unmasking china's shadow banking system

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Unmasking the shadow banking system 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 China’s 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. CCB’s 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. EQUITY RESEARCH ANCHOR REPORT 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. June 24, 2011 Research analysts China Banks Lucy Feng - NIHK l[email protected] +852 2252 2165 Donger Wang - NIHK d[email protected] +852 2252 1590 China banks

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Page 1: Unmasking China's Shadow Banking System

Unmasking the shadow banking system

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 China’s 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.

CCB’s 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.

EQUITY RESEARCH

AN

CH

OR

RE

PO

RT

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.

June 24, 2011

Research analysts 

China Banks 

Lucy Feng - NIHK [email protected] +852 2252 2165

Donger Wang - NIHK [email protected] +852 2252 1590

China banks

Page 2: Unmasking China's Shadow Banking System

Rating: See report end for details of Nomura’s rating system.

China banks

Banks

EQUITY RESEARCH

Unmasking the shadow banking system  

Shadow banking exposure less than feared and more than priced in

June 24, 2011

China’s 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 China’s total shadow banking loans reaching CNY8.5trn (our estimate), we think the market is rightly concerned. But we point out that: 1) China’s 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 regulator’s 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

Note: Prices as of 21 June close. Source: Bloomberg, Company data and Nomura research

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 [email protected] +852 2252 2165

Donger Wang - NIHK [email protected] +852 2252 1590

Bloomberg Price Current Potential

upside/

Company ticker Rating target (HK$) price (HK$) downside (%)

ABC 1288 HK BUY 5.20 3.94 32

ICBC 1398 HK BUY 7.50 5.84 28

CCB 939 HK NEUTRAL 7.02 6.44 9

BOC 3988 HK BUY 5.20 3.77 38

BOCOM 3328 HK NEUTRAL 8.30 7.24 15

CMB 3968 HK BUY 24.82 18.08 37

CITIC Bank 998 HK BUY 6.50 4.97 31

Minsheng 1988 HK NEUTRAL 7.40 7.29 2

CRCB 3618 HK BUY 6.52 4.71 38

China (H-share)

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.

Page 3: Unmasking China's Shadow Banking System

Nomura | AEJ China banks June 24, 2011

2

Contents

4 Executive summary  

7 Monetary policy — unlikely to be eased any time soon

 

8 Regulation on new capital framework – shift in focus to quality from quantity of capital

 

9 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

 

 

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Nomura | AEJ China banks June 24, 2011

3

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  

54 ICBC  

60 China Construction Bank-H  

66 Bank of China (H-share)  

71 Bank of Communications  

77 China Merchants Bank  

83 China CITIC Bank  

88 China Minsheng Bank - H  

93 Chongqing Rural Commercial Bank  

99 Appendix A-1  

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Nomura | AEJ China banks June 24, 2011

4

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 CBRC’s 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 sector’s valuation quickly reverted to the year’s 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 government’s 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 one-third 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 sector’s long-term prospects.

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Nomura | AEJ China banks June 24, 2011

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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

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

As % of total assets Current (%) Distressed level (2011) Chg Medium term (2012-14) Chg Long term (2015-19) Chg

Interest rate deregulation leading to lower margins (40bps)

Interest rate deregulation leading to lower margins (40bps)

+10-17bps +10-17bps

Revenue (%) 2.87-3.31 2.87-3.31 2.58-3.06 2.58-3.06

SG&A (0.94)-(1.16) unchanged 0bp unchanged 0bp unchanged 0bp

PPOP (%) 1.75-2.25 1.75-2.25 1.62-2.08 1.62-2.08

Loan loss provision (0.14)-(0.39) unchanged 0bp

30% increase in through-the-cycle average credit cost to guard against soft landing economy (9-34bps)

30% increase in through-the-cycle average credit cost to guard against soft landing economy (9-34bps)

LGFV provision

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 unchanged

Operating pretax (%) 1.49-1.95 0.98-1.67 1.06-1.62 1.06-1.62

Business tax & surcharges unchanged unchanged unchanged

Profit tax unchanged unchanged unchanged

Normalised ROA (%) 1.02-1.37 0.62-1.15 0.73-1.09 0.73-1.09

Non-operating gain/(loss) (0.05)-0.02 unchanged 0bp unchanged 0bp unchanged 0bp

Reported ROA (%) 1.02-1.37 0.62-1.16 0.73-1.09 0.73-1.09

Equity multiplier (x) 15.5-18.7 unchanged 0bp unchanged 0bp

Higher tier 1 ratio given risk weighting changes or higher requirement on core capital (1.5-4.7bps)

Normalised ROE (%) 18.0-24.1 10.5-20.7 13.6-18.1 10.2-15.2

Market PB - 2011 (x) 1.02-1.38

Implied PB (x) 0.78-2.24 1.22-1.87 0.74-1.45

0bp 0bp

Non-interest income 0.49-0.86 unchanged 0bp

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 growth

Net interest income 2.02-2.59 unchanged 0bp

(0.44)-(0.59) 0bp

Page 7: Unmasking China's Shadow Banking System

Nomura | AEJ China banks June 24, 2011

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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)

Source: Nomura estimates

In our view, market participants appear of the view that LGFV risks weren’t 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

Source: Bloomberg, Nomura research

RMB'mn ABC ICBC CCB BOC BCOM CMB Citic Minsheng CRCB Ave.

% of haircut as 2011F PBT 13.0% 13.6% 13.8% 12.8% 16.3% 16.4% 18.9% 38.1% 19.2% 18.0%

Total impact on 2011F PBT 29.0% 13.6% 33.9% 38.9% 38.5% 16.4% 18.9% 46.8% 19.2% 28.4%

2010 (RMBmn) ABC ICBC CCB BOC BOCOM CMB CITIC Minsheng CRCB Ave.Incremetnal RWA as % of total RWA 15% 14% 14% 14% 11% 11% 11% 11% 17% 13%

Total tier 1 impact (136) (127) (131) (135) (95) (80) (88) (84) (234) (123)

RMB'bn ABC ICBC CCB BOC BOCOM CMB CITIC Minsheng CRCB Ave.

% of total loans 5.8% 13.7% 5.6% 7.3% 7.9% 3.7%

Total tier 1 impact (27) (63) (24) (28) (29) (12) (31)

Note: ABC, BOC, CRCB did not release entrusted loan for 2010

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

Impact on 2011F earnings on LGFV loan write-off and provisioning

Tier 1 ratio impact from charging 50% risk weighting on entrusted loans (43% of shadow banking loans)

Tier 1 ratio impact from new capital framework

85

90

95

100

105

110

115

12/31/2010 1/31/2011 2/28/2011 3/31/2011 4/30/2011 5/31/2011

(%)

Sector Hang Seng Index HSCEI

2nd rate hike in 2011

1st rate hike in 2011

Market reports of CBRC 's proposing new capital rules

represents RRR hike

Announcement of new capitalframework by CBRC

Talk of government bail-out on LGFV loans

Talk of BOA selling part of CCB stake

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Nomura | AEJ China banks June 24, 2011

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

Note: closing prices as of 21 June, 2011

Source: Bloomberg, Nomura research

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

Note: closing prices as of 21 June, 2011 (20 June for MSCI index)

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 PBoC’s 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

Source: Bloomberg, Nomura research

Fig. 8: Household inflation expectations

Source: CEIC, Nomura research

(20)

(15)

(10)

(5)

0

5

10

15 M

insheng

ICB

C

AB

C

Citic

Secto

r

HS

CE

I

HS

I

BO

CO

M

CM

B

CC

B

BO

C

CR

CB

(%)(%) 1m 3m 6m 1y YTD

ABC (17) (6) (5) na (1)

ICBC (9) (4) 1 (1) 1

CCB (12) (9) (8) (1) (8)

BOC (12) (9) (9) (4) (9)

BOCOM (9) (8) (8) (19) (7)

CMB (9) (12) (8) (8) (8)

Citic (8) (4) 0 (5) (1)

Minsheng (1) 8 10 5 9

CRCB (20) (26) (15) na (16)

Sector (11) (7) (5) (3) (4)

Hang Seng Index (7) (4) (6) 4 (5)

HSCEI (6) (4) (4) 0 (4)

MSCI Financials - World (3) (5) (6) (2) 5

MSCI Financials - Europe (4) (5) (8) (6) (6)

MSCI Financials - US (6) (5) (8) (5) 2

-5

0

5

10

15

20

25

Jan

-05

Jul-

05

Jan

-06

Jul-

06

Jan

-07

Jul-

07

Jan

-08

Jul-

08

Jan

-09

Jul-

09

Jan

-10

Jul-

10

Jan

-11

food cpi non-food cpi

50

55

60

65

70

75

80

85

Mar-

01

Oct-

01

May-0

2

Dec-0

2

Jul-

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-04

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-06

Jan

-07

Aug

-07

Mar-

08

Oct-

08

May-0

9

Dec-0

9

Jul-

10

Feb-1

1

(%)

Page 9: Unmasking China's Shadow Banking System

Nomura | AEJ China banks June 24, 2011

8

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

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 regulator’s focus to quality of capital; and 2) the regulator’s intention to apply the CAR framework to support the central government’s 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 government’s 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

2010 (RMBmn) ABC ICBC CCB BOC BOCOM CMB CITIC Minsheng CRCB

Tier 1 ratio 9.8% 10.0% 10.4% 10.1% 9.4% 8.0% 8.5% 8.1% 14.8%

CAR 11.6% 12.3% 12.7% 12.6% 12.4% 11.5% 11.3% 10.4% 16.3%

RWA (RMB'm) 5,383,694 7,112,357 6,015,329 5,887,170 2,370,648 1,446,883 1,385,262 1,280,847 148,206

Core capital 524,910 709,102 625,594 594,015 222,130 116,329 117,055 103,364 21,905

Total capital 623,970 872,686 762,744 740,606 293,012 165,957 156,673 133,720 24,172

Incremental RWA as % of total RWA 5.0% 3.6% 3.3% 3.7% 3.0% 3.9% 2.6% 5.1% 4.1%

Tier 1 ratio impact (47) (35) (34) (36) (27) (30) (22) (39) (58)

Incremental RWA as % of total RWA 2.8% 1.6% 1.1% 3.6% 2.0% 4.0% 4.2% 4.6% 8.7%

Tier 1 ratio impact (27) (15) (11) (35) (18) (31) (34) (36) (118)

Incremental RWA as % of total RWA -1.9% -1.9% -1.2% -1.4% -1.6% -3.4% -1.0% -0.4% -3.1%

Tier 1 ratio impact 19 19 12 14 15 28 9 4 48

Incremental RWA as % of total RWA 8.5% 8.8% 9.0% 7.8% 6.9% 7.7% 6.2% 6.4% 7.9%

Tier 1 ratio impact (76) (81) (86) (73) (61) (58) (49) (49) (108)

Incremental RWA as % of total RWA -1.2% -1.2% -1.2% -1.2% -1.2% -1.9% -1.7% -4.7% -1.5%

Tier 1 ratio impact 11 12 12 12 11 15 15 39 23

Incremental RWA as % of total RWA 1.8% 2.9% 2.4% 1.8% 1.6% 0.6% 0.7% 0.4% 1.4%

Tier 1 ratio impact (17) (28) (25) (18) (15) (5) (6) (3) (21)

Total tier 1 impact (136) (127) (131) (135) (95) (80) (88) (84) (234)

Corporate loan over 5 years

Property

Interbank assets

Retail claims excluding mortgage

Operating risk

SME

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Nomura | AEJ China banks June 24, 2011

9

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 regulator’s policy direction.

In addition, the transparency offered by a comprehensive capital framework integrating BASEL III as well as China’s 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 CBRC’s 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

Source: Company data, Nomura research

Fig. 11: China banks’ Tier 1 CAR (1Q11) Minsheng and CRCB's figure is 4Q10

Source: Company data, Nomura research

Bail-out of LGFV loans

We believe the MOF’s 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.

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Fig. 12: Estimated impact on 2011F earnings by LGFV loan write-off and provisioning

Source: Company data, Nomura estimates

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 state-owned 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

RMB'mn ABC ICBC CCB BOC BCOM CMB Citic Minsheng CRCB Ave.

total LGFV as of Dec 2010 395,300 649,600 540,000 380,000 177,400 135,100 118,400 197,200 18,500

total LGFV as % of total loan 8.0% 9.6% 9.5% 6.7% 7.9% 9.4% 9.4% 18.6% 15.1% 10.5%

30% of LGFV loan spin off 108,718 178,658 148,515 104,510 48,790 37,156 32,563 54,235 5,088

20% write-off on the spin off 21,744 35,732 29,703 20,902 9,758 7,431 6,513 10,847 1,018

write off as % of 2011F PBT 13.0% 13.6% 13.8% 12.8% 16.3% 16.4% 18.9% 38.1% 19.2% 18.0%

total lower grade LGFV loans 162,073 162,400 234,681 190,000 75,395 14,402 710 59,160 37

remaining lower grade LGFV loans not spin off 53,355 0 86,166 85,490 26,605 0 0 4,925 0

50% provision on remaining lower grade LGFV to 2011F PBT 16% 0% 20% 26% 22% 0% 0% 9% 0% 10.3%

Total impact on 2011F PBT 29% 14% 34% 39% 39% 16% 19% 47% 19% 28.4%

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

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

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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

Source: CBRC, Nomura research

Fig. 14: Capital adequacy scenario analysis

Source: CBRC, Nomura estimates

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

Source: Bloomberg, Nomura estimates

Fig. 16: Current PB vs 1Q09 Trough/Historical low

Note: historical low is used for ABC, Minsheng and CRCB as they were not yet listed in 1Q09

Source: Bloomberg, Nomura estimates

Entrusted loans, 7.3%

Private lending

(民间借贷), 4.8%

Credit guarantee companies,

1.8%

Financing lease

companies, 1.4%

Trust companies,

1.3%

Small loan companies,

0.4%Pawn loan,

0.1%

RMB'bn 2010 Bear Case Base Case

Capital Ratio

Capital adequacy ratio 12.2 10.7 11.4

Core capital adequacy ratio 10.1 8.8 9.4

Capital Shortage (if capital ratios unchanged)

Capital adequacy 0 724 366

Core capital adequacy 0 599 303

Assumptions

Shadow Banking System Loans (RMB'bn)

bear case (all shadow banking loans) 8,500

base case (entrusted loans + trust loans) 4,300

On-balance sheet risk-weighted assets 35,537 41,469 38,538

Total loans 50,923 59,423 55,223On-balance sheet risk-weighted assets as % of total loans 70% 70% 70%

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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

China’s economic growth looks to be slowing in 2Q11, as indicated by lower-than-previous 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 Japan’s 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 PBoC’s 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 de-stocking 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 China’s economic growth and we expect to see increasing signs of a slowdown in 2Q11.

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Fig. 18: Inventory level of 5,000 entrepreneurs survey Diffusion Index

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 PBoC’s survey on urban household’s 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: China’s CPI inflation

Source: CEIC, Nomura research

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Fig. 20: Urban households’ future price expectation Diffusion index

Source: CEIC, PBoC, Nomura research

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

Source: CEIC, PBoC, Nomura research

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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Fig. 22: CPI versus 1-year deposit rate Rate hike behind the curve

Source: CEIC, Nomura research

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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

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.

Standard level (%) SIB non-SIB

Capital

Core T1 capital 5.00 By end-2013 By end-2016

T1 capital 6.00 By end-2014 By end-2017

Total capital 8.00 By end-2015 By end-2018

Conservation buffer 2.50 By end-2016 By end-2019

Counter-cyclical buffer 0-2.50 By end-2017 By end-2020

Additional capital for systemically important banks 1.00 By end-2018 By end-2021

Leverage

Leverage ratio 4.00 By end-2013 By end-2016

Provision

Coverage ratio 150.00 Current requirement Current requirement

Loan-loss provision ratio 2.50 By end-2013 By end-2016;

by end-2018 for banks with difficulties

Timetable to meet the new requirement

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Fig. 24: Differences between the CBRC’s new framework and Basel III

Source: CBRC, Nomura research

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

Source: Company data, Nomura research

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.

CBRC's new framework

Basel III

Common Equity (%) 5.00 4.50

T1 Leverage Ratio (%) 4.00 3.00

Provision Ratios2.5% for loan loss ratio and 150% for

coverage rationot specified

Commence Period 1-Jan-12 1-Jan-13

Grace Period by end 2016 by end 2018

(%) ICBC CCB BOC ABC Bocom CMB Citic Minsheng CRCB

Tier 1 CAR 9.7 10.3 10.0 9.6 9.2 7.7 8.2 8.0 14.8

Total CAR 11.8 12.5 12.4 11.4 12.1 10.9 11.1 11.0 16.3

Provision Coverage Ratio 247 229 206 197 198 335 231 301 173

Loan Loss Provision Ratio 2.5 2.5 2.1 3.5 2.1 2.1 1.5 2.0 4.1

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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 9-48bps. 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 long-term 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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Fig. 26: Draft of the New Version of the “Administration on Capital Adequacy Ratio of Commercial Banks”

Source: 21st Century Business Herald

Credit Risk Weighting Changes for On Balance Sheet Items Current RW New RWLoans to:Infrastructure 100% 110%Property development 100% 150%LGFVs 100% 100-300%

Claims on Public-sector EntitiesClaims on PRC public-sector entities invested by the PRC central government 50% 100%

Claims on PRC Commerical BanksClaims on PRC incorporated commercial banks with:

- an original maturity of 3m or less 0% 20% (0% for certain claims on PRC incorporated commercial banks as specified by CBRC)

- an original maturity of 3m to 4m 0% 50% - an original maturity of more than 4m 20% 50%Hybrid bonds and subordinated bonds of PRC incorporated commercial banks 20% 100%

Claims on non-PRC Commercial Banks or Securities Companies

Claims on non-PRC commercial banks and securities companies incorporatedin other countries or regions where the sovereign or region is rated at AA - or above 20% 50%

Claims on non-PRC commercial banks and securities companies incorporatedin other countries or regions where the sovereign or region is rated below B - 100% 150%

Claims on Foreign Sovereign DebtClaims on foreign sovereign debt with credit rating of below B- 100% 150%

Claims on Retail LoansClaims on individuals other than personal residential mortgages 100% 75%

Claims on Corporate LoansClaims on corporate where the credit rating is below BB- 100% 150%Claims on term loans with maturity over 5 years 100% adjsuted for maturity multiplier

Equity InvestmentsNon-deducted equity investment in financial institutions 100% 250%Equity investment in businesses other than financial institutions 100% 1250%Property not self-occupied 100% 1250%

Credit Risk Weighting Changes for Off Balance Sheet Items Current RW New RWLoan equivalent credit business (including issuance of acceptance draft, financing guarantees, etc) 100% 100%

Irrevocable credit commitment (credit card commitment, bond underwriting amount, etc) with original maturity less than 1 year 0% 75%

Irrevocable credit commitment (credit card commitment, bond underwriting amount, etc) for with original matuirty more than 1 year 50% 75%

Recocable credit commitment 0% 0%

Trade related contingent liability 20% 20%

Transaction related contigent liability 50% 50%

Repurchase agreement with credit risk rested on the bank 100% 100%

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Fig. 27: Estimated impact on Tier-1 ratio by new CAR rule o

Source: 21st Century Business Herald, Nomura research

Fig. 28: Estimated impact on 2011F earnings of LGFV loan write-off and provisioning

Source: Company data, Nomura research

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 bail-out 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.

