The expansion of interest spreads and the tax exemption effect led to growth in performance. In the first half of 2018, Bank of China's net profit increased 5.2% year-on-year to RMB 109.1 billion, accounting for 59% of our full-year profit forecast. Operating income increased 2.1% year over year, mainly due to an increase in net interest income of 7.1%, driven by widening interest spreads and steady growth in loans. The decline in revenue from investment bank-related businesses led to a 2.0% year-on-year decline in net commission fee revenue, which fell short of expectations. However, the company increased the tax exemption effect brought about by the company's investment in government bonds, which reduced income tax expenses by 11% year-on-year, which strongly supported the growth rate of net profit.

Net interest spreads improved more than peers. Benefiting from the rapid expansion of interest spreads between the asset side and the debt side, the Bank of China's net interest spread in the second quarter expanded 6 basis points month-on-month to 1.91%. The improvement in interest spreads was clearly superior to other major banks. As intermarket liquidity remained relatively abundant and interbank interest spreads narrowed, the Bank of China adjusted its balance sheet structure in the second quarter, shrank interbank assets (down 9.4% month-on-month), and increased investment in loans (up 2.4% month-on-month). Judging from the loan structure, in the first half of this year, the growth rate of retail loans was significantly higher than corporate loans. The two reached 6.0% and 3.9% respectively; the growth in personal loans mainly came from mortgage loans and credit cards. Furthermore, the growth rate of overseas loans reached 6.1%, higher than the growth rate of domestic loans of 4.3%. In the debt-side structure, deposits increased slightly by 0.4% month-on-month in the second quarter, while interbank debt increased sharply by 14.6%, indicating that in a situation where loan competition is becoming more intense, banks are more inclined to obtain capital from the interbank market where costs are declining.

The quality of assets remains stable. At the end of the second quarter of 2018, the Bank of China's non-performing loan ratio was 1.43%, which was the same as the previous month. At the same time, it also maintained the lowest non-performing loan ratio among the four major banks. The provision coverage rate declined 3.3 percentage points month-on-month to 164.8%. The company's bad confirmation continues the consistent principle of prudence, and the ratio of non-performing loans to loans overdue for 90 days or more reached 124%. However, we noticed that the company's overdue loan balance increased sharply by 35.5% in the first half of the year compared to the beginning of the year, while the balance of overdue loans under three months more than doubled. We hope to seek management's answer to this phenomenon during the earnings conference to be held later today.

The international layout favors the expansion of interest spreads in the future. In the process of raising interest rates in the US dollar, the Bank of China's interest rate spread is expected to expand at an accelerated pace. In 2017, overseas business and domestic foreign exchange business accounted for 16% of the bank's net interest income. Furthermore, at the end of the second quarter, the bank's foreign currency assets accounted for 25.0% of total assets, of which 74.3% were US dollar and Hong Kong dollar assets. This also allows the bank to naturally hedge against the impact of fluctuations in the RMB exchange rate under some Sino-US trade disputes.

Maintain the buy rating. We expect the interim results to have a neutral impact on the Bank of China's stock price. The current valuation of the Bank of China is equivalent to 0.61 times the market account ratio predicted in 2018, with a dividend rate of 6.0%. Based on the GGM valuation model, we gave the company a target price of HK$5.20, corresponding to the 2019 forecast of net assets of RMB 5.68 per share and 0.79 times the predicted market account ratio. Our main assumptions include adjusted ROE of 12.0%, COE of 14.5%, and long-term growth of 3.0%.