Incident: Bank of Hangzhou disclosed its 2023 annual report and 2024 quarterly report. 1Q24 revenue increased 3.5% year on year (2023:6.3%), and net profit to mother increased 21.1% year on year (2023:23.2%). The 1Q24 defect rate remained flat at 0.76% month-on-month, and the provision coverage rate decreased by 10pct to 551% month-on-month compared to 4Q23. The proposed dividend rate was raised to 22.5% in 2023 (2022:21.8%).

The performance is at the top of the listed banks. There are only a few banks that achieved positive revenue growth in the first quarter: 1Q24 revenue growth rate fell 2.8 pct to 3.5% from 2023, which was basically in line with forward-looking expectations (3.0%), and supported by continued excellent asset quality, the year-on-year net profit growth rate (21.1%) remained at the top of listed banks, better than the forward-looking expectations (18.2%). We believe that Bank of Hangzhou is one of the few banks that can achieve “positive revenue growth+profit growth rate of more than 20%” in a quarterly report. Judging from profit drivers, ① provisions are still the biggest positive contributor to performance, contributing 13.0pct (2023:18.7%); ② other investment-related non-interest income increased 36.4% year on year, driving the positive contribution of other non-interest income to 7.1pct (2023:6.5 pct); while median revenue fell 16.4% year on year, with negative contribution revenue 2.4 pct (2023: -1.9pct). ③ The margin of interest spreads stabilized in the first quarter, and the negative contribution (-6.2pct) was less than in 2023 (-7.6pct), but under the constraints of the core tier 1 capital adequacy ratio, asset scale expansion slowed down, and the positive contribution to performance (4.9pct) was less than 2023 (9.3pct).

The first quarterly report focuses on: ① Accelerated credit investment, focusing on core Tier 1 capital replenishment progress: 1Q24 loans increased 16.1% year on year (4Q23:14.9%), added 63.7 billion yuan in loans in a single quarter (up 15.5 billion yuan year on year), and the main increase in contribution to public credit (accounting for 93% of the increase in 1Q24) is expected to focus on politics-related assets; 1Q24 retail sales increased by 4.4 billion yuan (year-on-year increase of more than 10 billion dollars), continuing the recovery trend since the fourth quarter of last year. Although the 1Q24 core tier 1 capital adequacy ratio increased to 8.46% quarterly, it is still in the lower quartile of listed banks, and attention is being paid to the progress of the implementation of capital supplement plans such as fixed growth and convertible bonds. ② Under the optimization of deposit costs, quarterly interest spreads stabilized month-on-month: we estimate that 1Q24 interest spreads increased by 2 bps to 1.50% month-on-month. Among them, 1Q24 debt costs fell 7 bps to 2.20% from quarter to quarter, and the decline in deposit costs is expected to be the main cause. ③ The provision coverage ratio feeds back performance to better supplement core capital, but under low revenue growth, the short-term provision coverage rate is a trend: the 1Q24 provision coverage rate fell 10pct to 551% month-on-month, short-term interest spreads are difficult to fix, and the core Tier 1 capital adequacy ratio is expected to be under pressure, and revenue performance is still under pressure. Therefore, provision coverage is still the core and most stable support for performance. It is expected that provision coverage will still trend downward.

Stabilizing interest spreads is necessary. Improving debt costs hedge against the downward impact of asset pricing: the net interest spread for 1Q24 is estimated to be 1.50% (2023:1.50%), increasing by 2 bps from quarter to quarter. ① The stabilization of marginal interest spreads in the first quarter mainly benefited from improvements in debt-side costs: it is estimated that debt costs fell 7 bps to 2.20% from quarter to quarter in 1Q24, and the decline in deposit costs is expected to be the main cause. The cost of 2H23 deposits decreased by 8 bps to 2.15% compared to 1H23, and it can be seen that the deposit structure was optimized. The share of 1Q24 time deposits in total deposits decreased by 1.2 pct to 47.5% compared to 4Q23. ② Asset pricing is still under pressure. Optimizing the structure and improving the efficiency of capital use is inevitable: the return on 1Q24 interest-bearing assets decreased by 7 bps to 3.74% month-on-month (2H23 loan pricing decreased by 20 bps compared to 1H23). Against the backdrop of repricing of mortgages and difficulties in recovering significantly in interest rates for new loans (the central bank announced that the interest rate for newly issued corporate loans in the first quarter was 3.75%, the same as in December 2023), it is inevitable to further optimize the asset-side structure and increase credit inclination with relatively high returns. Credit investment accelerated marginally in 1Q24, driving the share of loans in total assets to 1.6 pct to 45.4% compared to 4Q23. In the next phase, we still need to pay attention to physical demand and retail credit demand.

Risk control has not been slackened. 2H23 real estate defects have been confirmed faster, yet the overall asset quality remains excellent, and 1Q24 bad generation is still at an absolute low level: although the bad rate for public real estate has risen marginally like an industry trend (4Q23 defect rate increased 2.5 pct to 6.36% in mid-year), the asset quality of the Bank of Hangzhou still maintains the absolute advantage of listed banks. We estimate the annualized bad generation rate of 1q24 plus write-off disposal is -29 bps (2023:33 bps). On the one hand, it benefits from its own prudent risk appetite; on the other hand, with excellent asset quality and high provision accumulation, risks can be identified and treated early, thereby driving a virtuous cycle of “credit investment - performance - asset quality”. Looking at forward-looking indicators, the 1Q24 attention rate and overdue rate increased by 12 bps and 5 bps to 0.52% and 0.67% month-on-month. It is expected to be affected by the new financial asset risk classification regulations, as well as the rising risk of real estate risk clearance and declining retail sales. However, the forward-looking indicators are all absolutely low for listed banks, and the pressure on potential asset quality is manageable.

Investment analysis opinion: The Bank of Hangzhou's quarterly performance growth rate remains at the top of listed banks. We believe that in the past, the Bank of Hangzhou placed emphasis on risk management and control and forward-looking risk disposal, laying the foundation for excellent asset quality, which can better support the continuous release of excellent performance and maintain a “buy” rating. In the future, we need to focus on tracking the trend of stabilizing interest spreads and the core tier 1 capital replenishment process, which is also the key to stabilizing revenue performance. Considering prudent risk appetite and pressure on interest spreads, we lowered the 2024-2025 net profit growth rate to 20.9%/21.4% (previously 25.0%, 25.6%) and added a 22.1% forecast for 2026. The current stock price corresponds to 0.66 times 2024 PB.

Risk warning: Economic recovery falls short of expectations, asset quality deteriorates beyond expectations; retail demand improvement is significantly lower than expected; interest spreads continue to be under pressure.