2010 (RMBmn) ABC ICBC CCB BOC BOCOM CMB CITIC Minsheng CRCB

Tier 1 ratio 9.8% 10.0% 10.4% 10.1% 9.4% 8.0% 8.5% 8.1% 14.8%

CAR 11.6% 12.3% 12.7% 12.6% 12.4% 11.5% 11.3% 10.4% 16.3%

RWA (RMB'm) 5,383,694 7,112,357 6,015,329 5,887,170 2,370,648 1,446,883 1,385,262 1,280,847 148,206

Core capital 524,910 709,102 625,594 594,015 222,130 116,329 117,055 103,364 21,905

Total capital 623,970 872,686 762,744 740,606 293,012 165,957 156,673 133,720 24,172

Incremental RWA as % of total RWA 5.0% 3.6% 3.3% 3.7% 3.0% 3.9% 2.6% 5.1% 4.1%

Tier 1 ratio impact (47) (35) (34) (36) (27) (30) (22) (39) (58)

Incremental RWA as % of total RWA 2.8% 1.6% 1.1% 3.6% 2.0% 4.0% 4.2% 4.6% 8.7%

Tier 1 ratio impact (27) (15) (11) (35) (18) (31) (34) (36) (118)

Incremental RWA as % of total RWA -1.9% -1.9% -1.2% -1.4% -1.6% -3.4% -1.0% -0.4% -3.1%

Tier 1 ratio impact 19 19 12 14 15 28 9 4 48

Incremental RWA as % of total RWA 8.5% 8.8% 9.0% 7.8% 6.9% 7.7% 6.2% 6.4% 7.9%

Tier 1 ratio impact (76) (81) (86) (73) (61) (58) (49) (49) (108)

Incremental RWA as % of total RWA -1.2% -1.2% -1.2% -1.2% -1.2% -1.9% -1.7% -4.7% -1.5%

Tier 1 ratio impact 11 12 12 12 11 15 15 39 23

Incremental RWA as % of total RWA 1.8% 2.9% 2.4% 1.8% 1.6% 0.6% 0.7% 0.4% 1.4%

Tier 1 ratio impact (17) (28) (25) (18) (15) (5) (6) (3) (21)

Total tier 1 impact (136) (127) (131) (135) (95) (80) (88) (84) (234)

Corporate loan over 5 years

Property

Interbank assets

Retail claims excluding mortgage

Operating risk

SME

RMB'mn ABC ICBC CCB BOC BCOM CMB CiticMinsheng CRCB Ave.

total LGFV as of Dec 2010 395,300 649,600 540,000 380,000 177,400 135,100 118,400 197,200 18,500

total LGFV as % of total loan 8.0% 9.6% 9.5% 6.7% 7.9% 9.4% 9.4% 18.6% 15.1% 10.5%

30% of LGFV loan spin off 108,718 178,658 148,515 104,510 48,790 37,156 32,563 54,235 5,088

20% w rite-off on the spin off 21,744 35,732 29,703 20,902 9,758 7,431 6,513 10,847 1,018

w rite off as % of 2011F PBT 13.0% 13.6% 13.8% 12.8% 16.3% 16.4% 18.9% 38.1% 19.2% 18.0%

total low er grade LGFV loans 162,073 162,400 234,681 190,000 75,395 14,402 710 59,160 37

remaining low er grade LGFV loans not spin off 53,355 0 86,166 85,490 26,605 0 0 4,925 0

50% provision on remaining low er grade LGFV to 2011F PBT 16% 0% 20% 26% 22% 0% 0% 9% 0% 10.3%

Total impact on 2011F PBT 29% 14% 34% 39% 39% 16% 19% 47% 19% 28.4%

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

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

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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 PBoC’s 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 CBRC’s 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 nation’s 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 government’s 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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Fig. 29: NPLs of state owned banks between 1998 and 2001

Source: CEIC, Nomura research

Fig. 30: Local Government Disposable Income (Land Sales Revenue +Budgetary Fiscal Income) (CNYmn)

Source: CEIC, Nomura research

Fig. 31: Land sales as % Local Government Disposable Income

Source: CEIC, Nomura research

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

(RMB bn) 1996 1997 1998 1999 2000 2001

Equity 261 274 559 570 598 663

Loan 3,625 4,482 5,361 5,746 5,825 6,466

Asset 5,948 7,213 8,253 9,176 9,839 10,325

Provision 43 36 30 71 60 102

NPL 2107 1689 1701 1642

NPL ratio 39% 29% 29% 25%

Provision to loan 1.2% 0.8% 0.6% 1.2% 1.0% 1.6%

NPL / equity 3.8 3.0 2.8 2.5

0

2,000,000

4,000,000

6,000,000

8,000,000

10,000,000

12,000,000

2004 2005 2006 2007 2008 2009 2010

local budgetary fiscal income

land sales revenue

0%

5%

10%

15%

20%

25%

30%

2004 2005 2006 2007 2008 2009 2010

land sales revenue to local government disposable income

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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 regulator’s 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

Source: 21st Century Business Herald

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.

Type of other financial business Number of commercial banks that have investment therein Fund management companies 8Insurance companies 4Financial leasing companies 7Trust companies 2

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Fig. 33: China new CNY loans and total social financing

Source: CEIC, Nomura research

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 de-leveraging 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% China’s 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.

(RMB bn) 2002 2003 2004 2005 2006 2007 2008 2009 2010 1Q11

Total new RMB loans 1,853 2,770 2,260 2,350 3,180 3,630 4,911 9,590 7,934 2,240

y-y growth 49% -18% 4% 35% 14% 35% 95% -17% -14%

Total social financing 2,015 3,419 2,868 2,862 4,010 5,921 6,868 14,082 14,270 4,190

y-y growth 70% -16% 0% 40% 48% 16% 105% 1% -7%

% of new RMB loans to social financing 92% 81% 79% 82% 79% 61% 72% 68% 56% 53%

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Fig. 34: US and China shadow banking systems

Source: CEIC, Nomura research

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

Source: CBRC, Nomura research

Balance RMB'bn US$'bn % of GDP US$'bn % of GDP

GDP 39,800 6,151 100% 14,660 100%

Debt Market 19,601 3,030 49% 31,775 217%

Bank Loan 47,919 7,406 120% 6,783 46%

Equity Market 26,542 4,102 67% 17,900 122%

Shadow Banking Business 8,518 1,317 21% 6,500 44%

Total Financing 102,580 15,855 258% 62,958 429%

Total Financing excl. Shadow Banking

94,062 14,538 236% 56,458 385%

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

China US

2010 2007

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

Entrusted loans, 7.3%

Private lending (民间借贷), 4.8%

Credit guarantee companies, 1.8%

Financing lease companies, 1.4%

Trust companies, 1.3%

Small loan companies, 0.4%

Pawn loan, 0.1%

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June 24, 2011

Fig. 36: China shadow banking business

Source: Nomura research

Business

Regulator Issuing Governing Rules Key Governing Rules

2010 Size (Number of companies)

2010 Est. Size (O/S Balance) (RMB'bn)

% of total bank loans (2010)

Source of 2010 Est. Size

Capital Leverage Requirement

Min. Registered Capital Requirement Source of other capital

Entrusted Loans PBOC, CBRC

Notice of Several Issues of Entrusted Loan Business by Commercial Banks (2000) Further Guidance on Bank Trust Cooperation (2011)

NA 3,660 7.3% Our estimate NA NA NA

Private Lending (民间借贷) The High Court

Several Opinions on Private Lending Case Hearing by the High Court (1991)

NA 2,400 4.8%

Head of Research Institute of PBOC

self capital NA

Only self capital is allowed, prohibiting collecting funds from public

Credit Guarantee Companies

Seven Ministries of State Council, CBRC

Provisioning Rules Governing Credit Guarantee Companies (2010), Guidelines on License Management of Credit Guarantee Companies (2010)

6030 893 1.8%

CBRC official in credit guarantee division

Outstanding guaranteed liability not over 10x of net assets

RMB5m NA

Financing Lease Companies

CBRC, MOFCOM

Administrative Rules on Financial Leasing Companies (2007) Measures on the Administration of Foreign Investment in the Leasing Industry (2005)

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

Administrative Rules on Trust Companies' Net Capital (2010), Notice of Standard for Net Capital Calculation of Trust Companies (2011)

NA 636 1.3% CBRC

Net capital no less than 100% of risk weighted assets, net capital no less than 40% of net assets

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 Bank borrowings no more than 50% of total equity

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%

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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)

Source: Nomura research, CBRC

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 LGFV-related infrastructure loans, to trust products that are sold to trustees.

(RMB bn) 2010 Bear Case Base Case

Capital Ratio

Capital adequacy ratio 12.2 10.7 11.4

Core capital adequacy ratio 10.1 8.8 9.4

Capital Shortage (if capital ratios unchanged)

Capital adequacy 0 724 366

Core capital adequacy 0 599 303

Assumptions

Shadow Banking System Loans (RMB'bn)

bear case (all shadow banking loans) 8,500

base case (entrusted loans + trust loans) 4,300

On-balance sheet risk-weighted assets 35,537 41,469 38,538

Total loans 50,923 59,423 55,223On-balance sheet risk-weighted assets as % of total loans 70% 70% 70%

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Fig. 38: Bank trust products – gross sales

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 China’s 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.

1Q10 2Q10 3Q10 4Q10 1Q11 Y-Y Arp.11

Bank-Trust Products - sale volume (units)

1,015 1,627 1,413 1,522 1,964 93% 804

Bank-Trust Product - sales value (RMB'bn)

560 1,134 1,107 1,045 1,732 209% 453

Credit-related Bank-Trust Product - sales volume (units)

380 623 318 109 159 -58% 28

Credit-related Bank-Trust Product - sales value (RMB'bn)*

210 434 249 75 140 -33% 16

% Credit-related to Bank-Trust Products

37% 38% 23% 7% 8% -29% 3%

% Credit-related to Net New Loans 8% 21% 15% 5% 6% -2% 2%

% Credit-ralated to Total Loan Balance 0.5% 1.0% 0.5% 0.2% 0.3% 0.0% 0.0%

Average Duration 273 254 118 188 241 -32 NA

Expected Annual Yields 3.0% 3.1% 2.8% 3.2% 3.7% NA

3 Month Deposit Rate 1.71% 1.71% 1.71% 1.71% - 2.25%

2.25% - 2.60%

Infrastructure 16% 11% 11% 4% 3% -13% 2%

Non-credit Related Money Market Investme 61% 59% 77% 92% 93% 31% 91%

Commercial and Industrial 20% 26% 12% 4% 4% -16% 6%

Real Estate 3% 3% 0% 0% 0% -2% 0%

Others 0% 1% 0% 0% 0% 0% 0%

Industry Breakdown - Bank-trust product unit sales

Size

Other Characteristics

* 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.

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Fig. 39: Monthly sales of bank-trust products

Source: Use Trust Studio, Nomura research

Fig. 40: Monthly sales of bank-trust products vs 1 year real interest rate

Source: CEIC, Use Trust Studio, Nomura research

Fig. 41: Trust loans as % of total banking loans

Source: CBRC, Nomura research

Fig. 42: Monthly sales of credit-related bank-trust -products

Source: Use Trust Studio, Nomura research

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.

0

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number of new issuance - RHS

(LHS)

(RHS)

(%)

0.8

1

1.2

1.4

1.6

0

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200

300

400

500

600

700

2003

2004

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2006

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total trust loans (RMB'bn) - LHS

% to total loans - RHS

(LHS)(RHS)

(RMB bn) (%)

0

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-08

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Credit related bank trust product as % of total bank trust product - LHSnumber of new credit related bank trust products - RHS

(LHS)

(RHS)

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Fig. 43: Corporate direct financing

Source: Wind, Nomura research

Fig. 44: Examples of trust products sold by Chinese banks

Source: Use Trust Studio, Nomura research

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.

Issuing Size (RMB'bn) 1Q10 2Q10 3Q10 4Q10 1Q11 YoY

Corporate Debt 91 50 114 122 102 12%

Mid Term Commercial Paper 115 175 139 67 188 63%

Short Term Commercial Paper 162 192 209 126 283 75%

Total Direct Financing 368 416 462 315 573 56%

Net New Bank Loans 2,603 2,015 1,672 1,630 2,256 -13%

Trust Loan Issuance (our estimate) 202 425 250 75 135 -33%

Issue date Bank Product Client Product

Type Size

(RMB'm) Term (days) Yield

Sales fees (applied to

total proceeds)

(%)

Custodian fee (applied to

total proceeds) (%)

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

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

RMB wealth management product (90

days) Trust loan projects Credit

Related 211 90 2.85 0.4 0.03 0.43 50,000

15/7/2010 ABC 2010 1074th

part

0-70% trust loan projects, 0-50% bond market, 0-50% bank

deposit Hybrid 3500 28 2.15 NA 0.05 NA 50,000

21/9/2010 CMB Trust Loan

No. 227

Ministry of Railways, Large SOEs, liquid

and high credit rated bonds and mid-term

bills Hybrid 200 169 2.8 NA NA NA 50,000

2/11/2010 ICBC

RMB wealth management product (30

days)

Financial products (i.e. interbank, PBOC bills, bank acceptance draft, corporate bond,

etc) Finance 3000 30 2.5 0.4 0.02 0.42 100,000

18/11/2010 BOC

3 month revolving wealth

management product

Trust loans of premium companies, money market, high

credit rated corporate bonds Hybrid 6000 95 2.5 0.2 0.08 0.28 50,000

22/2/2011 ABC 2011 1047th

part

Trust loans of premium companies, money market, high

credit rated corporate bonds Hybrid 5000 182 3.2 NA NA NA 50,000

25/3/2011 CCB 2011 20th part Guizhou Jinyuan

Group Credit

Related 500 364 4.41 NA NA NA 50,000

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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 credit-related 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 credit-related 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

Source: Company data, Nomura estimates

(RMB bn) ICBC CCB CMB Bocom Citic Minsheng

10A entrusted loan 395,216 778,349 104,013 124,254 99,662 38,810

10A gross loan 6,790,506 5,669,128 1,431,451 2,236,927 1,264,245 1,057,571

% of gross loan 5.8% 13.7% 7.3% 5.6% 7.9% 3.7%

10A RWA 7,112,357 6,015,329 1,446,883 2,370,648 1,385,262 1,280,847

10A adj. RWA 7,309,965 6,404,504 1,498,890 2,432,775 1,435,093 1,300,252

10A Tier 1 10.0 10.4 8.0 9.4 8.5 8.1

10A adj. Tier 1 9.7 9.8 7.8 9.1 8.2 7.9

10A CAR 12.3 12.7 11.5 12.4 11.3 10.4

10A adj. CAR 11.9 11.9 11.1 12.0 10.9 10.3

Capital shortfall 19,702 40,474 4,181 5,821 4,211 1,566

Market cap 1,653,814 1,500,391 316,706 351,349 202,637 162,049

as % of market cap 1.2% 2.7% 1.3% 1.7% 2.1% 1.0%

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Fig. 46: % of entrusted loans to total gross loans by Chinese banks

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 inflation-protected 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

Source: Benefit, Nomura research

-2%

0%

2%

4%

6%

8%

10%

12%

14%

2006 2007 2008 2009 2010

ICBC CCB CMB BOCOM Citic Minsheng

RMB'bn 1Q10 4Q10 1Q11 yoy 2010Number of issuance (units) 1,914 3,152 3,691 93% 9,958Value of issuance (RMB'bn) 1,250 2,060 4,170 234% 7,000

Net new bank loans (RMB'bn) 2,604 1,632 2,255 -13% 7,926Net new bank deposits (RMB'bn) 4,038 1,714 3,969 -2% 12,034

credit related WM as % of net new loans 3%

credit related WM as % of net new deposits 1%

credit related WM as % of total WM 1%

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Fig. 48: Corporate bond (listed on SHEX) yield curve

Source: Wind, Nomura research

Fig. 49: Wealth management product sales

Source: Benefit, 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

2

3

4

5

6

1 3 5 7 9 11 13 15 17 19

Mar-10 Jun-10

Sep-10 Dec-10

Mar-11 May-11

Duration: Years

(%) Expected Annual Yields for WM

Fixed Deposit Rate by PBOC

% 1Q11 Average As of 6 April

1 month 3.2 2.85

1-3 months 3.4 2.85

3-6 months 3.7 2.85

6-12 months 4.4 3.05

more than 12 months 5.5 >3.25

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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

Source: Company data, Nomura research

Fig. 51: Definition of SME loans Definitions by H-share banks

Source: NBS, Company data, Nomura research

Fig. 52: Definition of SMEs by NBS

* 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 end-2010, ICBC’s 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. ICBC’s 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.

2010 Balance (RMBmn) y-y growth (%) Total loans (RMBmn) % to total loans (%)

ABC 1,947,000 22 4,956,741 39.3

ICBC 3,429,206 19 6,790,506 50.5

CCB 1,585,220 29 5,669,128 28.0

BOC 239,365 35 5,660,621 4.2

BOCOM 754,700 46 2,236,927 33.7

CMB 388,418 26 1,431,451 27.1

CITIC 68,070 73 1,264,245 5.4

Minsheng 238,518 133 1,057,571 22.6

CRCB 64,000 31 122,145 52.4

Banks Loans to small-sized enterprises Loans to medium-sized enterprises DefinitionABC Included Included Definition by NBS ICBC Included Included Definition by NBS CCB Included Included Definition by NBS BOC Included Excluded Definition by the Bank BOCOM Included Included Definition by NBS CMB Included Included Definition by NBS CITIC Included Excluded Definition by the Bank Minsheng Included Included Definition by the Bank CRCB Included Included Definition by NBS

No. of employees (less than)* Sales (less than, unit RMB)* Total assets (less than, unit RMB)*Industrial 2,000 300m 400mConstruction 3,000 300m 400mRetail 500 150m naWholesale 200 300m naTransportation 3,000 300m naPostal services 1,000 300m naHotel and restaurant 800 150m na

Official SME definitions

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According to the PBoC’s 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 end-March 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

Source: 21st Century Business Herald, Nomura research

Fig. 54: % of loans charged with above-benchmark lending rates

Source: PBoC, CEIC and Nomura research

Type of borrower Lending rateState-owned enterprises 10% above benchmarkLarger listed companies 20% above benchmarkSmaller listed companies 30% above benchmarkSMEs 40-50% above benchmark, 60-70% under some circumstancesPersonal business loans 40-50% above benchmark, 60-70% under some circumstances

30

35

40

45

50

55

60

Dec-0

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r-08

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1

(% of loans)

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Fig. 55: % of loans charged at above benchmark rates

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 Wenzhou’s 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 under-financed 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 People’s 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.

0

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15

20Jan

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-11

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(% of loans) 10% above benchmark 10-30% above benchmark30-50% above benchmark 50-100% above benchmark100% above benchmark

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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 one-fifth 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, China’s 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 government’s target for this year’s 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

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

Cities

New floor space for public housing (Thousand sqm)

New units of public housing (Thousand units) Cities

New floor space for public housing (Thousand sqm)

New units of public housing (Thousand units)

Beijing - 1,000 Wuxi 4,000 -

Shanghai - 1,000 Hefei 10,000 -

Guangzhou 10,000 - Zhengzhou 22,113 292

Shenzhen 16,160 240 Jinan 5,500 100

Tianjin 26,350 400 Fuzhou 2,800 -

Dalian 1,180 - Nanning - 116

Nanjing 20,000 290 Guiyang 5,000 -

Suzhou - 50 Nanchang - 80

Hangzhou 20,000 - Urumqi - 58

Xaimen - 17 Harbin - 130

Wuhan 10,000 - Shijiazhuang - 100

Chengdu 20,000 - Yinchuan - 20

Chongqing 27,000 - Sanya 2,023 30

Xi'an 15,980 316

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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 People’s 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 year’s 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 bank’s 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

Source: 21st Century Business Herald, Nomura research

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 government’s 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

Income from land sale, RMB200bn

Local governments, RMB100bn

NDB, RMB100bn

Others - including banks, insurers, SSF, trusts and PE, RMB900bn

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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 Beijing’s 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 CNY4-5bn 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 non-banking 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 0.05-1.30pp), respectively.

Fig. 58: Sensitivity analysis under scenario 1 Scenario 1

Source: Company data, Nomura research

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.

Loan growth in 2011F (y-y)

FY11F NPAT growth (y-y) FY11F CAR

FY11F T1 CAR

Loan growth in 2011F (y-y)

FY11F NPAT growth (y-y)

FY11F CAR

FY11F T1 CAR

ABC 14.2 34.7 12.5 10.1 15.9 35.3 12.3 10.0

ICBC 14.5 21.3 12.2 9.9 16.1 22.0 11.9 9.6

CCB 13.0 19.2 12.1 10.0 14.5 19.2 11.9 9.9

BOC 11.8 15.5 12.2 9.6 12.8 16.1 12.2 9.5

BOCOM 16.3 18.4 12.2 8.5 18.1 18.7 10.3 7.2

CMB 18.1 34.1 11.5 8.6 19.8 38.0 11.3 8.5

CITIC 16.8 20.7 12.5 10.3 18.4 22.4 12.2 10.1

Minsheng 18.6 21.3 12.5 8.7 20.3 21.7 12.4 8.6

CRCB 16.4 30.9 14.6 13.4 17.1 31.3 14.5 13.4

Scenario 1Base line forecast

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Fig. 59: Sensitivity analysis under scenario 2 Scenario 2

Source: Company data, Nomura research

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 0.5-1.41pp 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.

Fig. 60: Sensitivity analysis under scenario 3 Scenario 3

Source: Company data, Nomura research

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.

Fig. 61: Sensitivity analysis under scenario 4 Scenario 4

Source: Company data and Nomura Research

We detected that, among all H-share banks, ICBC’s 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.

