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CMB: Second Reform Determines Investment Worth
 

Although the banking sector is a core cog in the economic system, the share prices of listed banks have remained low and undervalued for quite some time. In fact, compared with previous stock prices and the average stock prices in other sectors, the current valuation is at its lowest point ever. In 2009, CMB initiated its second reform strategy to expand its customer mix, optimize its assets/liabilities portfolio, and develop low-CAPEX services. These include retail banking, lending to SMEs and non-interest income, increasing loan-pricing capabilities, and raising the proportion of non-interest income. The analysis below describes the results of this strategy.

Competitive Advantages

Asset value on a bank’s balance sheet is invariably very high, and is underpinned by the economies of scale that enable large banks to generate high profits from customer assets through imposing charges.

Since its IPO in 2002, CMB consolidated its capital to drive expansion and growth. Both deposits and loans grew fast at first, and then decreased gradually. It is worth noting that although the lively stock market of 2006 and 2007 caused retail customers’ deposit accounts to increase more slowly than previously, CMB still led other banks in this area. After acquiring Wing Lung Bank in 2008, CMB’s deposits and loans continued to grow rapidly. In 2010 and 2011, tighter regulations, fiercer competition, and inflationary pressures slowed the growth of deposits and loans, though both still increased. According to the June 2012 Summary of Sources and Uses of Credit Funds of Financial Institutions issued by the PBoC, CMB’s CNY deposits accounted for 11.49% of the total amount generated by the 32 small and medium national banks – the highest in the sector. Equally, CMB’s CNY loans accounted for 9.76% of the total, ranking second.

In terms of deposit composition and percentage, 11-year statistics show that the percentages of demand, term, corporate and retail deposits remain relatively stable with a narrow fluctuation range, demonstrating CMB’s strong management prowess. With a constant rate exceeding 50% of the percentage of demand deposits, CMB evidently provides a low cost deposit service.

Profitability

Efficiency ratio measures the percentage of operating expenses in relation to net income and reveals the management efficiency of a bank, with lower values indicating greater efficiency; for example, the ratios of most well-performing banks are below 55%. Data shows that CMB’s management efficiency has continued to improve, and remains at a high level.

 Net interest margin (NIM) looks at the percentage of net interest income as part of the average balance of total interest-bearing assets, and it measures loan profitability. Data shows that, except in 2009 when NIM dropped due to the financial crisis and sluggish economic growth, CMB’s NIM has otherwise risen year on year. The proportions of service charge income and non-interest income have increased annually, with the latter exceeding 20%. This shows the diversity of CMB’s income scope, and its decreasing reliance on interest margins. The result of the second reform was evident after 2009, with a visible increase in the share of non-interest income. 

Pre-provision operating profit reveals actual profit levels before a bank implements various provisions. Data indicates that CMB enjoyed a stable improvement in profitability, with net profit growth high, except in 2009, when net profits suffered due to the financial crisis and the acquisition of Wing Lung Bank. Net service charge growth has also risen at a rapid speed, contributing to the increase in service charge income. Cost-to-income ratio refers to operating and management expenses against operating income, and also indicates the management efficiency of a bank. CMB Data shows a downward trend year on year, reflecting increased management efficiency.

In terms of bank shares other than annual dividends and bonuses, we need to focus on whether a high return can be derived from cumulative profits each year. Return on net assets is an accurate indicator, and both CMBs returns on assets and net assets show upward trends, indicating strong profitability.

Asset Quality and Capital Management

When investing in bank shares, the greatest challenge lies in evaluating the credit quality of a bank. Credit risk sits at the center of the lending service, and the non-performing loan (NPL) ratio and provision coverage are two precise indicators. CMB data reveals a downward trend in NPL ratio, resulting in its current low level. NPL provision coverage is the ratio of provision for loan impairment to NPL balance, which is also a key indicator for determining a bank’s asset quality. When a credit risk occurs, profits act as the first protection layer. When losses exceed profits, loan impairment provision serves as the second protection layer. Only when losses exceed the provision can the owner’s equity be lost. CMB data indicates that provision coverage has been rising significantly year on year, which enhances risk prevention and protects owner equity in the event of a credit risk. In view of the above two indicators, CMB's assets are in good shape.

In terms of capital management, CMB’s capital adequacy ratio and core capital adequacy ratio are rising mostly because of strong endogenous capabilities. Supplementing capital with annual profit growth can cover capital consumption by weighted risk asset growth. The decline of core capital adequacy ratio in 2008 resulted from the offset of capital reserves, and the reduction of core capital due the second premium incurred by the acquisition of Wing Lung Bank. The CNY 30 billion secondary bond issued at that time complemented tier 2 capital rather than core capital.

Dividend Distribution and Evaluation

Years of dividend distribution data show that, except for 2008 when a large amount of capital was used to acquire Wing Lung Bank, the ratio of dividends as part of net profits has been consistently above 20%, and remained stable. As stated in the 2011 annual report, the board agrees that, from 2012 onwards, annual cash dividends should be at least 30% of the net profits after auditing by the Chinese Accounting Standard, providing that the capital adequacy ratio required by laws and regulations and the regulator then in force is met, and that the dividend distribution policy remains consistent. In view of this, CMB’s dividend yield is relatively good.

Assuming a dividend growth of 15% over the next 10 years, 5% after that, and a discount rate of 9%, the multiple growth model for dividend discounts shows the resulting intrinsic value of CMB’s share is CNY 27.53. However, this is only theoretical and does not represent a fixed future trend.