting down the operating cost in rural areas seems difficult in the near term. Other than these, investment in IT infrastructure and potentially higher marketing expenses to compete for urban business will easily push up other operating costs. Other costs (net of staff cost and business tax) amounted to.53% of CRCB s average assets, which was comparable to big banks (which had already built up modern IT systems but had a more prudent loan growth strategy), but significantly lagged Minsheng (at.94%), which is aggressively expanding its SME business. Figure 42: Revenue per outlet (29) Rmb mn ICBC CCB BOC ABC BCOM CMB CITIC Minsheng CRCB Source: Company data, Credit Suisse Figure 43: Total domestic outlets versus staff number per outlet (29) 25, 6 2, , 3 1, 2 5, 1 - ICBC CCB BOC AB C BCOM CMB CITIC Minsheng CRCB Total domestic outlets Staff # per outlet Source: Company data, Credit Suisse Chongqing Rural Commercial Bank (3618.HK / 3618 HK) 18

19 Valuation We believe credit cost at Chongqing Rural Commercial Bank (CRCB) post its restructuring (in 27-8) remains a wildcard going forward. This, coupled with over 95% of the core earnings being contributed by the lending business points to the fact that its fair value is largely determined by credit cost (in particular) and loan pricing capability, in our view. Target price and rating We adopted the Gordon Growth Model to derive the fair value for Chinese banks. Our 12- month target price of HK$ 4.56 (post-shoes) for CRCB was derived from 1.4x forward P/B or 1.x forward P/E. We used a mid-term ROE of 14.1% and cost of equity of 11.5% (beta of 1.25, the highest in the peer group given: (1) its relatively higher rural and SME exposure; (2) geograhpical exposure to Chongqing only) and a long-term growth of 5%. Figure 44: Gordon growth model valuation methodology of Chinese banks Diluted COE (%) Rf Rm g Implied FV Implied FV Avg FV CMP Upside Bank Rating ROE (%) (Rf+Rm*beta) (%) (%) Beta (%) PB (x) (HK$) PE (x) (HK$) =TP (HK$) (%) ICBC O CCB O BOC O ABC O BCOM N CMB N CNCB N CMBC U CRCB U Source: Bloomberg, Company data, Credit Suisse estimates Sustainable ROE Figure 45: CRCB Dupont analysis and normalised ROE projection E 211E 212E 213E Normalised Net interest income Net fees Other non-interest income Operating income Operating expenses Pre-provision profits Impairment charges Profit before tax Income tax Net profits (ROAA) Leverage ROAE Key assumptions Net interest margin Fee income/assets Cost-income ratio Credit cost (bp) Net II / revenue Non II / revenue Effective tax rate *Excluding the impact from restructuring related government grant Source: Company data, Credit Suisse estimates Chongqing Rural Commercial Bank (3618.HK / 3618 HK) 19

20 Sensitivity analysis CRCB s earnings were heavily driven by margin and credit cost (net interest income dominating 95% its top line). Our sensitivity analysis (Figure 46) shows every 1 bp of margin change or credit cost change will lead to around.5% sustainable ROE change. Figure 46: Sensitivity analysis of CRCB s sustainable ROE to credit cost and NIM NIM (%) Credit cost (bp) Source: Credit Suisse estimates CRCB s current trading multiple implies that market expected its credit cost to stay at 5-6 bp versus margin at % in the medium term. Negative surprises, e.g., higherthan-expected credit cost hikes or margin coming short of expectations, will lead to share price corrections. Figure 47: Implied P/B multiple based on sensitivity against credit cost and NIM NIM (%) Credit cost (bp) Source: Credit Suisse estimates Chongqing Rural Commercial Bank (3618.HK / 3618 HK) 2