Loan growth in 2011F (y-y)

FY11F NPAT growth (y-y) FY11F CAR

FY11F T1 CAR

Loan growth in 2011F (y-y)

FY11F NPAT growth (y-y)

FY11F CAR

FY11F T1 CAR

ABC 14.2 34.7 12.5 10.1 15.7 35.2 12.3 10.0

ICBC 14.5 21.3 12.2 9.9 15.9 21.7 11.9 9.6

CCB 13.0 19.2 12.1 10.0 14.4 19.2 12.0 9.9

BOC 11.8 15.5 12.2 9.6 13.0 16.0 12.2 9.5

BOCOM 16.3 18.4 12.2 8.5 17.9 18.6 10.5 7.3

CMB 18.1 34.1 11.5 8.6 19.6 37.6 11.4 8.5

CITIC 16.8 20.7 12.5 10.3 18.2 22.1 12.2 10.1

Minsheng 18.6 21.3 12.5 8.7 20.1 21.5 12.4 8.6

CRCB 16.4 30.9 14.6 13.4 17.0 31.2 14.5 13.4

Base line forecast Scenario 2

Loan growth in 2011F (y-y)

FY11F NPAT growth (y-y) FY11F CAR

FY11F T1 CAR

Loan growth in 2011F (y-y)

FY11F NPAT growth (y-y)

FY11F CAR

FY11F T1 CAR

ABC 14.2 34.7 12.5 10.1 15.6 35.1 12.4 10.0

ICBC 14.5 21.3 12.2 9.9 15.8 21.6 11.9 9.7

CCB 13.0 19.2 12.1 10.0 14.2 19.2 12.0 9.9

BOC 11.8 15.5 12.2 9.6 12.5 16.0 12.2 9.6

BOCOM 16.3 18.4 12.2 8.5 17.7 18.6 10.7 7.5

CMB 18.1 34.1 11.5 8.6 19.4 37.1 11.4 8.5

CITIC 16.8 20.7 12.5 10.3 18.0 21.9 12.2 10.1

Minsheng 18.6 21.3 12.5 8.7 19.9 21.6 12.4 8.7

CRCB 16.4 30.9 14.6 13.4 16.9 31.2 14.5 13.4

Base line forecast Scenario 3

Loan growth in 2011F (y-y)

FY11F NPAT growth (y-y) FY11F CAR

FY11F T1 CAR

Loan growth in 2011F (y-y)

FY11F NPAT growth (y-y)

FY11F CAR

FY11F T1 CAR

ABC 14.2 34.7 12.5 10.1 15.2 35.0 12.4 10.0

ICBC 14.5 21.3 12.2 9.9 15.4 21.6 12.0 9.7

CCB 13.0 19.2 12.1 10.0 13.9 19.2 12.0 10.0

BOC 11.8 15.5 12.2 9.6 12.2 15.8 12.2 9.6

BOCOM 16.3 18.4 12.2 8.5 17.3 18.5 11.1 7.7

CMB 18.1 34.1 11.5 8.6 19.0 36.3 11.4 8.5

CITIC 16.8 20.7 12.5 10.3 17.7 21.5 12.2 10.1

Minsheng 18.6 21.3 12.5 8.7 19.5 21.8 12.5 8.7

CRCB 16.4 30.9 14.6 13.4 16.8 31.1 14.5 13.4

Base line forecast Scenario 4

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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 small- and 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)

Source: CBRC, Nomura research

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.

Type of institution Name of institution or sub-type Number of institutions

Large Commercial Bank Agricultural Bank of China 1

Policy Bank Agricultural Development Bank of China 1

Postal Savings Bank Postal Savings Bank of China 1

Rural credit cooperative institutions:

- rural credit cooperatives 2,646

- rural commercial banks 85

- rural cooperative banks 223

New -type rural f inancial institutions:

- village and tow nship banks 349

- lending companies 9

- rural mutual credit cooperatives 37

Small and Medium-sized RuralFinancial Institutions

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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

Source: CEIC, Nomura research

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.

0

200

400

600

800

1,000

1,200

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

(RMBbn)

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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)

Fig. 65: Total owners’ equity of banking institutions (2007-2010)

Fig. 66: Profit after tax of banking institutions (2007-2010)

Source: CBRC, Nomura research

Balance (RMBbn) Percentage of total (%)

Institutions/Year 2007 2008 2009 2010 2007 2008 2009 2010

Banking institutions 53,116 63,152 79,515 95,305

Policy banks & the CDB 4,278 5,645 6,946 7,652 8.05 8.94 8.73 8.03

Large commercial banks 28,500 32,575 40,800 46,894 53.66 51.58 51.31 49.20

Joint-stock commercial banks 7,274 8,834 11,818 14,904 13.69 13.99 14.86 15.64

City commercial banks 3,341 4,132 5,680 7,853 6.29 6.54 7.14 8.24

Rural commercial banks 610 929 1,866 2,767 1.15 1.47 2.35 2.90

Rural cooperative banks 646 1,003 1,279 1,500 1.22 1.59 1.61 1.57

Urban credit cooperatives 131 80 27 2 0.25 0.13 0.03 0.00

Rural credit cooperatives 4,343 5,211 5,495 6,391 8.18 8.25 6.91 6.71

Non-bank financial institutions 972 1,180 1,550 2,090 1.83 1.87 1.95 2.19

Foreign banks 1,253 1,345 1,349 1,742 2.36 2.13 1.70 1.83New-type rural financial institutions &Postal savings bank 1,769 2,216 2,705 3,510 3.33 3.51 3.40 3.68

Balance (RMBbn) Percentage of total (%)

Institutions/Year 2007 2008 2009 2010 2007 2008 2009 2010

Banking institutions 3,040 3,790 4,444 5,832

Policy banks & the CDB 358 381 406 436 11.77 10.04 9.14 7.48

Large commercial banks 1,582 1,961 2,196 2,861 52.06 51.74 49.42 49.06

Joint-stock commercial banks 339 441 564 817 11.16 11.65 12.69 14.00

City commercial banks 188 267 359 482 6.19 7.04 8.07 8.27

Rural commercial banks 33 53 112 203 1.09 1.41 2.51 3.47

Rural cooperative banks 41 65 85 112 1.35 1.72 1.91 1.91

Urban credit cooperatives 6 5 2 0 0.21 0.12 0.04 0.00

Rural credit cooperatives 187 222 234 279 6.14 5.86 5.27 4.79

Non-bank financial institutions 176 231 286 383 5.78 6.09 6.42 6.57

Foreign banks 117 142 167 185 3.86 3.75 3.77 3.18New-type rural financial institutions &Postal savings bank 12 22 33 74 0.39 0.58 0.75 1.26

Balance (RMBbn) Percentage of total (%)

Institutions/Year 2007 2008 2009 2010 2007 2008 2009 2010

Banking institutions 447 583 668 899

Policy banks & the CDB 48.9 23.0 35.3 41.5 10.95 3.94 5.27 4.62

Large commercial banks 246.6 354.2 400.1 515.1 55.20 60.72 59.86 57.29

Joint-stock commercial banks 56.4 84.1 92.5 135.8 12.63 14.42 13.84 15.10

City commercial banks 24.8 40.8 49.7 77.0 5.55 6.99 7.43 8.56

Rural commercial banks 4.3 7.3 14.9 28.0 0.96 1.25 2.23 3.11

Rural cooperative banks 5.5 10.4 13.5 17.9 1.22 1.78 2.02 1.99

Urban credit cooperatives 0.8 0.6 0.2 0.0 0.17 0.11 0.03 0.00

Rural credit cooperatives 19.3 21.9 22.8 23.3 4.33 3.76 3.41 2.59

Non-bank financial institutions 33.4 28.5 29.9 40.8 7.47 4.88 4.47 4.54

Foreign banks 6.1 11.9 6.5 7.8 1.36 2.04 0.96 0.87New-type rural financial institutions &Postal savings bank 0.7 0.7 3.2 11.9 0.15 0.11 0.48 1.32

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Key company data: See page 2 for company data, and detailed price/index chart. Rating: See report end for details of Nomura’s rating system.

Agricultural Bank of China 1288.HK 1288 HK

FINANCIALS

EQUITY RESEARCH

2Q11 earnings growth expected to remain strong  

Rural growth story largely remains intact; reiterate BUY

June 24, 2011

Rating Remains

Buy

Target price Remains

HKD 5.20

Closing price June 21, 2011

HKD 3.94

Potential upside +32%

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 China’s 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 ABC’s 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 FY10 FY11F FY12F FY13F

Currency (CNY) Actual Old New Old New Old New

PPOP (mn) 164,146 203,316 203,316 246,260 246,260 297,268 297,268

Reported net profit (mn) 94,873 127,766 127,766 158,091 158,091 194,278 194,278

Normalised net profit (mn) 94,873 127,766 127,766 158,091 158,091 194,278 194,278

Normalised EPS 0.32 0.39 0.39 0.49 0.49 0.60 0.60

Norm. EPS growth (%) 29.8 21.2 21.2 23.7 23.7 22.9 22.9

Norm. P/E (x) 10.4 N/A 8.2 N/A 6.3 N/A 5.0

Price/adj. book (x) 2.0 N/A 1.6 N/A 1.3 N/A 1.1

Price/book (x) 2.0 N/A 1.6 N/A 1.3 N/A 1.1

Dividend yield (%) 1.6 N/A 5.5 N/A 7.2 N/A 9.0

ROE (%) 21.4 21.5 21.5 22.6 22.6 24.0 24.0

ROA (%) 1.0 1.1 1.1 1.2 1.2 1.3 1.3

Source: Nomura estimates

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 re-rating 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

China Banks

Lucy Feng - NIHK [email protected] +852 2252 2165

Donger Wang - NIHK [email protected] +852 2252 1590

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.

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Key data on Agricultural Bank of China Profit and Loss (CNYmn) Year-end 31 Dec FY09 FY10 FY11F FY12F FY13FInterest income 296,147 357,660 434,079 517,904 612,549Interest expense -114,508 -115,508 -145,777 -182,037 -222,391Net interest income 181,639 242,152 288,302 335,866 390,158Net fees and commissions 35,640 46,128 56,211 69,136 85,044Trading related profits 271 -998 -909 -1,244 -1,694Other operating revenue 6,087 4,971 -677 937 1,179Non-interest income 41,998 50,101 54,625 68,829 84,528Operating income 223,637 292,253 342,927 404,696 474,686Depreciation -10,775 -11,296 -11,861 -12,454 -13,077Amortisation 0 0 0 0 0Operating expenses -98,792 -116,811 -127,751 -145,982 -164,342Employee share expense

Op. profit before provisions 114,070 164,146 203,316 246,260 297,268Provisions for bad debt -44,289 -43,536 -36,252 -39,551 -43,251Other provision charges 4,147 124 0 0 0Operating profit 73,928 120,734 167,064 206,709 254,017Other non-operating income 0 0 0 0 0Associates & JCEs 0 0 0 0 0Pre-tax profit 73,928 120,734 167,064 206,709 254,017Income tax -8,926 -25,827 -39,260 -48,577 -59,694Net profit after tax 65,002 94,907 127,804 158,132 194,323Minority interests -10 -34 -37 -41 -45Other items 0 0 0 0 0Preferred dividends 0 0 0 0 0Normalised NPAT 64,992 94,873 127,766 158,091 194,278Extraordinary items 0 0 0 0 0Reported NPAT 64,992 94,873 127,766 158,091 194,278Dividends -20,000 -17,539 -57,512 -71,159 -87,446Transfer to reserves 44,992 77,334 70,255 86,931 106,833

Valuation and ratio analysis

FD normalised P/E (x) 13.8 10.4 8.2 6.3 5.0FD normalised P/E at price target (x) 18.6 14.1 11.1 8.5 6.7Reported P/E (x) 13.8 10.4 8.2 6.3 5.0Dividend yield (%) 2.2 1.6 5.5 7.2 9.0Price/book (x) 2.6 2.0 1.6 1.3 1.1Price/adjusted book (x) 2.6 2.0 1.6 1.3 1.1Net interest margin (%) 2.28 2.57 2.68 2.74 2.80Yield on interest earning assets (%) 3.71 3.80 4.04 4.23 4.39Cost of interest bearing liabilities (%) 1.51 1.30 1.42 1.54 1.64Net interest spread (%) 2.20 2.50 2.62 2.69 2.75Non-interest/operating income (%) 18.8 17.1 15.9 17.0 17.8Cost to income (%) 49.0 43.8 40.7 39.1 37.4Effective tax rate (%) 12.1 21.4 23.5 23.5 23.5Dividend payout (%) 30.8 18.5 45.0 45.0 45.0ROE (%) 20.5 21.4 21.5 22.6 24.0ROA (%) 0.82 0.99 1.15 1.23 1.31Operating ROE (%) 23.3 27.3 28.1 29.6 31.3Operating ROA (%) 0.93 1.26 1.50 1.61 1.72

Growth (%)

Net interest income -9.2 33.3 19.1 16.5 16.2Non-interest income 199.7 19.3 9.0 26.0 22.8Non-interest expenses 0.0 18.2 9.4 14.3 12.6Pre-provision earnings 9.9 43.9 23.9 21.1 20.7Net profit 26.3 46.0 34.7 23.7 22.9Normalised EPS -7.3 29.8 21.2 23.7 22.9Normalised FDEPS -7.3 29.8 21.2 23.7 22.9Source: Nomura estimates

 Notes

Continued NIM expansion

Price and price relative chart (one year) 

 

(%) 1M 3M 12M

Absolute (HKD) -14.9 -3.7

Absolute (USD) -15.1 -3.6

Relative to index -7.6 0.2

Market cap (USDmn) 164,258.5

Estimated free float (%)

62.0

52-week range (HKD) 4.85/3.2

3-mth avg daily turnover (USDmn)

103.82

Major shareholders (%) MOF 39.2

Huijin 40.0

 

3

3.5

4

4.5

5

95

100

105

110

115

120

125

130

Aug

10

Sep

10

Oct

10

Nov

10

Dec

10

Jan

11

Feb

11

Mar

11

Apr

11

May

11

Jun

11

PriceRel MSCI China(HKD)

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50

Balance Sheet (CNYmn) As at 31 Dec FY09 FY10 FY11F FY12F FY13FCash and equivalents 1,517,806 2,082,332 2,728,437 3,302,118 4,042,436Inter-bank lending 111,128 173,268 194,060 217,347 243,429Deposits with central bank 0 0 0 0 0Total securities 2,504,496 2,477,174 2,758,995 3,073,090 3,423,178Other interest earning assets 421,093 525,331 577,864 635,651 699,216Gross loans 4,138,187 4,956,741 5,662,892 6,521,574 7,462,156Less provisions -126,692 -168,733 -200,140 -235,951 -275,229Net loans 4,011,495 4,788,008 5,462,752 6,285,623 7,186,927Long-term investments 141 141 141 141 141Fixed assets 111,973 121,391 123,819 126,295 128,821Goodwill 0 0 0 0 0Other intangible assets 19,659 31,470 28,323 25,491 22,942Other non IEAs 184,797 138,291 79,650 80,446 81,251Total assets 8,882,588 10,337,406 11,954,041 13,746,202 15,828,340Customer deposits 7,497,618 8,887,905 10,276,556 11,886,157 13,752,013Bank deposits, CDs, debentures 714,218 617,995 680,950 753,700 836,972Other interest bearing liabilities 163,681 112,189 165,936 170,057 174,591Total interest bearing liabilities 8,375,517 9,618,089 11,123,441 12,809,914 14,763,576Non interest bearing liabilities 164,146 177,081 181,942 187,033 192,370Total liabilities 8,539,663 9,795,170 11,305,383 12,996,946 14,955,946Minority interest 106 165 167 168 170Common stock 260,000 324,794 324,794 324,794 324,794Preferred stock

Retained earnings 39,817 27,945 70,844 129,059 200,972Proposed dividends 20,000 17,539 57,512 71,159 87,446Other equity 23,002 171,793 195,341 224,075 259,012Shareholders' equity 342,819 542,071 648,491 749,087 872,224Total liabilities and equity 8,882,588 10,337,406 11,954,041 13,746,202 15,828,340Non-performing assets (CNY) 120,241 100,405 89,618 89,002 88,315

Balance sheet ratios (%)

Loans to deposits 55.2 55.8 55.1 54.9 54.3Equity to assets 3.9 5.2 5.4 5.4 5.5

Asset quality & capital

NPAs/gross loans (%) 2.9 2.0 1.6 1.4 1.2Bad debt charge/gross loans (%) 1.07 0.88 0.64 0.61 0.58Loss reserves/assets (%) 1.43 1.63 1.67 1.72 1.74Loss reserves/NPAs (%) 105.4 168.1 223.3 265.1 311.6Tier 1 capital ratio (%) 7.7 9.7 10.1 9.7 9.4Total capital ratio (%) 10.1 11.6 12.5 11.8 11.2

Growth (%)

Loan growth 33.1 19.4 14.1 15.1 14.3Interest earning assets 25.0 13.0 12.9 13.5 13.1Interest bearing liabilities 28.9 14.8 15.7 15.2 15.3Asset growth 26.6 16.4 15.6 15.0 15.1Deposit growth 23.0 18.5 15.6 15.7 15.7

Per share

Reported EPS (CNY) 0.25 0.32 0.39 0.49 0.60Norm EPS (CNY) 0.25 0.32 0.39 0.49 0.60Fully diluted norm EPS (CNY) 0.25 0.32 0.39 0.49 0.60DPS (CNY) 0.08 0.05 0.18 0.22 0.27PPOP PS (CNY) 0.44 0.56 0.63 0.76 0.92BVPS (CNY) 1.32 1.67 2.00 2.31 2.69ABVPS (CNY) 1.32 1.67 2.00 2.31 2.69NTAPS (CNY) 1.24 1.57 1.91 2.23 2.61Source: Nomura estimates

 Notes

Steady and low LDR

 

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51

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 hard-landing 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, China’s 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

Source: Company data and Nomura Research.

(RMBmn, except %) ABC ICBC CCB BOC BCOM CMB Citic Minsheng2010 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 SepFull 389,400 622,500 406,300 209,850 79,925 116,142 218,680 133,350 - % of total LFGV loans 59.0% 75.0% 56.5% 50.0% 57.5% 89.3% 99.4% 70.0%BasicPartialNo - % of lower grade LGFV loans 41.0% 25.0% 43.5% 50.0% 42.5% 10.7% 0.6% 30.0%Total 660,000 830,000 718,600 419,700 139,000 130,000 220,000 190,500

13,858 57,150 270,600 312,300 1,320 207,500 209,850 59,075

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Nomura | ASIA Agricultural Bank of China June 24, 2011

52

Fig. 68: Impact on FY11F credit cost and net profits By Individual banks

Source: Company data and Nomura Research.

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 ABC’s 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

Source: Company data and Nomura Research.

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.

ABC ICBC CCB BOC BCOM CMB Citic MinshengLGFV loans need to charge provision after the bailout (RMB mn) 6,600 0 24,860 41,970 3475 0 0 0Assume 25% of provision chargedImpact on FY11F credit cost 0.03% Nil 0.14% 0.17% 0.04% Nil Nil NilImpact on FY11F NPAT -0.99% Nil -2.89% -6.61% -1.46% Nil Nil NilAssume 50% of provision chargedImpact on FY11F credit cost 0.06% Nil 0.28% 0.35% 0.07% Nil Nil NilImpact on FY11F NPAT -1.98% Nil -5.78% -13.22% -2.91% Nil Nil NilAssume 100% of provision chargedImpact on FY11F credit cost 0.13% Nil 0.57% 0.70% 0.14% Nil Nil NilImpact on FY11F NPAT -3.95% Nil -11.57% -26.44% -5.83% Nil Nil Nil

2010 (RMBmn) ABC ICBC CCB BOC BOCOM CMB CITICMinsheng CRCB

Incremetnal RWA as % of total RWA 15% 14% 14% 14% 11% 11% 11% 11% 17%

Total tier 1 impact (136) (127) (131) (135) (95) (80) (88) (84) (234)

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Nomura | ASIA Agricultural Bank of China June 24, 2011

53

Fig. 70: The trading date of shares subject to restrictions on sales

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 new The remaining The remaining

shares for trading number of shares number of shares

upon the expiry subject to the not subject to the

of the restrictions restrictions on restrictions on

Date on sales sales sales Description

15-Oct-10 5,032,028,000 291,981,302,904 32,812,814,096 Allottees of A shares under off-line placement

16-Jan-11 912,960,000 291,068,342,904 33,725,774,096 Cornerstone investors of H shares

15-Jul-11 5,114,117,500 285,954,225,404 38,839,891,596 Strategic investors of A shares

16-Jul-11 12,355,402,000 273,598,823,404 51,195,293,596 Cornerstone investors of H shares

15-Jan-12 5,114,117,500 268,484,705,904 56,309,411,096 Strategic investors of A shares

15-Jul-13 258,592,941,197 9,891,764,707 314,902,352,293 A shares held by the MOF and Huijin, and A shares transferred

to the SSF from the MOF

15-May-15 9,891,764,707 0 324,794,117,000 A shares held by the SSF, and A shares transferred to the

SSF by itself

Page 55: Unmasking China's Shadow Banking System

Key company data: See page 2 for company data, and detailed price/index chart. Rating: See report end for details of Nomura’s rating system.

ICBC 1398.HK 1398 HK

BANKS

EQUITY RESEARCH

Top pick among H-share Chinese banks 

Most resilient player in a slowing economy; top BUY with TP of HKD7.50

June 24, 2011

Rating Remains

Buy

Target price Reduced from 7.60

HKD 7.50

Closing price June 21, 2011

HKD 5.84

Potential upside +28.4%

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 H-share 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 China’s 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.

31 Dec FY10 FY11F FY12F FY13F

Currency (CNY) Actual Old New Old New Old New

PPOP (mn) 241,268 295,821 291,497 353,486 344,800 409,639 402,621

Reported net profit (mn) 165,156 200,409 197,101 245,789 239,144 279,722 274,317

Normalised net profit (mn) 165,156 200,409 197,101 245,789 239,144 279,722 274,317

Normalised EPS 0.48 0.57 0.56 0.70 0.69 0.80 0.79

Norm. EPS growth (%) 25.6 18.7 16.8 22.6 21.3 13.8 14.7

Norm. P/E (x) 10.3 N/A 8.5 N/A 6.6 N/A 5.6

Price/adj. book (x) 2.1 N/A 1.7 N/A 1.4 N/A 1.2

Price/book (x) 2.1 N/A 1.7 N/A 1.4 N/A 1.2

Dividend yield (%) 3.7 N/A 5.3 N/A 6.9 N/A 8.1

ROE (%) 22.1 22.5 22.1 23.6 23.1 23.2 23.0

ROA (%) 1.3 1.4 1.3 1.4 1.4 1.4 1.4

Source: Nomura estimates

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 re-rating 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

China Banks

Lucy Feng - NIHK [email protected] +852 2252 2165

Donger Wang - NIHK [email protected] +852 2252 1590

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.

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Key data on ICBC Profit and Loss (CNYmn) Year-end 31 Dec FY09 FY10 FY11F FY12F FY13FInterest income 405,878 462,762 594,112 710,577 838,302Interest expense -160,057 -159,013 -233,212 -286,249 -345,832Net interest income 245,821 303,749 360,900 424,328 492,471Net fees and commissions 55,147 72,840 87,623 105,796 130,369Trading related profits 7,135 316 146 24 -103Other operating revenue 1,308 3,843 3,920 3,998 4,078Non-interest income 63,590 76,999 91,688 109,818 134,345Operating income 309,411 380,748 452,588 534,146 626,815Depreciation

Amortisation 0 0 0 0 0Operating expenses -120,819 -139,480 -161,092 -189,346 -224,195Employee share expense

Op. profit before provisions 188,592 241,268 291,497 344,800 402,621Provisions for bad debt -21,682 -27,888 -34,959 -33,416 -38,178Other provision charges -1,603 -100 0 0 0Operating profit 165,307 213,280 256,537 311,384 364,442Other non-operating income 0 0 0 0 0Associates & JCEs 1,987 2,146 2,361 2,597 2,856Pre-tax profit 167,294 215,426 258,898 313,981 367,299Income tax -37,898 -49,401 -60,841 -73,785 -91,825Net profit after tax 129,396 166,025 198,057 240,195 275,474Minority interests -751 -869 -956 -1,051 -1,157Other items 0 0 0 0 0Preferred dividends 0 0 0 0 0Normalised NPAT 128,645 165,156 197,101 239,144 274,317Extraordinary items 0 0 0 0 0Reported NPAT 128,645 165,156 197,101 239,144 274,317Dividends -56,783 -64,219 -89,126 -108,088 -123,963Transfer to reserves 71,862 100,937 107,975 131,056 150,354

Valuation and ratio analysis

FD normalised P/E (x) 13.2 10.3 8.5 6.6 5.6FD normalised P/E at price target (x) 17.3 13.5 11.1 8.6 7.3Reported P/E (x) 13.2 10.3 8.5 6.6 5.6Dividend yield (%) 3.3 3.7 5.3 6.9 8.1Price/book (x) 2.5 2.1 1.7 1.4 1.2Price/adjusted book (x) 2.5 2.1 1.7 1.4 1.2Net interest margin (%) 2.26 2.44 2.55 2.63 2.67Yield on interest earning assets (%) 3.74 3.72 4.19 4.40 4.55Cost of interest bearing liabilities (%) 1.58 1.37 1.75 1.87 1.96Net interest spread (%) 2.16 2.35 2.44 2.53 2.59Non-interest/operating income (%) 20.6 20.2 20.3 20.6 21.4Cost to income (%) 39.0 36.6 35.6 35.4 35.8Effective tax rate (%) 22.7 22.9 23.5 23.5 25.0Dividend payout (%) 44.1 38.9 45.2 45.2 45.2ROE (%) 20.2 22.1 22.1 23.1 23.0ROA (%) 1.19 1.31 1.35 1.39 1.38Operating ROE (%) 25.9 28.5 28.8 30.1 30.5Operating ROA (%) 1.53 1.69 1.75 1.80 1.84

Growth (%)

Net interest income -6.5 23.6 18.8 17.6 16.1Non-interest income 34.8 21.1 19.1 19.8 22.3Non-interest expenses 8.5 15.4 15.5 17.5 18.4Pre-provision earnings -5.2 27.9 20.8 18.3 16.8Net profit 16.1 28.4 19.3 21.3 14.7Normalised EPS 16.1 25.6 16.8 21.3 14.7Normalised FDEPS 16.1 25.6 16.8 21.3 14.7Source: Nomura estimates

 Notes

Continued NIM expansion

Price and price relative chart (one year) 

 

(%) 1M 3M 12M

Absolute (HKD) -7.8 -3.3 3.2

Absolute (USD) -8.0 -3.2 3.1

Relative to index -1.8 -1.8 -1.3

Market cap (USDmn) 248,967.3

Estimated free float (%)

62.0

52-week range (HKD) 6.77/5.43

3-mth avg daily turnover (USDmn)

205.04

Major shareholders (%) Huijin 35.4

MOF 35.3

 

5.4

5.6

5.8

6

6.2

6.4

6.6

6.8

90

92

94

96

98

100

102

104

Jul 1

0

Aug

10

Sep

10

Oct

10

Nov

10

Dec

10

Jan

11

Feb

11

Mar

11

Apr

11

May

11

Jun

11

PriceRel MSCI China(HKD)

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56

Balance Sheet (CNYmn) As at 31 Dec FY09 FY10 FY11F FY12F FY13FCash and equivalents 0 0 0 0 0Inter-bank lending 235,301 248,860 278,723 312,170 349,630Deposits with central bank 1,693,048 2,282,999 3,218,770 4,360,014 4,908,318Total securities 3,579,026 3,719,282 4,155,562 4,643,192 5,188,233Other interest earning assets 408,826 262,227 288,450 317,295 349,024Gross loans 5,728,626 6,790,506 7,775,769 8,932,091 10,157,074Less provisions -145,452 -167,134 -197,061 -224,725 -256,361Net loans 5,583,174 6,623,372 7,578,708 8,707,367 9,900,712Long-term investments 36,278 40,325 40,325 40,325 40,325Fixed assets 95,684 103,412 105,480 107,590 109,742Goodwill 0 0 0 0 0Other intangible assets 18,696 21,712 19,541 17,587 15,828Other non IEAs 135,020 156,433 157,997 159,577 161,173Total assets 11,785,053 13,458,622 15,843,556 18,665,116 21,022,986Customer deposits 9,771,277 11,145,557 13,251,509 15,765,490 17,955,961Bank deposits, CDs, debentures 1,003,106 1,059,170 1,182,697 1,321,761 1,321,761Other interest bearing liabilities 111,060 185,298 193,787 203,124 203,124Total interest bearing liabilities 10,885,443 12,390,025 14,627,993 17,290,375 19,480,846Non interest bearing liabilities 220,676 246,889 254,553 262,643 262,643Total liabilities 11,106,119 12,636,914 14,882,546 17,553,018 19,743,489Minority interest 5,041 1,227 1,239 1,252 1,264Common stock 334,019 349,019 349,019 349,019 349,019Preferred stock

Retained earnings 61,977 137,767 246,360 378,468 529,979Proposed dividends 56,783 64,219 89,126 108,088 123,963Other equity 221,114 269,476 275,266 275,272 275,272Shareholders' equity 673,893 820,481 959,771 1,110,847 1,278,233Total liabilities and equity 11,785,053 13,458,622 15,843,556 18,665,117 21,022,986Non-performing assets (CNY) 88,467 73,241 72,629 76,146 85,151

Balance sheet ratios (%)

Loans to deposits 58.6 60.9 58.7 56.7 56.6Equity to assets 5.7 6.1 6.1 6.0 6.1

Asset quality & capital

NPAs/gross loans (%) 1.5 1.1 0.9 0.9 0.8Bad debt charge/gross loans (%) 0.38 0.41 0.45 0.37 0.38Loss reserves/assets (%) 1.23 1.24 1.24 1.20 1.22Loss reserves/NPAs (%) 164.4 228.2 271.3 295.1 301.1Tier 1 capital ratio (%) 9.9 10.0 9.8 9.7 9.6Total capital ratio (%) 12.4 12.3 12.1 11.7 11.4

Growth (%)

Loan growth 25.9 18.6 14.4 14.9 13.7Interest earning assets 21.4 14.2 18.1 18.2 12.8Interest bearing liabilities 22.2 13.8 18.1 18.2 12.7Asset growth 20.8 14.2 17.7 17.8 12.6Deposit growth 18.8 14.1 18.9 19.0 13.9

Per share

Reported EPS (CNY) 0.39 0.48 0.56 0.69 0.79Norm EPS (CNY) 0.39 0.48 0.56 0.69 0.79Fully diluted norm EPS (CNY) 0.39 0.48 0.56 0.69 0.79DPS (CNY) 0.17 0.18 0.26 0.31 0.36PPOP PS (CNY) 0.56 0.71 0.84 0.99 1.15BVPS (CNY) 2.02 2.35 2.75 3.18 3.66ABVPS (CNY) 2.02 2.35 2.75 3.18 3.66NTAPS (CNY) 1.96 2.29 2.69 3.13 3.62Source: Nomura estimates

 Notes

Benign asset quality

 

Page 58: Unmasking China's Shadow Banking System

Nomura | ASIA ICBC June 24, 2011

57

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 H-share 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, China’s 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 ICBC’s 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

Source: Reuters, Company data, Nomura estimates

RMB'mn ABC ICBC CCB BOC BCOM CMB Citic Minsheng CRCB

total LGFV as of Dec 2010 395,300 649,600 540,000 380,000 177,400 135,100 118,400 197,200 18,500

total LGFV as % of total loan 8.0% 9.6% 9.5% 6.7% 7.9% 9.4% 9.4% 18.6% 15.1%

30% of LGFV loan spin off 108,718 178,658 148,515 104,510 48,790 37,156 32,563 54,235 5,088

20% write-off on the spin off 21,744 35,732 29,703 20,902 9,758 7,431 6,513 10,847 1,018

haircut as % of LGFV 6% 6% 6% 6% 6% 6% 6% 6% 6%

haircut as % of total loans 0.44% 0.53% 0.52% 0.37% 0.44% 0.52% 0.52% 1.03% 0.83%

2011F pre tax profit 167,064 263,222 214,915 163,658 59,829 45,178 34,383 28,445 5,291

write off as % of 2011F PBT 13.0% 13.6% 13.8% 12.8% 16.3% 16.4% 18.9% 38.1% 19.2%

total lower grade LGFV loans 162,073 162,400 234,681 190,000 75,395 14,402 710 59,160 37

remaining lower grade LGFV loans not spin off 53,355 0 86,166 85,490 26,605 0 0 4,925 0

50% provision on remaining lower grade LGFV to 2011F PBT 16% 0% 20% 26% 22% 0% 0% 9% 0%

Total impact on 2011F PBT 29% 14% 34% 39% 39% 16% 19% 47% 19%

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

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

Page 59: Unmasking China's Shadow Banking System

Nomura | ASIA ICBC June 24, 2011

58

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 ICBC’s 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 CBRC’s 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 ICBC’s tier 1 ratio

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 company’s 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 ICBC’s 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.

2010 (RMB'mn) Property Interbank

Retail claims excluding mortgage

Operating risk SME

Corporate loan over 5

years Total

Total exposure 512,018 511,087 543,097 50,018 339,525 1,361,018

Incremental RWA 256,009 111,519 -135,774 625,221 -84,881 204,153 976,246

% to RWA 3.6% 1.6% -1.9% 8.8% -1.2% 2.9% 13.7%

Tier 1 impact (bps) -35 -15 19 -81 12 -28 -127

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Nomura | ASIA ICBC June 24, 2011

59

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 market’s 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 ICBC’s 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

Source: Company data, Nomura research

Fig. 74: 2010 loan provision ratio

Source: Company data, Nomura research

Fig. 75: 2011F net profit sensitivity to credit cost Net profit change for each 10bp change in credit cost

Source: Company data, Nomura estimates

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.

2010 ABC ICBC CCB BOC BOCOM CMB CITIC Minsheng CRCB

Property 11% 8% 7% 8% 6% 8% 6% 12% 10%

Mortgage 15% 16% 19% 19% 12% 21% 13% 9% 20%

Manufacturing 21% 14% 17% 21% 20% 18% 21% 14% 18%

Risk Sectors 46.7% 37.4% 43.6% 47.8% 38.0% 46.5% 39.0% 35.0% 47.9%

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2011F net profit sensitivity to credit cost

Page 61: Unmasking China's Shadow Banking System

Key company data: See page 2 for company data, and detailed price/index chart. Rating: See report end for details of Nomura’s rating system.

China Construction Bank-H 0939.HK 939 HK

BANKS

EQUITY RESEARCH

Downgrade to NEUTRAL, valuation protective 

Material exposure to shadow credit (entrusted loans), risk yet to be priced in

June 24, 2011

Rating Down from Buy

Neutral

Target price Reduced from 8.60

HKD 7.02

Closing price June 21, 2011

HKD 6.44

Potential upside +9%

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 CCB’s total loan in 2010), then CCB’s Tier-1 CAR could be cut by 63bps – one of the most among H-share banks. In addition, we expect the new capital framework, if implemented, to lower CCB’s 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 BoA’s 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.

31 Dec FY10 FY11F FY12F FY13F

Currency (CNY) Actual Old New Old New Old New

PPOP (mn) 204,414 248,087 243,225 297,497 288,424 352,315 336,694

Reported net profit (mn) 134,844 165,279 160,141 199,743 189,052 233,387 216,049

Normalised net profit (mn) 134,844 165,279 160,141 199,743 189,052 233,387 216,049

Normalised EPS 0.56 0.66 0.64 0.80 0.76 0.93 0.86

Norm. EPS growth (%) 22.0 18.6 14.9 20.9 18.1 16.8 14.3

Norm. P/E (x) 10.2 N/A 8.5 N/A 6.8 N/A 5.8

Price/adj. book (x) 2.0 N/A 1.6 N/A 1.4 N/A 1.2

Price/book (x) 2.0 N/A 1.6 N/A 1.4 N/A 1.2

Dividend yield (%) 3.7 N/A 5.3 N/A 6.6 N/A 7.7

ROE (%) 21.5 21.9 21.3 22.9 21.9 23.2 21.9

ROA (%) 1.3 1.4 1.4 1.5 1.4 1.5 1.4

Source: Nomura estimates

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 re-rating 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

China Banks

Lucy Feng - NIHK [email protected] +852 2252 2165

Donger Wang - NIHK [email protected] +852 2252 1590

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.

Page 62: Unmasking China's Shadow Banking System

Nomura | ASIA China Construction Bank-H June 24, 2011

61

Key data on China Construction Bank-H Profit and Loss (CNYmn) Year-end 31 Dec FY09 FY10 FY11F FY12F FY13FInterest income 339,463 377,783 470,321 558,696 649,464Interest expense -127,578 -126,283 -171,096 -208,357 -242,919Net interest income 211,885 251,500 299,225 350,338 406,545Net fees and commissions 48,059 66,132 81,787 104,688 130,860Trading related profits 6,704 5,412 4,330 3,464 2,771Other operating revenue 2,666 2,736 2,886 3,043 3,209Non-interest income 57,429 74,280 89,003 111,194 136,839Operating income 269,314 325,780 388,228 461,533 543,384Depreciation 0 0 0 0 0Amortisation 0 0 0 0 0Operating expenses -105,146 -121,366 -145,003 -173,109 -206,690Employee share expense 0 0 0 0 0Op. profit before provisions 164,168 204,414 243,225 288,424 336,694Provisions for bad debt -24,256 -25,641 -35,021 -42,620 -53,997Other provision charges -1,204 -3,651 0 0 0Operating profit 138,708 175,122 208,204 245,804 282,697Other non-operating income 0 0 0 0 0Associates & JCEs 17 34 37 41 45Pre-tax profit 138,725 175,156 208,242 245,845 282,742Income tax -31,889 -40,125 -47,896 -56,544 -66,444Net profit after tax 106,836 135,031 160,346 189,301 216,298Minority interests -80 -187 -206 -249 -249Other items 0 0 0 0 0Preferred dividends 0 0 0 0 0Normalised NPAT 106,756 134,844 160,141 189,052 216,049Extraordinary items 0 0 0 0 0Reported NPAT 106,756 134,844 160,141 189,052 216,049Dividends -47,205 -53,052 -72,063 -85,084 -97,222Transfer to reserves 59,551 81,792 88,077 103,968 118,827

Valuation and ratio analysis

FD normalised P/E (x) 12.7 10.2 8.5 6.8 5.8FD normalised P/E at price target (x) 17.6 14.2 11.8 9.5 8.1Reported P/E (x) 12.7 10.2 8.5 6.8 5.8Dividend yield (%) 3.5 3.7 5.3 6.6 7.7Price/book (x) 2.4 2.0 1.6 1.4 1.2Price/adjusted book (x) 2.4 2.0 1.6 1.4 1.2Net interest margin (%) 2.41 2.49 2.60 2.67 2.72Yield on interest earning assets (%) 3.85 3.74 4.09 4.25 4.34Cost of interest bearing liabilities (%) 1.55 1.34 1.60 1.73 1.81Net interest spread (%) 2.30 2.40 2.49 2.52 2.53Non-interest/operating income (%) 21.3 22.8 22.9 24.1 25.2Cost to income (%) 39.0 37.3 37.3 37.5 38.0Effective tax rate (%) 23.0 22.9 23.0 23.0 23.5Dividend payout (%) 44.2 39.3 45.0 45.0 45.0ROE (%) 20.9 21.5 21.3 21.9 21.9ROA (%) 1.24 1.32 1.36 1.38 1.35Operating ROE (%) 27.2 28.0 27.7 28.5 28.6Operating ROA (%) 1.61 1.71 1.77 1.79 1.77

Growth (%)

Net interest income -5.8 18.7 19.0 17.1 16.0Non-interest income 28.1 29.3 19.8 24.9 23.1Non-interest expenses 6.0 15.4 19.5 19.4 19.4Pre-provision earnings -3.7 24.5 19.0 18.6 16.7Net profit 15.3 26.3 18.8 18.1 14.3Normalised EPS 15.3 22.0 14.9 18.1 14.3Normalised FDEPS 15.3 22.0 14.9 18.1 14.3Source: Nomura estimates

 Notes

Continued NIM expansion

Price and price relative chart (one year) 

 

(%) 1M 3M 12M

Absolute (HKD) -6.7 -4.2 8.3

Absolute (USD) -7.0 -4.1 8.2

Relative to index -0.7 -2.6 3.8

Market cap (USDmn) 199,068.0

Estimated free float (%)

31.8

52-week range (HKD) 8.22/5.92

3-mth avg daily turnover (USDmn)

231.12

Major shareholders (%) Huijin 57.1

Bank of America 10.2

 

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Nomura | ASIA China Construction Bank-H June 24, 2011

62

Balance Sheet (CNYmn) As at 31 Dec FY09 FY10 FY11F FY12F FY13FCash and equivalents 29,173 36,961 50,257 63,022 80,965Inter-bank lending 123,380 142,280 170,736 204,883 245,860Deposits with central bank 1,429,475 1,811,068 2,462,600 3,088,084 3,967,298Total securities 2,578,799 2,904,994 3,340,743 3,841,855 4,418,133Other interest earning assets 0 0 0 0 0Gross loans 4,819,773 5,669,128 6,407,031 7,341,372 8,310,064Less provisions -126,826 -143,102 -162,752 -199,499 -248,814Net loans 4,692,947 5,526,026 6,244,279 7,141,873 8,061,249Long-term investments 1,791 1,777 1,955 2,150 2,365Fixed assets 74,693 83,434 87,606 91,986 96,585Goodwill 1,590 1,534 1,381 1,243 1,118Other intangible assets 10,790 17,825 16,043 14,438 12,994Other non IEAs 680,717 284,418 298,639 313,571 329,249Total assets 9,623,355 10,810,317 12,674,238 14,763,105 17,215,818Customer deposits 8,001,323 9,075,369 10,708,935 12,636,544 14,911,122Bank deposits, CDs, debentures 812,911 751,590 774,262 797,627 821,707Other interest bearing liabilities 98,644 93,315 173,315 173,315 173,315Total interest bearing liabilities 8,912,878 9,920,274 11,656,513 13,607,486 15,906,144Non interest bearing liabilities 151,457 189,138 208,052 228,857 251,743Total liabilities 9,064,335 10,109,412 11,864,565 13,836,343 16,157,886Minority interest 3,545 4,113 4,524 4,977 5,474Common stock 233,689 250,011 250,011 250,011 250,011Preferred stock 0 0 0 0 0Retained earnings 88,907 142,898 212,497 294,258 388,632Proposed dividends 47,205 53,052 72,063 85,084 97,222Other equity 185,640 250,831 270,577 292,432 316,593Shareholders' equity 555,441 696,792 805,149 921,785 1,052,458Total liabilities and equity 9,623,355 10,810,317 12,674,238 14,763,105 17,215,818Non-performing assets (CNY) 72,156 64,712 66,217 73,653 87,621

Balance sheet ratios (%)

Loans to deposits 60.2 62.5 59.8 58.1 55.7Equity to assets 5.8 6.4 6.4 6.2 6.1

Asset quality & capital

NPAs/gross loans (%) 1.5 1.1 1.0 1.0 1.1Bad debt charge/gross loans (%) 0.50 0.45 0.55 0.58 0.65Loss reserves/assets (%) 1.32 1.32 1.28 1.35 1.45Loss reserves/NPAs (%) 175.8 221.1 245.8 270.9 284.0Tier 1 capital ratio (%) 9.3 10.4 9.9 9.2 9.0Total capital ratio (%) 11.7 12.7 13.1 11.8 11.2

Growth (%)

Loan growth 27.4 17.8 13.0 14.4 12.9Interest earning assets 23.6 17.7 17.7 16.8 16.9Interest bearing liabilities 28.8 11.3 17.5 16.7 16.9Asset growth 27.4 12.3 17.2 16.5 16.6Deposit growth 25.5 13.4 18.0 18.0 18.0

Per share

Reported EPS (CNY) 0.46 0.56 0.64 0.76 0.86Norm EPS (CNY) 0.46 0.56 0.64 0.76 0.86Fully diluted norm EPS (CNY) 0.46 0.56 0.64 0.76 0.86DPS (CNY) 0.20 0.21 0.29 0.34 0.39PPOP PS (CNY) 0.70 0.85 0.97 1.15 1.35BVPS (CNY) 2.38 2.79 3.22 3.69 4.21ABVPS (CNY) 2.38 2.79 3.22 3.69 4.21NTAPS (CNY) 2.32 2.71 3.15 3.62 4.15Source: Nomura estimates

 Notes

Benign asset quality

 

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63

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 PBOC’s financial report that total LGFV loans may reach as much as RMB14tn (instead of RMB9tn as suggested by the CBRC) shadowed the market’s 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 management’s 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 government’s 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

Source: Nomura research, company report

Fig. 77: Impact on 2011F PBT in our worse case on LGFV loans

Source: Nomura research, company report

New CAR rule – penalised by its bias towards long-term and corporate loans

We estimate CCB’s 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, CCB’s 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.