21 Figure 48: Valuation comp sheet for H-share-listed Chinese banks Rating 12M PT Price Mkt. cap P/E P/B ROAE Div Y. (HK$) 21/Jan (US$ mn) 1E 11E 12E 1E 11E 12E 1E 11E 12E 1E 11E 12E ICBC-H O , % 22.1% 2.7% 3.4% 4.8% 5.1% CCB-H O , % 22.% 21.1% 3.3% 4.7% 5.2% BOC-H O , % 16.4% 16.1% 3.3% 4.6% 5.1% ABC-H O , % 21.% 19.8% 3.2% 3.9% 4.3% BCOM-H N , % 2.4% 19.6% 2.7% 3.9% 4.2% CMB-H N , % 23.2% 21.8% 1.5% 2.5% 2.8% CITIC-H N , % 16.9% 15.% 2.3% 3.1% 3.1% CMBC-H U , % 14.9% 14.8% 2.7% 3.2% 3.5% CRCB-H U , % 13.6% 13.2% 1.9% 2.% 2.2% Sector mean % 2.5% 19.5% 3.1% 4.3% 4.7% Figure 49: Valuation comp sheet for A-share-listed medium and small cap banks Last close Mkt. cap P/E P/B ROAE Div Y. 21/Jan (US$mn) 1E 11E 12E 1E 11E 12E 1E 11E 12E 1E 11E 12E SPDB , % 17.2% 18.3% 1.53% 1.8% 2.67% Industrial Bank , % 21.3% 2.8% 3.33% 3.5% 3.91% Minsheng 5. 17, % 19.1% 18.6% 2.18% 2.64% 3.4% Huaxia , % 13.8% 13.% 1.32% 1.8% 2.45% SZDB , % 19.8% 2.6%.98% 1.39% 1.5% Bank of Nanjing 1.8 3, % 15.2% 14.6% 2.72% 3.17% 2.65% Bank of Ningbo , % 17.3% 17.% 1.93% 2.47% 2.87% Bank of Beijing , % 17.9% 2.1% 2.26% 2.8% 3.67% Sector mean % 2.1% 19.7% 4.27% 4.88% 5.38% Figure 5: Bank of Beijing forward P/B versus ROE Figure 51: Bank of Nanjing forward P/B versus ROE Figure 52: Bank of Ningbo forward P/B versus ROE Forw ard P/B ROAE Sep-7 Oct-7 Dec-7 Jan-8 Feb-8 Mar-8 May-8 Jun-8 Jul-8 Aug-8 Oct-8 Nov-8 Dec-8 Jan-9 Mar-9 Apr-9 May-9 Jun-9 Jul-9 Sep-9 Oct-9 Nov-9 Dec-9 Feb-1 Mar-1 Apr-1 May-1 Jul-1 Aug-1 Sep-1 Nov-1 Dec-1 Jan-11 19% 18% 17% 16% 15% 14% Forw ard P/B ROAE Jul-7 Aug-7 Sep-7 Nov-7 Dec-7 Jan-8 Mar-8 Apr-8 May-8 Jun-8 Jul-8 Sep-8 Oct-8 Nov-8 Dec-8 Feb-9 Mar-9 Apr-9 May-9 Jul-9 Aug-9 Sep-9 Oct-9 Nov-9 Jan-1 Feb-1 Mar-1 Apr-1 Jun-1 Jul-1 Aug-1 Sep-1 Nov-1 Dec-1 16.% 15.% 14.% 13.% 12.% Jul-7 Aug-7 Sep-7 Nov-7 Forward P/B Dec-7 Jan-8 Mar-8 Apr-8 May-8 Jun-8 Jul-8 Sep-8 Oct-8 Nov-8 Dec-8 Feb-9 Mar-9 ROAE Apr-9 Jun-9 Jul-9 Aug-9 Sep-9 Oct-9 Dec-9 Jan-1 Feb-1 Mar-1 May-1 Jun-1 Jul-1 Aug-1 Oct-1 Nov-1 Dec-1 18% 17% 16% 15% 14% Source: Bloomberg, company data and Credit Suisse estimates Chongqing Rural Commercial Bank (3618.HK / 3618 HK) 21