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64

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

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%), CCB’s 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

Source: Nomura research, company report

Fig. 80: Tier-1 impact on risk weighting charged at 50%

Source: Nomura research, company report

2010 (RMB mn) Property Interbank

Retail claims

excluding mortgage

Operating risk SME

Corporate loan over 5

years Total

Total exposure 402,922 323,355 277,695 43,242 283,456 976,838

Incremental RWA 201,461 67,206 -69,424 540,526 -70,864 146,526 815,431

% to RWA 3.3% 1.1% -1.2% 9.0% -1.2% 2.4% 13.6%

Tier 1 impact (bps) -34 -11 12 -86 12 -25 -131

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Nomura | ASIA China Construction Bank-H June 24, 2011

65

Moderate net interest margin expansion

We expect the net interest margin of Chinese banks to peak in 2Q11. We believe CCB’s 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 management’s 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 three-month 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.

Page 67: Unmasking China's Shadow Banking System

Key company data: See page 2 for company data, and detailed price/index chart. Rating: See report end for details of Nomura’s rating system.

Bank of China (H-share) 3988.HK 3988 HK

BANKS

EQUITY RESEARCH

Mild NIM expansion expected in 2Q11F 

Reiterate BUY on current dips

June 24, 2011

Rating Remains

Buy

Target price Remains

HKD 5.20

Closing price June 21, 2011

HKD 3.77

Potential upside +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 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.

RMB32bn subordinated bonds issuance completed As of 31 March, 2011, BOC’s 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, BOC’s CAR will climb by 0.5pp and reach 12.8% by end-FY11.

31 Dec FY10 FY11F FY12F FY13F

Currency (CNY) Actual Old New Old New Old New

PPOP (mn) 154,109 191,008 190,502 230,625 228,777 266,215 264,240

Reported net profit (mn) 104,418 120,625 117,945 144,005 142,600 164,753 163,252

Normalised net profit (mn) 104,418 120,625 117,945 144,005 142,600 164,753 163,252

Normalised EPS 0.39 0.43 0.42 0.52 0.51 0.59 0.58

Norm. EPS growth (%) 23.1 10.3 7.8 19.4 20.9 14.4 14.5

Norm. P/E (x) 8.3 N/A 7.3 N/A 5.7 N/A 4.9

Price/adj. book (x) 1.4 N/A 1.2 N/A 1.0 N/A 0.9

Price/book (x) 1.4 N/A 1.2 N/A 1.0 N/A 0.9

Dividend yield (%) 4.5 N/A 6.1 N/A 7.8 N/A 9.2

ROE (%) 18.0 17.8 17.4 19.2 19.1 19.7 19.6

ROA (%) 1.1 1.1 1.1 1.1 1.1 1.1 1.1

Source: Nomura estimates

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 re-rating 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

China Banks

Lucy Feng - NIHK [email protected] +852 2252 2165

Donger Wang - NIHK [email protected] +852 2252 1590

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.

Page 68: Unmasking China's Shadow Banking System

Nomura | ASIA Bank of China (H-share) June 24, 2011

67

Key data on Bank of China (H-share) Profit and Loss (CNYmn) Year-end 31 Dec FY09 FY10 FY11F FY12F FY13FInterest income 261,424 313,533 409,293 495,549 572,611Interest expense -102,543 -119,571 -182,259 -228,682 -265,518Net interest income 158,881 193,962 227,033 266,867 307,093Net fees and commissions 46,013 54,483 78,440 98,498 122,533Trading related profits 5,849 3,491 4,740 6,760 8,893Other operating revenue 21,827 24,582 16,217 17,565 19,028Non-interest income 73,689 82,556 99,397 122,823 150,454Operating income 232,570 276,518 326,430 389,690 457,547Depreciation

Amortisation

Operating expenses -107,307 -122,409 -135,928 -160,913 -193,308Employee share expense

Op. profit before provisions 125,263 154,109 190,502 228,777 264,240Provisions for bad debt -14,987 -12,993 -31,502 -36,686 -44,197Other provision charges

Operating profit 110,276 141,116 159,001 192,092 220,042Other non-operating income

Associates & JCEs 821 1,029 1,132 1,245 1,307Pre-tax profit 111,097 142,145 160,133 193,337 221,350Income tax -25,748 -32,454 -36,387 -44,356 -51,079Net profit after tax 85,349 109,691 123,746 148,981 170,271Minority interests -4,530 -5,273 -5,800 -6,380 -7,018Other items

Preferred dividends

Normalised NPAT 80,819 104,418 117,945 142,600 163,252Extraordinary items

Reported NPAT 80,819 104,418 117,945 142,600 163,252Dividends -35,537 -40,755 -53,075 -64,170 -73,464Transfer to reserves 45,282 63,663 64,870 78,430 89,789

Valuation and ratio analysis

FD normalised P/E (x) 10.4 8.3 7.3 5.7 4.9FD normalised P/E at price target (x) 17.6 14.1 12.4 9.7 8.3Reported P/E (x) 10.4 8.3 7.3 5.7 4.9Dividend yield (%) 4.2 4.5 6.1 7.8 9.2Price/book (x) 1.6 1.4 1.2 1.0 0.9Price/adjusted book (x) 1.6 1.4 1.2 1.0 0.9Net interest margin (%) 2.04 2.07 2.14 2.23 2.27Yield on interest earning assets (%) 3.36 3.34 3.87 4.14 4.23Cost of interest bearing liabilities (%) 1.41 1.37 1.81 1.98 2.01Net interest spread (%) 1.94 1.97 2.06 2.16 2.22Non-interest/operating income (%) 31.7 29.9 30.4 31.5 32.9Cost to income (%) 46.1 44.3 41.6 41.3 42.2Effective tax rate (%) 23.2 22.8 22.7 22.9 23.1Dividend payout (%) 44.0 39.0 45.0 45.0 45.0ROE (%) 16.5 18.0 17.4 19.1 19.6ROA (%) 1.03 1.09 1.05 1.11 1.09Operating ROE (%) 22.5 24.3 23.5 25.7 26.4Operating ROA (%) 1.40 1.47 1.42 1.49 1.48

Growth (%)

Net interest income -2.5 22.1 17.1 17.5 15.1Non-interest income 11.7 12.0 20.4 23.6 22.5Non-interest expenses 10.2 14.1 11.0 18.4 20.1Pre-provision earnings -4.7 23.0 23.6 20.1 15.5Net profit 25.6 29.2 13.0 20.9 14.5Normalised EPS 25.6 23.1 7.8 20.9 14.5Normalised FDEPS 25.6 23.1 7.8 20.9 14.5Source: Nomura estimates

 Notes

Enhancing ROE

Price and price relative chart (one year) 

 

(%) 1M 3M 12M

Absolute (HKD) -11.7 -8.0 -7.8

Absolute (USD) -11.9 -8.0 -8.0

Relative to index -4.4 -4.2 -7.9

Market cap (USDmn) 122,835.4

Estimated free float (%)

67.3

52-week range (HKD) 4.88/3.69

3-mth avg daily turnover (USDmn)

152.29

Major shareholders (%) Huijin 67.5

HKSCC Nominees 21.8

 

3.6

3.8

4

4.2

4.4

4.6

4.8

5

5.2

9092949698100102104106108

Jul 1

0

Aug

10

Sep

10

Oct

10

Nov

10

Dec

10

Jan

11

Feb

11

Mar

11

Apr

11

May

11

Jun

11

PriceRel MSCI China(HKD)

Page 69: Unmasking China's Shadow Banking System

Nomura | ASIA Bank of China (H-share) June 24, 2011

68

Balance Sheet (CNYmn) As at 31 Dec FY09 FY10 FY11F FY12F FY13FCash and equivalents 434,351 636,126 1,147,608 1,842,813 2,643,804Inter-bank lending 223,444 213,716 213,716 213,716 213,716Deposits with central bank 1,111,351 1,573,922 1,762,793 1,974,328 2,211,247Total securities 1,816,679 2,055,324 2,160,527 2,271,186 2,387,588Other interest earning assets 36,099 42,469 42,469 42,469 42,469Gross loans 4,910,358 5,668,478 6,326,213 7,217,779 8,136,415Less provisions -112,950 -130,713 -147,408 -170,776 -183,633Net loans 4,797,408 5,537,765 6,178,805 7,047,003 7,952,782Long-term investments 10,668 12,631 14,147 15,844 17,746Fixed assets 109,954 123,568 129,746 136,234 143,045Goodwill

Other intangible assets

Other non IEAs 211,989 264,344 291,018 320,488 353,059Total assets 8,751,943 10,459,865 11,940,829 13,864,081 15,965,456Customer deposits 6,620,552 7,483,254 8,582,500 10,103,239 11,745,637Bank deposits, CDs, debentures 1,126,963 1,549,126 1,780,220 2,045,824 2,351,098Other interest bearing liabilities 175,599 247,922 304,605 332,225 363,368Total interest bearing liabilities 7,923,114 9,280,302 10,667,324 12,481,288 14,460,104Non interest bearing liabilities 283,435 503,413 530,304 558,763 588,895Total liabilities 8,206,549 9,783,715 11,197,628 13,040,051 15,048,998Minority interest 30,402 31,985 34,166 36,565 39,204Common stock 253,839 279,147 279,147 279,147 279,147Preferred stock

Retained earnings 65,221 107,600 160,150 227,485 307,980Proposed dividends 35,537 40,755 53,075 64,170 73,464Other equity 160,395 216,663 216,663 216,663 216,663Shareholders' equity 514,992 644,165 709,035 787,465 877,254Total liabilities and equity 8,751,943 10,459,865 11,940,829 13,864,081 15,965,456Non-performing assets (CNY) 76,006 63,965 62,319 69,707 73,926

Balance sheet ratios (%)

Loans to deposits 74.2 75.7 73.7 71.4 69.3Equity to assets 5.9 6.2 5.9 5.7 5.5

Asset quality & capital

NPAs/gross loans (%) 1.5 1.1 1.0 1.0 0.9Bad debt charge/gross loans (%) 0.31 0.23 0.50 0.51 0.54Loss reserves/assets (%) 1.29 1.25 1.23 1.23 1.15Loss reserves/NPAs (%) 148.6 204.4 236.5 245.0 248.4Tier 1 capital ratio (%) 9.1 10.1 9.7 9.4 9.1Total capital ratio (%) 11.1 12.6 12.8 12.2 11.7

Growth (%)

Loan growth 50.4 15.4 11.6 14.1 12.9Interest earning assets 21.6 18.0 9.9 11.5 10.9Interest bearing liabilities 29.8 17.1 14.9 17.0 15.9Asset growth 25.9 19.5 14.2 16.1 15.2Deposit growth 29.8 13.0 14.7 17.7 16.3

Per share

Reported EPS (CNY) 0.32 0.39 0.42 0.51 0.58Norm EPS (CNY) 0.32 0.39 0.42 0.51 0.58Fully diluted norm EPS (CNY) 0.32 0.39 0.42 0.51 0.58DPS (CNY) 0.14 0.15 0.19 0.23 0.26PPOP PS (CNY) 0.49 0.58 0.68 0.82 0.95BVPS (CNY) 2.03 2.31 2.54 2.82 3.14ABVPS (CNY) 2.03 2.31 2.54 2.82 3.14NTAPS (CNY) 2.03 2.31 2.54 2.82 3.14Source: Nomura estimates

 Notes

Benign asset quality

 

Page 70: Unmasking China's Shadow Banking System

Nomura | ASIA Bank of China (H-share) June 24, 2011

69

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

Source: Company data, Nomura estimates

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.

Profit & Loss (RMBmn, except %) 2011F 2012F 2013F 2011F 2012F 2013F 2011F 2012F 2013F

Net interest income 227,033 266,867 307,093 227,567 268,816 309,176 (0.2) (0.7) (0.7) Fee income 78,440 98,498 122,533 78,440 98,498 122,533 0.0 0.0 0.0Non-interest income 99,397 122,823 150,454 99,397 122,823 150,454 0.0 0.0 0.0Operating Income 326,430 389,690 457,547 326,964 391,639 459,631 (0.2) (0.5) (0.5)

Operating Expenses (135,928) (160,913) (193,308) (135,955) (161,014) (193,416) (0.0) (0.1) (0.1)PPOP 190,502 228,777 264,240 191,008 230,625 266,215 (0.3) (0.8) (0.7)

Provisions (31,502) (36,686) (44,197) (28,482) (36,686) (44,197) 10.6 0.0 0.0Associated Companies 1,132 1,245 1,307 1,132 1,245 1,307 0.0 0.0 0.0Operating pre-tax 160,133 193,337 221,350 163,658 195,185 223,325 (2.2) (0.9) (0.9)Profit tax (36,387) (44,356) (51,079) (37,233) (44,799) (51,553) (2.3) (1.0) (0.9)Minority Interest (5,800) (6,380) (7,018) (5,800) (6,380) (7,018) 0.0 0.0 0.0Profits attributable to equity holders 117,945 142,600 163,252 120,625 144,005 164,753 (2.2) (1.0) (0.9)

Revised Previous Change (%)

Page 71: Unmasking China's Shadow Banking System

Nomura | ASIA Bank of China (H-share) June 24, 2011

70

Fig. 82: RMB deposits in Hong Kong

Source: HKMA, Nomura research

Fig. 83: RMB settlement for cross-border trade

Source: CEIC, Nomura research

RMB32bn subordinated bonds issuance completed

As of 31 March, 2011, BOC’s 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, BOC’s 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 Kong’s economy, could also weigh on the bank’s earnings performance given its bigger foreign exposure relative to that of peers.

(10)

0

10

20

30

40

50

0

100,000

200,000

300,000

400,000

500,000

600,000 Ja

n-0

9

Mar

-09

May

-09

Jul-

09

Sep

-09

No

v-09

Jan

-10

Mar

-10

May

-10

Jul-

10

Sep

-10

No

v-10

Jan

-11

Mar

-11

(%)(RMBmn)

Total deposit m-m growth (%)

0

50

100

150

200

250

300

350

400

1Q10 2Q10 3Q10 4Q10 1Q11

(RMBbn)

RMB Settlement for Cross Border Trade

Page 72: Unmasking China's Shadow Banking System

Key company data: See page 2 for company data, and detailed price/index chart. Rating: See report end for details of Nomura’s rating system.

Bank of Communications 3328.HK 3328 HK

BANKS

EQUITY RESEARCH

No surprise expected in 2Q11F; remain Neutral 

No upside surprise expected in NIM expansion; NEUTRAL maintained

June 24, 2011

Rating Remains

Neutral

Target price Reduced from 9.00

HKD 8.30

Closing price June 21, 2011

HKD 7.24

Potential upside +14.6%

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.

31 Dec FY10 FY11F FY12F FY13F

Currency (CNY) Actual Old New Old New Old New

PPOP (mn) 62,200 75,552 73,768 89,326 85,334 104,117 97,462

Reported net profit (mn) 39,042 46,225 43,931 54,413 50,523 62,647 57,098

Normalised net profit (mn) 39,042 46,225 43,931 54,413 50,523 62,647 57,098

Normalised EPS 0.74 0.78 0.74 0.88 0.82 1.01 0.92

Norm. EPS growth (%) 20.7 5.5 0.2 12.4 9.8 15.1 13.0

Norm. P/E (x) 8.4 N/A 8.0 N/A 6.9 N/A 5.9

Price/adj. book (x) 1.5 N/A 1.4 N/A 1.2 N/A 1.1

Price/book (x) 1.5 N/A 1.4 N/A 1.2 N/A 1.1

Dividend yield (%) 3.0 N/A 4.8 N/A 5.8 N/A 6.8

ROE (%) 20.2 19.4 18.5 20.4 19.1 20.9 19.4

ROA (%) 1.1 1.1 1.0 1.1 1.0 1.0 0.9

Source: Nomura estimates

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 re-rating 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

China Banks

Lucy Feng - NIHK [email protected] +852 2252 2165

Donger Wang - NIHK [email protected] +852 2252 1590

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.

Page 73: Unmasking China's Shadow Banking System

Nomura | ASIA Bank of Communications June 24, 2011

72

Key data on Bank of Communications Profit and Loss (CNYmn) Year-end 31 Dec FY09 FY10 FY11F FY12F FY13FInterest income 116,743 141,905 174,584 207,241 239,903Interest expense -50,075 -56,910 -74,159 -90,359 -105,813Net interest income 66,668 84,995 100,425 116,883 134,091Net fees and commissions 11,399 14,479 18,488 23,539 29,895Trading related profits 2,126 1,245 1,121 1,008 908Other operating revenue 1,385 3,425 3,599 3,783 3,975Non-interest income 14,910 19,149 23,208 28,330 34,778Operating income 81,578 104,144 123,633 145,212 168,868Depreciation

Amortisation 0 0 0 0 0Operating expenses -32,022 -41,944 -49,865 -59,878 -71,407Employee share expense 0 0 0 0

Op. profit before provisions 49,556 62,200 73,768 85,334 97,462Provisions for bad debt -11,255 -12,246 -16,898 -19,940 -23,564Other provision charges 0 0 0 0 0Operating profit 38,301 49,954 56,870 65,394 73,898Other non-operating income 0 0 0 0 0Associates & JCEs 0 0 0 0 0Pre-tax profit 38,301 49,954 56,870 65,394 73,898Income tax -8,047 -10,782 -12,796 -14,714 -16,627Net profit after tax 30,254 39,172 44,074 50,680 57,271Minority interests -136 -130 -143 -157 -173Other items 0 0 0 0 0Preferred dividends 0 0 0 0 0Normalised NPAT 30,118 39,042 43,931 50,523 57,098Extraordinary items 0 0 0 0 0Reported NPAT 30,118 39,042 43,931 50,523 57,098Dividends -9,799 -10,525 -17,630 -20,272 -22,908Transfer to reserves 20,319 28,517 26,301 30,251 34,189

Valuation and ratio analysis

FD normalised P/E (x) 10.3 8.4 8.0 6.9 5.9FD normalised P/E at price target (x) 12.7 10.3 9.8 8.5 7.3Reported P/E (x) 10.3 8.4 8.0 6.9 5.9Dividend yield (%) 3.2 3.0 4.8 5.8 6.8Price/book (x) 1.9 1.5 1.4 1.2 1.1Price/adjusted book (x) 1.9 1.5 1.4 1.2 1.1Net interest margin (%) 2.26 2.46 2.51 2.57 2.60Yield on interest earning assets (%) 3.96 4.11 4.37 4.55 4.65Cost of interest bearing liabilities (%) 1.78 1.72 1.97 2.13 2.20Net interest spread (%) 2.18 2.38 2.40 2.42 2.45Non-interest/operating income (%) 18.3 18.4 18.8 19.5 20.6Cost to income (%) 39.3 40.3 40.3 41.2 42.3Effective tax rate (%) 21.0 21.6 22.5 22.5 22.5Dividend payout (%) 32.5 27.0 40.1 40.1 40.1ROE (%) 19.2 20.2 18.5 19.1 19.4ROA (%) 1.01 1.08 1.02 0.99 0.95Operating ROE (%) 24.4 25.8 24.0 24.7 25.1Operating ROA (%) 1.28 1.38 1.32 1.29 1.23

Growth (%)

Net interest income 1.2 27.5 18.2 16.4 14.7Non-interest income 30.6 28.4 21.2 22.1 22.8Non-interest expenses 3.7 31.0 18.9 20.1 19.3Pre-provision earnings 6.8 25.5 18.6 15.7 14.2Net profit 6.1 29.6 12.5 15.0 13.0Normalised EPS 6.1 20.7 0.2 9.8 13.0Normalised FDEPS 6.1 20.7 0.2 9.8 13.0Source: Nomura estimates

 Notes

We expect a moderate expansion of 9bp in FY11F NIM.

Price and price relative chart (one year) 

(%) 1M 3M 12M

Absolute (HKD) -9.5 -8.4 -18.6

Absolute (USD) -9.7 -8.3 -18.7

Relative to index -2.2 -4.5 -18.6

Market cap (USDmn) 45,538.3

Estimated free float (%)

62.9

52-week range (HKD) 9.53/7.18

3-mth avg daily turnover (USDmn)

33.45

Major shareholders (%) MOF 26.5

HSBC 18.6

 

7

7.5

8

8.5

9

9.5

75

80

85

90

95

100

105

Jul 1

0

Aug

10

Sep

10

Oct

10

Nov

10

Dec

10

Jan

11

Feb

11

Mar

11

Apr

11

May

11

Jun

11

PriceRel MSCI China(HKD)

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Balance Sheet (CNYmn) As at 31 Dec FY09 FY10 FY11F FY12F FY13FCash and equivalents 13,050 17,597 24,828 33,455 44,535Inter-bank lending 222,671 262,976 302,422 347,786 399,954Deposits with central bank 421,946 568,957 802,780 1,081,711 1,439,965Total securities 778,131 814,551 898,308 990,787 1,092,910Other interest earning assets 0 0 0 0 0Gross loans 1,839,314 2,236,927 2,591,009 3,025,925 3,519,603Less provisions -37,776 -46,437 -59,522 -73,846 -89,227Net loans 1,801,538 2,190,490 2,531,487 2,952,079 3,430,375Long-term investments 0 0 0 0 0Fixed assets 29,878 33,911 35,607 37,387 39,256Goodwill 0 0 0 0 0Other intangible assets 5,821 7,341 6,607 5,946 5,352Other non IEAs 36,102 55,770 58,559 61,486 64,561Total assets 3,309,137 3,951,593 4,660,598 5,510,638 6,516,907Customer deposits 2,372,055 2,867,847 3,498,773 4,268,503 5,207,574Bank deposits, CDs, debentures 715,547 783,411 840,701 899,926 941,193Other interest bearing liabilities 0 0 0 0 0Total interest bearing liabilities 3,087,602 3,651,258 4,339,474 5,168,430 6,148,767Non interest bearing liabilities 57,110 76,678 69,874 63,902 58,628Total liabilities 3,144,712 3,727,936 4,409,348 5,232,332 6,207,395Minority interest 577 884 0 0 0Common stock 48,994 56,260 61,886 61,886 61,886Preferred stock 0 0 0 0 0Retained earnings 16,247 19,416 38,613 66,221 97,775Proposed dividends 9,799 10,525 17,630 20,272 22,908Other equity 88,808 136,572 133,122 129,927 126,943Shareholders' equity 163,848 222,773 251,251 278,306 309,512Total liabilities and equity 3,309,137 3,951,593 4,660,598 5,510,638 6,516,907Non-performing assets (CNY) 25,009 24,988 26,195 29,003 33,913

Balance sheet ratios (%)

Loans to deposits 77.5 78.0 74.1 70.9 67.6Equity to assets 5.0 5.6 5.4 5.1 4.7

Asset quality & capital

NPAs/gross loans (%) 1.4 1.1 1.0 1.0 1.0Bad debt charge/gross loans (%) 0.61 0.55 0.65 0.66 0.67Loss reserves/assets (%) 1.14 1.18 1.28 1.34 1.37Loss reserves/NPAs (%) 151.0 185.8 227.2 254.6 263.1Tier 1 capital ratio (%) 8.2 9.4 8.9 8.7 8.5Total capital ratio (%) 12.0 12.4 12.0 11.7 11.2

Growth (%)

Loan growth 38.7 21.6 15.6 16.6 16.2Interest earning assets 23.6 19.0 18.2 18.5 18.4Interest bearing liabilities 24.2 18.3 18.8 19.1 19.0Asset growth 23.3 19.4 17.9 18.2 18.3Deposit growth 27.1 20.9 22.0 22.0 22.0

Per share

Reported EPS (CNY) 0.61 0.74 0.74 0.82 0.92Norm EPS (CNY) 0.61 0.74 0.74 0.82 0.92Fully diluted norm EPS (CNY) 0.61 0.74 0.74 0.82 0.92DPS (CNY) 0.20 0.19 0.28 0.33 0.37PPOP PS (CNY) 1.01 1.18 1.25 1.38 1.57BVPS (CNY) 3.34 3.96 4.06 4.50 5.00ABVPS (CNY) 3.34 3.96 4.06 4.50 5.00NTAPS (CNY) 3.23 3.83 3.95 4.40 4.91Source: Nomura estimates

 Notes

Benign asset quality.

 

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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 BOCOM’s 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 BOCOM’s 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

Source: Company data, Nomura estimates

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.

Profit & Loss (RMBmn, except %) 2011F 2012F 2013F 2011F 2012F 2013F 2011F 2012F 2013F

Net interest income 100,425 116,883 134,091 101,745 119,746 138,611 (1.3) (2.4) (3.3) Fee income 18,488 23,539 29,895 18,488 23,539 29,895 0.0 0.0 0.0Non-interest income 23,208 28,330 34,778 23,208 28,330 34,778 0.0 0.0 0.0Operating Income 123,633 145,212 168,868 124,953 148,075 173,388 (1.1) (1.9) (2.6)Operating Expenses (49,865) (59,878) (71,407) (49,400) (58,749) (69,272) 0.9 1.9 3.1PPOP 73,768 85,334 97,462 75,552 89,326 104,117 (2.4) (4.5) (6.4)Provisions (16,898) (19,940) (23,564) (15,723) (18,913) (23,059) 7.5 5.4 2.2Operating pre-tax 56,870 65,394 73,898 59,829 70,413 81,057 (4.9) (7.1) (8.8)Profit tax (12,796) (14,714) (16,627) (13,462) (15,843) (18,238) (4.9) (7.1) (8.8)Minority Interest (143) (157) (173) (143) (157) (173) 0.0 0.0 0.0Profits attributable to equity holders 43,931 50,523 57,098 46,225 54,413 62,647 (5.0) (7.1) (8.9)

Revised Previous Change (%)

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75

Fig. 85: BOCOM: quarterly NIM NIM remained flattish q-q in 1Q11

Source: Company data, Nomura research

Fig. 86: BOCOM: % of new RMB loans at benchmark interest rates and above benchmark interest rates Improving pricing power

Source: Company data, Nomura research

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 BOCOM’s 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 BOCOM’s 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 bank’s 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 bank’s provision, RWA and overall loan growth would be limited

2.36

2.38

2.40

2.42

2.44

2.46

2.48

2.50

2.52

1Q10 2Q10 3Q10 4Q10 1Q11

(%)

0

10

20

30

40

50

60

70

80

90

100

FY10 1Q11 2Q11

(%)

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76

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.

Page 78: Unmasking China's Shadow Banking System

Key company data: See page 2 for company data, and detailed price/index chart. Rating: See report end for details of Nomura’s rating system.

China Merchants Bank 3968.HK 3968 HK

BANKS

EQUITY RESEARCH

Robust fee income growth to continue in 2Q11 

Margin expansion facing headwinds from potential asymmetric rate hikes

June 24, 2011

Rating Remains

Buy

Target price Reduced from 26.86

HKD 24.82

Closing price June 21, 2011

HKD 18.08

Potential upside +37.3%

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 CMB’s asset-sensitive 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 sector’s 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.

31 Dec FY10 FY11F FY12F FY13F

Currency (CNY) Actual Old New Old New Old New

PPOP (mn) 38,780 52,125 49,908 65,559 63,763 81,176 78,961

Reported net profit (mn) 25,769 34,561 33,007 43,127 4 ,089 52,905 51,281

Normalised net profit (mn) 25,769 34,561 33,007 43,127 42,089 52,905 51,281

Normalised EPS 1.19 1.60 1.53 2.00 1.95 2.45 2.38

Norm. EPS growth (%) 33.3 34.1 28.1 24.8 27.5 22.7 21.8

Norm. P/E (x) 13.0 N/A 9.7 N/A 7.2 N/A 5.8

Price/adj. book (x) 2.5 N/A 1.9 N/A 1.5 N/A 1.3

Price/book (x) 2.5 N/A 1.9 N/A 1.5 N/A 1.3

Dividend yield (%) 1.9 N/A 3.1 N/A 4.2 N/A 5.2

ROE (%) 22.7 23.4 22.5 24.2 23.9 24.6 24.1

ROA (%) 1.2 1.3 1.2 1.3 1.3 1.4 1.3

Source: Nomura estimates

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

China Banks

Lucy Feng - NIHK [email protected] +852 2252 2165

Donger Wang - NIHK [email protected] +852 2252 1590

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.

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Key data on China Merchants Bank Profit and Loss (CNYmn) Year-end 31 Dec FY09 FY10 FY11F FY12F FY13FInterest income 65,838 84,513 109,289 137,328 165,996Interest expense -25,474 -27,437 -39,440 -51,305 -62,074Net interest income 40,364 57,076 69,848 86,023 103,922Net fees and commissions 7,993 11,330 14,291 18,040 22,831Trading related profits 1,318 1,947 2,171 2,422 2,704Other operating revenue 2,173 1,339 1,540 1,771 2,036Non-interest income 11,484 14,616 18,002 22,234 27,571Operating income 51,848 71,692 87,851 108,256 131,493Depreciation

Amortisation 0 0 0 0 0Operating expenses -26,562 -32,912 -37,943 -44,493 -52,532Employee share expense

Op. profit before provisions 25,286 38,780 49,908 63,763 78,961Provisions for bad debt -3,073 -5,570 -6,838 -8,837 -12,037Other provision charges 102 69 0 0 0Operating profit 22,315 33,279 43,070 54,927 66,924Other non-operating income 0 0 0 0 0Associates & JCEs 69 64 77 92 111Pre-tax profit 22,384 33,343 43,147 55,019 67,035Income tax -4,149 -7,574 -10,139 -12,929 -15,753Net profit after tax 18,235 25,769 33,007 42,089 51,281Minority interests 0 0 0 0 0Other items 0 0 0 0 0Preferred dividends 0 0 0 0 0Normalised NPAT 18,235 25,769 33,007 42,089 51,281Extraordinary items 0 0 0 0 0Reported NPAT 18,235 25,769 33,007 42,089 51,281Dividends -4,015 -6,257 -9,902 -12,627 -15,384Transfer to reserves 14,220 19,512 23,105 29,463 35,897

Valuation and ratio analysis

FD normalised P/E (x) 18.7 13.0 9.7 7.2 5.8FD normalised P/E at price target (x) 27.0 18.8 14.0 10.4 8.3Reported P/E (x) 17.7 13.0 9.7 7.2 5.8Dividend yield (%) 1.3 1.9 3.1 4.2 5.2Price/book (x) 3.3 2.5 1.9 1.5 1.3Price/adjusted book (x) 3.3 2.5 1.9 1.5 1.3Net interest margin (%) 2.23 2.65 2.77 2.86 2.92Yield on interest earning assets (%) 3.65 3.93 4.34 4.56 4.66Cost of interest bearing liabilities (%) 1.50 1.37 1.71 1.83 1.85Net interest spread (%) 2.14 2.56 2.63 2.72 2.81Non-interest/operating income (%) 22.1 20.4 20.5 20.5 21.0Cost to income (%) 51.2 45.9 43.2 41.1 40.0Effective tax rate (%) 18.5 22.7 23.5 23.5 23.5Dividend payout (%) 22.0 24.3 30.0 30.0 30.0ROE (%) 21.2 22.7 22.5 23.9 24.1ROA (%) 1.00 1.15 1.24 1.31 1.33Operating ROE (%) 25.9 29.3 29.3 31.2 31.5Operating ROA (%) 1.23 1.49 1.62 1.71 1.74

Growth (%)

Net interest income -13.9 41.4 22.4 23.2 20.8Non-interest income 31.1 27.3 23.2 23.5 24.0Non-interest expenses 11.9 23.9 15.3 17.3 18.1Pre-provision earnings -20.7 53.4 28.7 27.8 23.8Net profit -13.5 41.3 28.1 27.5 21.8Normalised EPS -28.1 33.3 28.1 27.5 21.8Normalised FDEPS -18.4 41.3 28.1 27.5 21.8Source: Nomura estimates

 Notes

Continued NIM expansion

Price and price relative chart (one year) 

 

(%) 1M 3M 12M

Absolute (HKD) -8.8 -11.8 -8.4

Absolute (USD) -9.0 -11.7 -8.6

Relative to index -1.5 -7.9 -8.5

Market cap (USDmn) 44,381.2

Estimated free float (%)

100.0

52-week range (HKD) 23.9/17.62

3-mth avg daily turnover (USDmn)

57.21

Major shareholders (%) China Merchants Steam Navigation

12.4

China Ocean Shipping

6.4

 

16

18

20

22

24

85

90

95

100

105

110

Jul 1

0

Aug

10

Sep

10

Oct

10

Nov

10

Dec

10

Jan

11

Feb

11

Mar

11

Apr

11

May

11

Jun

11

PriceRel MSCI China(HKD)

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Balance Sheet (CNYmn) As at 31 Dec FY09 FY10 FY11F FY12F FY13FCash and equivalents 8,342 11,428 14,970 17,880 20,282Inter-bank lending 277,738 273,675 324,589 385,303 457,741Deposits with central bank 200,212 274,277 359,276 429,127 486,762Total securities 377,072 394,176 498,810 631,430 799,580Other interest earning assets 0 0 0 0 0Gross loans 1,185,859 1,431,495 1,676,881 2,005,105 2,371,917Less provisions -24,042 -29,335 -34,805 -41,961 -51,916Net loans 1,161,817 1,402,160 1,642,076 1,963,144 2,320,001Long-term investments 466 443 532 638 766Fixed assets 16,008 18,397 22,076 26,492 31,790Goodwill 0 0 0 0 0Other intangible assets 2,786 3,706 4,818 6,263 8,142Other non IEAs 23,500 24,245 36,368 54,551 68,189Total assets 2,067,941 2,402,507 2,903,514 3,514,828 4,193,253Customer deposits 1,608,146 1,897,178 2,314,557 2,823,760 3,388,512Bank deposits, CDs, debentures 307,023 319,473 361,893 410,670 466,757Other interest bearing liabilities 0 0 0 0 0Total interest bearing liabilities 1,915,169 2,216,651 2,676,450 3,234,430 3,855,269Non interest bearing liabilities 59,989 51,850 67,405 87,627 105,538Total liabilities 1,975,158 2,268,501 2,743,855 3,322,056 3,960,807Minority interest 0 0 0 0 0Common stock 19,119 21,577 21,577 21,577 21,577Preferred stock 0 0 0 0 0Retained earnings 27,592 42,806 62,911 89,374 122,271Proposed dividends 6,296 8,719 9,902 12,627 15,384Other equity 39,776 60,904 65,269 69,195 73,213Shareholders' equity 92,783 134,006 159,659 192,772 232,445Total liabilities and equity 2,067,941 2,402,507 2,903,514 3,514,828 4,193,253Non-performing assets (CNY) 9,732 9,686 11,240 13,633 16,916

Balance sheet ratios (%)

Loans to deposits 73.7 75.5 72.4 71.0 70.0Equity to assets 4.5 5.6 5.5 5.5 5.5

Asset quality & capital

NPAs/gross loans (%) 0.8 0.7 0.7 0.7 0.7Bad debt charge/gross loans (%) 0.26 0.39 0.41 0.44 0.51Loss reserves/assets (%) 1.16 1.22 1.20 1.19 1.24Loss reserves/NPAs (%) 247.0 302.9 309.6 307.8 306.9Tier 1 capital ratio (%) 6.6 8.0 8.5 8.6 8.8Total capital ratio (%) 10.4 11.5 11.3 10.9 10.7

Growth (%)

Loan growth 36.2 20.7 17.1 19.6 18.2Interest earning assets 32.3 16.2 20.5 20.7 19.2Interest bearing liabilities 31.1 15.7 20.7 20.8 19.2Asset growth 31.6 16.2 20.9 21.1 19.3Deposit growth 28.6 18.0 22.0 22.0 20.0

Per share

Reported EPS (CNY) 0.90 1.19 1.53 1.95 2.38Norm EPS (CNY) 0.90 1.19 1.53 1.95 2.38Fully diluted norm EPS (CNY) 0.85 1.19 1.53 1.95 2.38DPS (CNY) 0.21 0.29 0.46 0.59 0.71PPOP PS (CNY) 1.24 1.80 2.31 2.96 3.66BVPS (CNY) 4.85 6.21 7.40 8.93 10.77ABVPS (CNY) 4.85 6.21 7.40 8.93 10.77NTAPS (CNY) 4.71 6.04 7.18 8.64 10.40Source: Nomura estimates

 Notes

Benign asset quality

 

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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 CMB’s 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

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.

10

12

14

16

18

20

20

32

44

56

68

80

1Q10 2Q10 3Q10 4Q10 1Q11

(% share)(% y-y) Fee income as % share of total income (RHS)Net fee income growth (LHS)

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Fig. 88: Entrusted loan as % of total loans

Source: Company data and Nomura research

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 China’s property market, we understand from management that a moderate decline (10-30%) in property prices would only have a limited impact on CMB’s asset quality based on a stress test conducted by the bank. CMB’s 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 bank’s asset quality should remain stable in 2011F with risks on the downside.

Fig. 89: NPL balance and NPL ratio

Source: Company data and Nomura research

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 CMB’s 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.

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

0.3

0.4

0.5

0.6

0.7

0.8

8,500

8,800

9,100

9,400

9,700

10,000

1Q10 2Q10 3Q10 4Q10 1Q11

(% ratio)(RMb mn) NPL ratio (RHS) NPL balance (LHS)

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Fig. 90: Estimated impact on new rules on RWA

Source: Company data and Nomura estimates

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 bank’s 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

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

Valuation methodology and risks

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.

2010 (RMBmn) ABC ICBC CCB BOC BOCOM CMB CITIC Minsheng CRCB

Incremetnal RWA as % of total RWA 15% 14% 14% 14% 11% 11% 11% 11% 17%

Total tier 1 impact (136) (127) (131) (135) (95) (80) (88) (84) (234)

FY11F FY12F FY11F FY12F FY11F FY12F

T1 CAR (%) 8.5 8.59 10.65 10.37 2.2pp 1.8pp

CAR (%) 11.34 10.94 13.46 12.69 2.1pp 1.8pp

ROE (%) 22.5 23.9 19.8 19.5 -2.7pp -4.4pp

EPS (RMB) 1.53 1.95 1.33 1.69 -13.3% -13.3%

BVPS (RMB) 7.40 8.93 8.02 9.35 8.4% 4.7%

P/B (using 21 June closing price at HK$ 18.08) 2.00 1.66 1.85 1.59

P/E (using 21 June closing price at HK$ 18.08) 9.69 7.60 11.18 8.77

Baseline forecast Scenario (RMB40bn raised)

Post-money financials Impact

Page 84: Unmasking China's Shadow Banking System

Key company data: See page 2 for company data, and detailed price/index chart. Rating: See report end for details of Nomura’s rating system.

China CITIC Bank 0998.HK 998 HK

BANKS

EQUITY RESEARCH

A+H rights issues soon be completed 

CNY26bn capital-raising plan soon be completed; reaffirm BUY

June 24, 2011

Rating Remains

Buy

Target price Remains

HKD 6.50

Closing price June 21, 2011

HKD 4.97

Potential upside +30.8%

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 bank’s 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 Citic’s 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 Citic’s 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.

31 Dec FY10 FY11F FY12F FY13F

Currency (CNY) Actual Old New Old New Old New

PPOP (mn) 33,718 43,974 43,813 53,140 52,951 62,863 62,642

Reported net profit (mn) 21,509 25,959 25,837 31,029 30,887 36,092 35,925

Normalised net profit (mn) 21,509 25,959 25,837 31,029 30,887 36,092 35,925

Normalised EPS 0.55 0.60 0.60 0.65 0.65 0.76 0.75

Norm. EPS growth (%) 50.2 8.7 8.2 8.8 8.8 16.3 16.3

Norm. P/E (x) 7.8 N/A 6.8 N/A 6.0 N/A 5.0

Price/adj. book (x) 1.4 N/A 1.2 N/A 1.0 N/A 0.9

Price/book (x) 1.4 N/A 1.2 N/A 1.0 N/A 0.9

Dividend yield (%) na N/A 4.6 N/A 5.9 N/A 7.0

ROE (%) 19.3 18.3 18.3 17.9 17.9 18.5 18.4

ROA (%) 1.1 1.1 1.1 1.1 1.1 1.1 1.1

Source: Nomura estimates

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 re-rating 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

China Banks

Lucy Feng - NIHK [email protected] +852 2252 2165

Donger Wang - NIHK [email protected] +852 2252 1590

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.

Page 85: Unmasking China's Shadow Banking System

Nomura | ASIA China CITIC Bank June 24, 2011

84

Key data on China CITIC Bank Profit and Loss (CNYmn) Year-end 31 Dec FY09 FY10 FY11F FY12F FY13FInterest income 56,131 72,460 95,990 118,014 140,556Interest expense -20,147 -24,325 -36,423 -46,699 -56,025Net interest income 35,984 48,135 59,567 71,315 84,531Net fees and commissions 4,220 5,696 7,990 10,521 13,261Trading related profits 383 1,431 1,416 1,084 878Other operating revenue 396 1,094 1,313 1,510 1,736Non-interest income 4,999 8,221 10,720 13,115 15,876Operating income 40,983 56,356 70,286 84,430 100,406Depreciation

Amortisation 0 0 0 0 0Operating expenses -19,132 -22,638 -26,474 -31,479 -37,765Employee share expense

Op. profit before provisions 21,851 33,718 43,813 52,951 62,642Provisions for bad debt -2,446 -4,238 -9,591 -12,042 -15,059Other provision charges -173 -1,011 0 0 0Operating profit 19,232 28,469 34,221 40,909 47,582Other non-operating income 32 226 0 0 0Associates & JCEs 0 0 0 0 0Pre-tax profit 19,264 28,695 34,221 40,909 47,582Income tax -4,705 -6,916 -8,384 -10,023 -11,658Net profit after tax 14,559 21,779 25,837 30,887 35,925Minority interests -240 -270 0 0 0Other items 0 0 0 0 0Preferred dividends 0 0 0 0 0Normalised NPAT 14,319 21,509 25,837 30,887 35,925Extraordinary items 0 0 0 0 0Reported NPAT 14,319 21,509 25,837 30,887 35,925Dividends -3,435 0 -9,043 -10,810 -12,574Transfer to reserves 10,884 21,509 16,794 20,076 23,351

Valuation and ratio analysis

FD normalised P/E (x) 11.9 7.8 6.8 6.0 5.0FD normalised P/E at price target (x) 21.2 13.9 12.3 10.7 8.9Reported P/E (x) 11.9 7.8 6.8 6.0 5.0Dividend yield (%) 2.0 na 4.6 5.9 7.0Price/book (x) 1.7 1.4 1.2 1.0 0.9Price/adjusted book (x) 1.7 1.4 1.2 1.0 0.9Net interest margin (%) 2.39 2.63 2.71 2.76 2.81Yield on interest earning assets (%) 3.73 3.96 4.37 4.58 4.68Cost of interest bearing liabilities (%) 1.53 1.42 1.77 1.94 1.99Net interest spread (%) 2.20 2.54 2.60 2.64 2.68Non-interest/operating income (%) 12.2 14.6 15.3 15.5 15.8Cost to income (%) 46.7 40.2 37.7 37.3 37.6Effective tax rate (%) 24.4 24.1 24.5 24.5 24.5Dividend payout (%) 24.0 0.0 35.0 35.0 35.0ROE (%) 14.4 19.3 18.3 17.9 18.4ROA (%) 0.98 1.13 1.12 1.12 1.11Operating ROE (%) 19.4 25.5 24.2 23.6 24.4Operating ROA (%) 1.30 1.48 1.49 1.48 1.47

Growth (%)

Net interest income -0.3 33.8 23.7 19.7 18.5Non-interest income 16.8 64.5 30.4 22.3 21.0Non-interest expenses 18.5 18.3 16.9 18.9 20.0Pre-provision earnings -9.8 54.3 29.9 20.9 18.3Net profit 7.2 50.2 20.1 19.5 16.3Normalised EPS 7.2 50.2 8.2 8.8 16.3Normalised FDEPS 7.2 50.2 8.2 8.8 16.3Source: Nomura estimates

 Notes

Continued NIM expansion.

Price and price relative chart (one year) 

  

(%) 1M 3M 12M

Absolute (HKD) -8.5 -4.1 -5.2

Absolute (USD) -8.7 -3.9 -5.3

Relative to index -1.5 -1.0 -19.2

Market cap (USDmn) 24,907.1

Estimated free float (%)

51.1

52-week range (HKD) 6.26/4.7

3-mth avg daily turnover (USDmn)

25.57

Major shareholders (%) Citic Group 62.3

BBVA 15.0

4.64.8

55.25.45.65.8

66.26.4

75

80

85

90

95

100

105

Jul 1

0

Aug

10

Sep

10

Oct

10

Nov

10

Dec

10

Jan

11

Feb

11

Mar

11

Apr

11

May

11

Jun

11

PriceRel MSCI HK(HKD)

Page 86: Unmasking China's Shadow Banking System

Nomura | ASIA China CITIC Bank June 24, 2011

85

Balance Sheet (CNYmn) As at 31 Dec FY09 FY10 FY11F FY12F FY13FCash and equivalents 4,480 5,126 8,857 11,914 14,928Inter-bank lending 81,808 130,588 146,259 163,810 183,467Deposits with central bank 219,523 251,197 434,006 583,780 731,452Total securities 206,260 269,005 301,229 337,313 377,722Other interest earning assets 0 0 0 0 0Gross loans 1,065,649 1,264,245 1,476,113 1,734,973 2,029,886Less provisions -15,170 -18,219 -20,826 -24,707 -30,222Net loans 1,050,479 1,246,026 1,455,287 1,710,266 1,999,664Long-term investments 0 0 0 0 0Fixed assets 10,482 10,222 10,426 10,635 10,848Goodwill 0 0 0 0 0Other intangible assets 2,095 2,565 0 0 0Other non IEAs 199,904 166,585 168,251 169,933 171,633Total assets 1,775,031 2,081,314 2,524,315 2,987,651 3,489,712Customer deposits 1,341,927 1,730,816 2,111,596 2,533,915 2,990,019Bank deposits, CDs, debentures 298,024 183,650 202,774 223,384 245,631Other interest bearing liabilities 0 0 0 0 0Total interest bearing liabilities 1,639,951 1,914,466 2,314,369 2,757,299 3,235,651Non interest bearing liabilities 28,072 42,310 42,570 42,856 43,170Total liabilities 1,668,023 1,956,776 2,356,939 2,800,155 3,278,820Minority interest 4,210 4,363 4,407 4,451 4,495Common stock 39,033 39,033 47,620 47,620 47,620Preferred stock 0 0 0 0 0Retained earnings 14,286 30,576 38,327 56,636 78,224Proposed dividends 3,435 0 9,043 10,810 12,574Other equity 46,044 50,566 67,979 67,979 67,979Shareholders' equity 102,798 120,175 162,969 183,046 206,397Total liabilities and equity 1,775,031 2,081,314 2,524,315 2,987,651 3,489,712Non-performing assets (CNY) 10,157 8,533 9,218 10,824 13,647

Balance sheet ratios (%)

Loans to deposits 79.4 73.0 69.9 68.5 67.9Equity to assets 5.8 5.8 6.5 6.1 5.9

Asset quality & capital

NPAs/gross loans (%) 1.0 0.7 0.6 0.6 0.7Bad debt charge/gross loans (%) 0.23 0.34 0.65 0.69 0.74Loss reserves/assets (%) 0.85 0.88 0.83 0.83 0.87Loss reserves/NPAs (%) 149.4 213.5 225.9 228.3 221.4Tier 1 capital ratio (%) 9.2 8.4 10.3 9.9 9.5Total capital ratio (%) 10.7 11.3 12.4 11.9 11.5

Growth (%)

Loan growth 61.3 18.6 16.8 17.5 16.9Interest earning assets 41.2 21.7 23.2 19.6 17.8Interest bearing liabilities 53.5 16.7 20.9 19.1 17.3Asset growth 49.4 17.3 21.3 18.4 16.8Deposit growth 41.9 29.0 22.0 20.0 18.0

Per share

Reported EPS (CNY) 0.37 0.55 0.60 0.65 0.75Norm EPS (CNY) 0.37 0.55 0.60 0.65 0.75Fully diluted norm EPS (CNY) 0.37 0.55 0.60 0.65 0.75DPS (CNY) 0.09 0.00 0.19 0.23 0.26PPOP PS (CNY) 0.56 0.86 1.01 1.11 1.32BVPS (CNY) 2.63 3.08 3.42 3.84 4.33ABVPS (CNY) 2.63 3.08 3.42 3.84 4.33NTAPS (CNY) 2.58 3.01 3.42 3.84 4.33Source: Nomura estimates

 Notes

Lowering LDR.

 

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Nomura | ASIA China CITIC Bank June 24, 2011

86

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 bank’s 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 bank’s 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

Source: Company data, Nomura estimates

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 Citic’s 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 Citic’s 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 H-share 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.

Profit & Loss (RMBmn, except %) 2011F 2012F 2013F 2011F 2012F 2013F 2011F 2012F 2013F

Net interest income 59,567 71,315 84,531 59,738 71,516 84,766 (0.3) (0.3) (0.3) Fee income 7,990 10,521 13,261 7,990 10,521 13,261 0.0 0.0 0.0Non-interest income 10,720 13,115 15,876 10,720 13,115 15,876 0.0 0.0 0.0Operating Income 70,286 84,430 100,406 70,457 84,631 100,642 (0.2) (0.2) (0.2)Operating Expenses (26,474) (31,479) (37,765) (26,484) (31,491) (37,778) (0.0) (0.0) (0.0)PPOP 43,813 52,951 62,642 43,974 53,140 62,863 (0.4) (0.4) (0.4)Provisions (9,591) (12,042) (15,059) (9,591) (12,042) (15,059) 0.0 0.0 0.0Operating pre-tax 34,221 40,909 47,582 34,383 41,098 47,804 (0.5) (0.5) (0.5)Profit tax (8,384) (10,023) (11,658) (8,424) (10,069) (11,712) (0.5) (0.5) (0.5)Profits attributable to equity holders 25,837 30,887 35,925 25,959 31,029 36,092 (0.5) (0.5) (0.5)

Revised Previous Change (%)

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Nomura | ASIA China CITIC Bank June 24, 2011

87

CAR & T1 CAR to be boosted by 1.5pp After the CNY26bn A+H shares rights issues, we estimate Citic’s 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

Source: Company data, Nomura research

Fig. 94: Citic: quarterly CAR

Source: Company data, Nomura research

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 Citic’s 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.

6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5

10.0 10.5 11.0

2Q09

3Q09

4Q09

1Q10

2Q10

3Q10

4Q10

1Q11

(%)

6

7

8

9

10

11

12

13

2Q09

3Q09

4Q09

1Q10

2Q10

3Q10

4Q10

1Q11

(%)

Page 89: Unmasking China's Shadow Banking System

Key company data: See page 2 for company data, and detailed price/index chart. Rating: See report end for details of Nomura’s rating system.

China Minsheng Bank - H 1988.HK 1988 HK

BANKS

EQUITY RESEARCH

Stretched loan yields capped NIM expansion 

Asset quality could worsen as economic growth slows sharply; remain NEUTRAL

June 24, 2011

Rating Remains

Neutral

Target price Remains

HKD 7.40

Closing price June 21, 2011

HKD 7.29

Potential upside +1.5%

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.

31 Dec FY10 FY11F FY12F FY13F

Currency (CNY) Actual Old New Old New Old New

PPOP (mn) 28,480 35,190 35,190 43,165 43,165 52,931 52,931

Reported net profit (mn) 17,581 21,334 21,334 25,729 25,729 31,037 31,037

Normalised net profit (mn) 17,581 21,334 21,334 25,729 25,729 31,037 31,037

Normalised EPS 0.72 0.77 0.77 0.88 0.88 1.02 1.02

Norm. EPS growth (%) 21.8 7.9 7.9 13.2 13.2 16.7 16.7

Norm. P/E (x) 8.7 N/A 7.7 N/A 6.5 N/A 5.5

Price/adj. book (x) 1.6 N/A 1.4 N/A 1.2 N/A 1.0

Price/book (x) 1.6 N/A 1.4 N/A 1.2 N/A 1.0

Dividend yield (%) 1.6 N/A 2.6 N/A 3.1 N/A 3.7

ROE (%) 18.3 18.9 18.9 19.5 19.5 20.2 20.2

ROA (%) 1.1 1.1 1.1 1.0 1.0 1.0 1.0

Source: Nomura estimates

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 re-rating 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

China Banks

Lucy Feng - NIHK [email protected] +852 2252 2165

Donger Wang - NIHK [email protected] +852 2252 1590

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.

Page 90: Unmasking China's Shadow Banking System

Nomura | ASIA China Minsheng Bank - H June 24, 2011

89

Key data on China Minsheng Bank - H Profit and Loss (CNYmn) Year-end 31 Dec FY09 FY10 FY11F FY12F FY13FInterest income 53,441 70,776 83,169 98,865 116,098Interest expense -21,201 -24,903 -30,411 -36,767 -43,128Net interest income 32,240 45,873 52,759 62,098 72,970Net fees and commissions 4,664 8,289 10,822 14,124 18,429Trading related profits 5,133 505 600 714 849Other operating revenue 0 0 0 0 0Non-interest income 9,797 8,794 11,422 14,838 19,277Operating income 42,037 54,667 64,181 76,936 92,247Depreciation

Amortisation

Operating expenses -21,074 -26,187 -28,991 -33,772 -39,316Employee share expense

Op. profit before provisions 20,963 28,480 35,190 43,165 52,931Provisions for bad debt -5,307 -5,504 -6,745 -8,860 -11,547Other provision charges

Operating profit 15,656 22,976 28,445 34,305 41,383Other non-operating income

Associates & JCEs 0 0 0 0 0Pre-tax profit 15,656 22,976 28,445 34,305 41,383Income tax -3,548 -5,288 -7,111 -8,576 -10,346Net profit after tax 12,108 17,688 21,334 25,729 31,037Minority interests -4 -107 0 0 0Other items

Preferred dividends

Normalised NPAT 12,104 17,581 21,334 25,729 31,037Extraordinary items

Reported NPAT 12,104 17,581 21,334 25,729 31,037Dividends -1,113 -2,672 -4,395 -5,318 -6,306Transfer to reserves 10,991 14,909 16,939 20,411 24,731

Valuation and ratio analysis

FD normalised P/E (x) 10.8 8.7 7.7 6.5 5.5FD normalised P/E at price target (x) 11.0 8.9 7.9 6.6 5.6Reported P/E (x) 10.8 8.7 7.7 6.5 5.4Dividend yield (%) 0.8 1.6 2.6 3.1 3.7Price/book (x) 1.6 1.6 1.4 1.2 1.0Price/adjusted book (x) 1.6 1.6 1.4 1.2 1.0Net interest margin (%) 2.59 2.94 2.99 3.06 3.12Yield on interest earning assets (%) 4.29 4.54 4.72 4.86 4.97Cost of interest bearing liabilities (%) 1.80 1.72 1.83 1.94 2.00Net interest spread (%) 2.49 2.82 2.89 2.93 2.97Non-interest/operating income (%) 23.3 16.1 17.8 19.3 20.9Cost to income (%) 50.1 47.9 45.2 43.9 42.6Effective tax rate (%) 22.7 23.0 25.0 25.0 25.0Dividend payout (%) 9.2 15.2 20.6 20.7 20.3ROE (%) 17.1 18.3 18.9 19.5 20.2ROA (%) 0.98 1.08 1.05 1.04 1.03Operating ROE (%) 22.1 23.9 25.2 26.0 26.9Operating ROA (%) 1.26 1.41 1.40 1.39 1.37

Growth (%)

Net interest income 6.1 42.3 15.0 17.7 17.5Non-interest income 104.4 -10.2 29.9 29.9 29.9Non-interest expenses 16.0 24.3 10.7 16.5 16.4Pre-provision earnings 23.3 35.9 23.6 22.7 22.6Net profit 53.5 45.2 21.3 20.6 20.6Normalised EPS 8.2 21.8 7.9 13.2 16.7Normalised FDEPS 8.2 21.8 7.9 13.2 14.9Source: Nomura estimates

 Notes

Continued NIM expansion

Price and price relative chart (one year) 

 

(%) 1M 3M 12M

Absolute (HKD) -0.4 8.2 4.6

Absolute (USD) -0.6 8.3 4.4

Relative to index 6.5 11.2 -9.4

Market cap (USDmn) 20,831.1

Estimated free float (%)

26.0

52-week range (HKD) 7.75/6.3

3-mth avg daily turnover (USDmn)

29.89

Major shareholders (%) New Hope 5.0

China Life 4.0

 

6.2

6.4

6.6

6.8

7

7.2

7.4

7.6

7.8

70

75

80

85

90

95

100

105

Jul 1

0

Aug

10

Sep

10

Oct

10

Nov

10

Dec

10

Jan

11

Feb

11

Mar

11

Apr

11

May

11

Jun

11

PriceRel MSCI HK(HKD)

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Balance Sheet (CNYmn) As at 31 Dec FY09 FY10 FY11F FY12F FY13FCash and equivalents 66,312 130,059 281,514 453,330 687,776Inter-bank lending 73,015 149,385 156,854 164,697 172,932Deposits with central bank 221,590 262,238 288,462 317,308 349,039Total securities 156,491 180,943 207,241 237,475 272,236Other interest earning assets 0 0 0 0 0Gross loans 882,979 1,057,571 1,254,020 1,496,787 1,777,032Less provisions -15,241 -19,848 -27,928 -32,868 -38,932Net loans 867,738 1,037,723 1,226,092 1,463,919 1,738,100Long-term investments 0 0 0 0 0Fixed assets 8,068 8,809 10,130 11,650 13,397Goodwill

Other intangible assets

Other non IEAs 33,178 54,580 62,767 72,182 83,009Total assets 1,426,392 1,823,737 2,233,061 2,720,561 3,316,490Customer deposits 1,127,938 1,416,939 1,742,835 2,143,687 2,636,735Bank deposits, CDs, debentures 166,188 250,355 300,426 360,511 432,613Other interest bearing liabilities 23,060 21,496 31,496 31,496 31,496Total interest bearing liabilities 1,317,186 1,688,790 2,074,757 2,535,694 3,100,844Non interest bearing liabilities 20,312 29,690 34,972 41,203 48,556Total liabilities 1,337,498 1,718,480 2,109,729 2,576,898 3,149,401Minority interest 860 1,149 1,264 1,390 1,529Common stock 22,262 26,715 28,366 30,330 31,313Preferred stock

Retained earnings 11,390 17,209 25,690 35,098 47,536Proposed dividends 1,113 2,672 4,395 5,318 6,306Other equity 53,269 57,512 63,618 71,527 80,406Shareholders' equity 88,034 104,108 122,068 142,274 165,560Total liabilities and equity 1,426,392 1,823,737 2,233,061 2,720,561 3,316,490Non-performing assets (CNY) 7,397 7,339 8,495 10,558 13,013

Balance sheet ratios (%)

Loans to deposits 78.3 74.6 72.0 69.8 67.4Equity to assets 6.2 5.7 5.5 5.2 5.0

Asset quality & capital

NPAs/gross loans (%) 0.8 0.7 0.7 0.7 0.7Bad debt charge/gross loans (%) 0.60 0.52 0.54 0.59 0.65Loss reserves/assets (%) 1.07 1.09 1.25 1.21 1.17Loss reserves/NPAs (%) 206.0 270.4 328.8 311.3 299.2Tier 1 capital ratio (%) 8.9 8.1 8.7 9.2 9.6Total capital ratio (%) 10.8 10.4 12.5 12.8 13.0

Growth (%)

Loan growth 34.2 19.6 18.2 19.4 18.7Interest earning assets 30.6 23.6 15.2 16.2 16.0Interest bearing liabilities 34.0 28.2 22.9 22.2 22.3Asset growth 35.3 27.9 22.4 21.8 21.9Deposit growth 43.5 25.6 23.0 23.0 23.0

Per share

Reported EPS (CNY) 0.59 0.72 0.77 0.88 1.02Norm EPS (CNY) 0.59 0.72 0.77 0.88 1.02Fully diluted norm EPS (CNY) 0.59 0.72 0.77 0.88 1.01DPS (CNY) 0.05 0.10 0.15 0.18 0.20PPOP PS (CNY) 1.02 1.16 1.28 1.47 1.75BVPS (CNY) 3.95 3.90 4.30 4.69 5.29ABVPS (CNY) 3.95 3.90 4.30 4.69 5.29NTAPS (CNY) 3.95 3.90 4.30 4.69 5.29Source: Nomura estimates

 Notes

Benign asset quality

 

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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 Minsheng’s risk-weighted 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

Source: Company data, Nomura estimates

“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.

2010 (RMB mn) ABC ICBC CCB BOC BOCOM CMB CITIC Minsheng CRCB

Incremetnal RWA as % of total RWA 15% 14% 14% 14% 11% 11% 11% 11% 17%

Total tier 1 impact (136) (127) (131) (135) (95) (80) (88) (84) (234)

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Valuation methodology and risks

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.

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Key company data: See page 2 for company data, and detailed price/index chart. Rating: See report end for details of Nomura’s rating system.

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

June 24, 2011

Rating Remains

Buy

Target price Reduced from 6.68

HKD 6.52

Closing price June 21, 2011

HKD 4.71

Potential upside +38.4%

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 CRCB’s 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, CRCB’s 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 management’s 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.

31 Dec FY10 FY11F FY12F FY13F

Currency (CNY) Actual Old New Old New Old New

PPOP (mn) 3,835 5,591 5,591 7,303 7,303 9,036 9,036

Reported net profit (mn) 3,064 4,011 3,973 5,126 5,126 6,302 6,302

Normalised net profit (mn) 3,064 4,011 3,973 5,126 5,126 6,302 6,302

Normalised EPS 0.41 0.44 0.43 0.55 0.55 0.68 0.68

Norm. EPS growth (%) 29.8 7.3 6.3 25.7 26.9 22.9 22.9

Norm. P/E (x) 9.9 N/A 8.9 N/A 6.6 N/A 5.3

Price/adj. book (x) 1.6 N/A 1.3 N/A 1.1 N/A 0.9

Price/book (x) 1.6 N/A 1.3 N/A 1.1 N/A 0.9

Dividend yield (%) 1.1 N/A 3.3 N/A 5.3 N/A 6.7

ROE (%) 19.3 16.6 16.4 18.2 18.3 19.3 19.3

ROA (%) 1.3 1.2 1.2 1.3 1.3 1.3 1.3

Source: Nomura estimates

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 re-rating 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

China Banks

Lucy Feng - NIHK [email protected] +852 2252 2165

Donger Wang - NIHK [email protected] +852 2252 1590

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.

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Key data on Chongqing Rural Commercial Bank Profit and Loss (CNYmn) Year-end 31 Dec FY09 FY10 FY11F FY12F FY13FInterest income 8,703 11,473 15,053 18,983 23,144Interest expense -3,228 -3,972 -5,012 -6,232 -7,427Net interest income 5,474 7,502 10,042 12,750 15,717Net fees and commissions 137 286 384 486 618Trading related profits 8 -46 23 24 25Other operating revenue 57 3 4 3 4Non-interest income 202 243 410 513 648Operating income 5,677 7,745 10,452 13,264 16,365Depreciation -331 -331 -348 -365 -383Amortisation 0 0 0 0 0Operating expenses -2,860 -3,579 -4,513 -5,595 -6,945Employee share expense

Op. profit before provisions 2,486 3,835 5,591 7,303 9,036Provisions for bad debt -118 -5 -350 -540 -721Other provision charges -5 50 0 0 0Operating profit 2,363 3,880 5,241 6,763 8,315Other non-operating income 121 106 0 0 0Associates & JCEs 0 0 0 0 0Pre-tax profit 2,485 3,986 5,241 6,763 8,315Income tax -596 -925 -1,271 -1,640 -2,016Net profit after tax 1,888 3,061 3,970 5,123 6,299Minority interests 0 3 3 3 3Other items 0 0 0 0 0Preferred dividends 0 0 0 0 0Normalised NPAT 1,888 3,064 3,973 5,126 6,302Extraordinary items 0 0 0 0 0Reported NPAT 1,888 3,064 3,973 5,126 6,302Dividends -360 -404 -1,192 -1,793 -2,205Transfer to reserves 1,528 2,661 2,781 3,333 4,097

Valuation and ratio analysis

FD normalised P/E (x) 13.1 9.9 8.9 6.6 5.3FD normalised P/E at price target (x) 18.6 14.1 12.6 9.4 7.5Reported P/E (x) 13.1 9.9 8.9 6.6 5.3Dividend yield (%) 1.5 1.1 3.3 5.3 6.7Price/book (x) 2.6 1.6 1.3 1.1 0.9Price/adjusted book (x) 2.6 1.6 1.3 1.1 0.9Net interest margin (%) 3.06 3.07 3.16 3.21 3.25Yield on interest earning assets (%) 4.87 4.70 4.74 4.79 4.78Cost of interest bearing liabilities (%) 1.93 1.73 1.75 1.81 1.80Net interest spread (%) 2.93 2.97 2.99 2.97 2.98Non-interest/operating income (%) 3.6 3.1 3.9 3.9 4.0Cost to income (%) 56.2 50.5 46.5 44.9 44.8Effective tax rate (%) 24.0 23.2 24.3 24.3 24.3Dividend payout (%) 19.1 13.2 30.0 35.0 35.0ROE (%) 21.7 19.3 16.4 18.3 19.3ROA (%) 1.02 1.26 1.24 1.29 1.31Operating ROE (%) 27.2 24.4 21.7 24.1 25.5Operating ROA (%) 1.28 1.59 1.63 1.70 1.72

Growth (%)

Net interest income 5.6 37.0 33.9 27.0 23.3Non-interest income 82.2 20.0 69.0 25.0 26.2Non-interest expenses 32.2 25.2 26.1 24.0 24.1Pre-provision earnings -11.9 54.2 45.8 30.6 23.7Net profit -5.4 62.3 29.7 29.0 22.9Normalised EPS -39.7 29.8 6.3 26.9 22.9Normalised FDEPS -39.7 29.8 6.3 26.9 22.9Source: Nomura estimates

 Notes

We expect NPAT to double in three years.

Price and price relative chart (one year) 

(%) 1M 3M 12M

Absolute (HKD) -14.4 -20.3

Absolute (USD) -14.5 -20.2

Relative to index -7.1 -16.4

Market cap (USDmn) 5,442.0

Estimated free float (%)

1.0

52-week range (HKD) 6.46/4.33

3-mth avg daily turnover (USDmn)

25.85

Major shareholders (%) Chongqing Yufu 6.9

Chongqing City Construction

6.6

 

4

4.5

5

5.5

6

6.5

85

90

95

100

105

110

115

120

Jan

11

Feb

11

Mar

11

Apr

11

May

11

Jun

11

PriceRel MSCI China(HKD)

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Balance Sheet (CNYmn) As at 31 Dec FY09 FY10 FY11F FY12F FY13FCash and equivalents 27,416 37,322 75,555 118,787 161,074Inter-bank lending 10,154 19,220 21,527 24,110 27,003Deposits with central bank 0 0 0 0 0Total securities 40,882 59,373 66,074 73,536 81,846Other interest earning assets 13,374 37,158 40,874 44,961 49,457Gross loans 101,821 122,145 142,210 166,425 194,072Less provisions -5,005 -5,031 -5,232 -5,548 -5,989Net loans 96,816 117,114 136,978 160,878 188,082Long-term investments 0 0 0 0 0Fixed assets 2,117 2,341 2,388 2,436 2,485Goodwill 0 0 0 0 0Other intangible assets 1,264 1,308 1,177 1,059 953Other non IEAs 9,338 11,710 12,594 13,565 14,629Total assets 201,361 285,546 357,166 439,331 525,529Customer deposits 153,776 205,563 263,042 327,725 392,422Bank deposits, CDs, debentures 4,136 12,157 15,225 19,793 25,731Other interest bearing liabilities 28,806 38,063 45,215 53,798 64,098Total interest bearing liabilities 186,718 255,782 323,482 401,316 482,250Non interest bearing liabilities 5,166 7,333 7,559 7,806 8,077Total liabilities 191,883 263,115 331,042 409,123 490,328Minority interest 0 85 94 103 113Common stock 6,000 9,000 9,300 9,300 9,300Preferred stock

Retained earnings 1,710 2,243 4,236 6,967 10,651Proposed dividends 360 404 1,192 1,793 2,205Other equity 1,408 10,699 11,303 12,046 12,932Shareholders' equity 9,477 22,345 26,031 30,105 35,088Total liabilities and equity 201,361 285,546 357,166 439,331 525,529Non-performing assets (CNY) 3,946 2,912 2,481 2,191 1,929

Balance sheet ratios (%)

Loans to deposits 66.2 59.4 54.1 50.8 49.5Equity to assets 4.7 7.8 7.3 6.9 6.7

Asset quality & capital

NPAs/gross loans (%) 3.9 2.4 1.7 1.3 1.0Bad debt charge/gross loans (%) 0.12 0.00 0.25 0.32 0.37Loss reserves/assets (%) 2.49 1.76 1.46 1.26 1.14Loss reserves/NPAs (%) 126.8 172.8 210.9 253.2 310.6Tier 1 capital ratio (%) 8.1 14.8 13.3 12.2 11.6Total capital ratio (%) 10.2 16.3 14.5 13.1 12.3

Growth (%)

Loan growth 34.1 21.0 17.0 17.4 16.9Interest earning assets 15.9 44.4 14.0 14.3 14.1Interest bearing liabilities 21.1 37.0 26.5 24.1 20.2Asset growth 20.4 41.8 25.1 23.0 19.6Deposit growth 31.1 33.7 28.0 24.6 19.7

Per share

Reported EPS (CNY) 0.31 0.41 0.43 0.55 0.68Norm EPS (CNY) 0.31 0.41 0.43 0.55 0.68Fully diluted norm EPS (CNY) 0.31 0.41 0.43 0.55 0.68DPS (CNY) 0.06 0.04 0.13 0.19 0.24PPOP PS (CNY) 0.41 0.51 0.61 0.79 0.97BVPS (CNY) 1.58 2.48 2.80 3.24 3.77ABVPS (CNY) 1.58 2.48 2.80 3.24 3.77NTAPS (CNY) 1.37 2.34 2.67 3.12 3.67Source: Nomura estimates

 Notes

Lowering NPL ratio.

 

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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 CRCB’s 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

Source: Company data, Nomura estimates

FY11F NIM will likely reach 3.30-3.50%

According to management, CRCB’s 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 bank’s 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 bank’s 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 bank’s 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.

Profit & Loss (RMBmn, except %) 2011F 2012F 2013F 2011F 2012F 2013F 2011F 2012F 2013F

Net interest income 10,042 12,750 15,717 10,042 12,750 15,717 0.0 0.0 0.0 Fee income 384 486 618 384 486 618 0.0 0.0 0.0Non-interest income 410 513 648 410 513 648 0.0 0.0 0.0Operating Income 10,452 13,264 16,365 10,452 13,264 16,365 0.0 0.0 0.0Operating Expenses (4,861) (5,960) (7,329) (4,861) (5,960) (7,329) 0.0 0.0 0.0PPOP 5,591 7,303 9,036 5,591 7,303 9,036 0.0 0.0 0.0Provisions (350) (540) (721) (300) (540) (721) 16.7 0.0 0.0Operating pretax 5,241 6,763 8,315 5,291 6,763 8,315 (0.9) 0.0 0.0Profit tax (1,271) (1,640) (2,016) (1,283) (1,640) (2,016) (0.9) 0.0 0.0Minority Interest 3 3 3 3 3 3 0.0 0.0 0.0Profits attributable to equity holders 3,973 5,126 6,302 4,011 5,126 6,302 (0.9) 0.0 0.0

Revised Previous Change (%)

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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

Source: Company data, Nomura research

Fig. 98: CRCB: NIM

Source: Company data, Nomura research

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 bank’s 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 management’s 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.

40

45

50

55

60

65

70

75

80

85

2007 2008 2009 2010 1Q11

(%)

2.0

2.5

3.0

3.5

4.0

1H09 2H09 1H10 2H10 1Q11

(%)

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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 regulator’s 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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Nomura | AEJ China banks June 24, 2011

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

Disclosures required in the U.S.

24 Disclosure of share ownership positions Nomura International plc holds a proprietory position in the issuer.

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48 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.

50 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.

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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.

61 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.

Previous Rating Issuer name Previous Rating Date of change Agricultural Bank of China Not Rated 26-Aug-2010 ICBC Strong Buy 10-Dec-2008 China Construction Bank-H Buy 23-Jun-2011 Bank of Communications Buy 14-Jan-2011 China Merchants Bank Neutral 03-Feb-2010 Chongqing Rural Commercial Bank Not Rated 26-Jan-2011 China Minsheng Bank - H Not Rated 03-Feb-2010 China CITIC Bank Reduce 26-Jun-2009 Bank of China (H-share) Neutral 12-Feb-2009

Rating and target price changes

Ticker Old stock rating New stock rating Old target price New target price

ICBC 1398 HK Buy Buy HKD 7.60 HKD 7.50

China Construction Bank-H 939 HK Buy Neutral HKD 8.60 HKD 7.02

Bank of Communications 3328 HK Neutral Neutral HKD 9.00 HKD 8.30

China Merchants Bank 3968 HK Buy Buy HKD 26.86 HKD 24.82

Chongqing Rural Commercial Bank 3618 HK Buy Buy HKD 6.68 HKD 6.52

Agricultural Bank of China (1288 HK) HKD 3.85 (22-Jun-2011) Rating and target price chart (three year history)

Buy (Sector rating: Not rated)

Date Rating Target price Closing price 05-May-2011 5.20 4.48 14-Jan-2011 4.80 3.97 22-Oct-2010 4.70 4.07 26-Aug-2010 4.30 3.53 26-Aug-2010 Buy 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 ABC’s 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 China’s 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) HKD 5.80 (22-Jun-2011) Rating and target price chart (three year history)

Buy (Sector rating: Not rated)

Date Rating Target price Closing price 14-Jan-2011 7.60 6.08 22-Oct-2010 7.30 6.14 30-Jul-2010 7.00 5.82 13-May-2010 7.70 5.62 03-Feb-2010 7.36 5.72 18-Dec-2009 7.50 6.08 31-Aug-2009 6.70 5.19 26-Jun-2009 6.25 5.35 26-Mar-2009 4.94 4.03 10-Dec-2008 4.97 4.38 10-Dec-2008 Buy 4.38

For explanation of ratings refer to the stock rating keys located after chart(s)

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) HKD 6.40 (22-Jun-2011) Rating and target price chart (three year history)

Neutral (Sector rating: Not rated)

Date Rating Target price Closing price 14-Jan-2011 8.60 7.32 22-Oct-2010 8.50 7.20 30-Jul-2010 7.60 6.39 13-May-2010 7.90 6.17 03-Feb-2010 7.48 5.92 18-Dec-2009 8.50 6.17 04-Sep-2009 7.80 5.86 18-Jun-2009 7.30 5.37 25-May-2009 5.65 4.65 30-Mar-2009 4.95 4.12 12-Feb-2009 4.99 3.84 12-Feb-2009 Buy 3.84 10-Dec-2008 5.05 4.73 10-Dec-2008 Neutral 4.73

For explanation of ratings refer to the stock rating keys located after chart(s)

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) HKD 7.26 (22-Jun-2011) Rating and target price chart (three year history)

Neutral (Sector rating: Not rated)

Date Rating Target price Closing price 14-Jan-2011 9.00 8.00 14-Jan-2011 Neutral 8.00 22-Oct-2010 11.00 9.28 07-Jun-2010 10.00 7.71 13-May-2010 10.20 7.92 09-Mar-2010 10.00 8.19 09-Mar-2010 Buy 8.19 23-Feb-2010 9.09 7.58 03-Feb-2010 8.81 7.63 18-Dec-2009 10.00 8.28 04-Sep-2009 9.80 9.00 26-Jun-2009 8.65 7.99 26-Jun-2009 Neutral 7.99 19-Mar-2009 4.10 4.91 10-Dec-2008 4.40 5.50 10-Dec-2008 Reduce 5.50

For explanation of ratings refer to the stock rating keys located after chart(s)

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 China’s 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) HKD 18.26 (22-Jun-2011) Rating and target price chart (three year history)

Buy (Sector rating: Not rated)

Date Rating Target price Closing price 14-Jan-2011 26.86 20.25 22-Oct-2010 26.36 22.70 13-May-2010 23.40 18.16 14-Apr-2010 23.33 20.70 02-Mar-2010 23.30 19.09 03-Feb-2010 23.99 18.29 03-Feb-2010 Buy 18.29 18-Dec-2009 22.00 18.40 02-Sep-2009 17.20 15.50 25-Aug-2009 16.65 17.02 08-Jun-2009 16.55 15.14 10-Dec-2008 14.00 11.61 10-Dec-2008 Neutral 11.61

For explanation of ratings refer to the stock rating keys located after chart(s)

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) HKD 4.42 (22-Jun-2011) Rating and target price chart (three year history)

Buy (Sector rating: Not rated)

Date Rating Target price Closing price 30-Mar-2011 6.68 5.23 26-Jan-2011 6.90 5.41 26-Jan-2011 Buy 5.41

For explanation of ratings refer to the stock rating keys located after chart(s)

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) HKD 7.28 (22-Jun-2011) Rating and target price chart (three year history)

Neutral (Sector rating: Not rated)

Date Rating Target price Closing price 22-Oct-2010 7.40 7.22 30-Jul-2010 7.90 7.25 13-May-2010 9.00 6.61 03-Feb-2010 8.81 6.62 03-Feb-2010 Neutral 6.62

For explanation of ratings refer to the stock rating keys located after chart(s)

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) HKD 4.96 (22-Jun-2011) Rating and target price chart (three year history)

Buy (Sector rating: Not rated)

Date Rating Target price Closing price 05-May-2011 6.50 5.47 14-Jan-2011 6.30 5.35 22-Oct-2010 6.60 5.73 13-May-2010 5.80 4.64 03-Feb-2010 6.57 5.55 18-Dec-2009 8.25 6.18 04-Sep-2009 6.10 4.79 26-Jun-2009 5.85 4.94 26-Jun-2009 Buy 4.94 10-Dec-2008 2.40 3.03 10-Dec-2008 Reduce 3.03

For explanation of ratings refer to the stock rating keys located after chart(s)

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 Citic’s 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) HKD 3.76 (22-Jun-2011) Rating and target price chart (three year history)

Buy (Sector rating: Not rated)

Date Rating Target price Closing price 14-Jan-2011 5.20 4.30 22-Oct-2010 5.30 4.32 30-Jul-2010 4.90 3.93 24-Jun-2010 5.00 3.91 13-May-2010 4.80 3.84 15-Mar-2010 4.64 3.75 03-Feb-2010 4.55 3.68 18-Dec-2009 5.50 3.86 04-Sep-2009 4.90 3.79 26-Jun-2009 4.30 3.51 20-Apr-2009 3.25 2.83 25-Mar-2009 2.57 2.32 12-Feb-2009 2.61 2.02 12-Feb-2009 Buy 2.02 10-Dec-2008 2.63 2.49 10-Dec-2008 Neutral 2.49

For explanation of ratings refer to the stock rating keys located after chart(s)

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 Kong’s economy, could also weigh on the bank’s earnings performance given its bigger foreign exposure relative to that of peers.

Important Disclosures Conflict-of-interest disclosures Important disclosures may be accessed through the following website: http://www.nomura.com/research/pages/disclosures/disclosures.aspx . If you have difficulty with this site or you do not have a password, please contact your Nomura Securities International, Inc. salesperson (1-877-865-5752) or email [email protected] for assistance. Online availability of research and additional conflict-of-interest disclosures Nomura Japanese Equity Research is available electronically for clients in the US on NOMURA.COM, REUTERS, BLOOMBERG and THOMSON ONE ANALYTICS. For clients in Europe, Japan and elsewhere in Asia it is available on NOMURA.COM, REUTERS and BLOOMBERG. Important disclosures may be accessed through the left hand side of the Nomura Disclosure web page http://www.nomura.com/research or requested from Nomura Securities International, Inc., on 1-877-865-5752. If you have any difficulties with the website, please email [email protected] for technical assistance. The analysts responsible for preparing this report have received compensation based upon various factors including the firm's total revenues, a portion of which is generated by Investment Banking activities. Unless otherwise noted, the non-US analysts listed at the front of this report are not registered/qualified as research analysts under FINRA/NYSE rules, may not be associated persons of NSI, and may not be subject to FINRA Rule 2711 and NYSE Rule 472 restrictions on communications with covered companies, public appearances, and trading securities held by a research analyst account. Industry Specialists identified in some Nomura International plc research reports are employees within the Firm who are responsible for the sales and trading effort in the sector for which they have coverage. Industry Specialists do not contribute in any manner to the content of research reports in which their names appear. Marketing Analysts identified in some Nomura research reports are research analysts employed by Nomura International plc who are primarily responsible for marketing Nomura’s Equity Research product in the sector for which they have coverage. Marketing Analysts may also contribute to research reports in which their names appear and publish research on their sector. 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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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 (ex-Asia): 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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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. 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