Incident: The Shanghai Agricultural Commercial Bank disclosed its 2023 annual report and 2024 quarterly report. 1Q24 revenue increased 3.7% year on year (2023:3.1%), and net profit to mother increased 1.48% year on year (2023:10.6%). The 1Q24 defect rate increased by 2 bps to 0.99% month-on-month, and provision coverage decreased by 23.1pct to 382% month-on-month.

The performance growth rate was lower than expected, and the increase in credit impairment losses over the same period last year led to a slowdown in net profit growth. Although 1Q24 revenue growth (3.7%) was slightly better than 2023 (3.1%), driven by non-interest revenue, credit impairment losses dragged down performance. 1Q24 net profit growth converged to 1.48%, lower than our forward-looking expectations (5.4%), and the marginal decline also exceeded market expectations. Looking at the driving factors: ① Non-interest income contributed positively to the performance 5.2 pct: 1Q24 non-interest income increased 21% year over year. In addition to investment income ($542 million), housing expropriation led to an increase in one-time income (528 million), completely hedging the impact of a 24% year-on-year decline in the adjustment of dropshipping insurance premiums. ② The 1Q24 scale contributed positively to revenue by 6.5 pct (2023:7.1 pct), but interest spreads still narrowed month-on-month, so the net interest revenue contribution was 1.5 pct (2023: -0.2%).

③ The contribution of the provision to performance changed from positive to negative, with a negative contribution of 7.2 pcts (2023:5.7 pct).

The focus of the first quarterly report: ① Net profit growth decelerated, temporarily affected by new asset classification regulations and disrupted by the pace of preparations. With a slight acceleration in revenue, the year-on-year growth rate of 1Q24 net profit slowed to 1.48% compared to 2023 (10.6%) (net profit after deducting asset disposal income fell 10% year over year), mainly due to a year-on-year increase in the scale of credit impairment. 1Q24 credit impairment losses increased 72% year-on-year, of which: 1) the new financial asset risk regulations extended the scope of recognition from loans to all financial assets that bear credit risk, with corresponding impairment charges for off-balance sheet credit commitments, which had a one-time accrual impact; 2) The impact of differences in calculation rhythm: 1Q23 credit impairment losses were only 490 million, accounting for 17.2% of the year, and 1Q21-1Q22 accounted for 26.5% and 17.1% respectively. Considering the increase in non-operating income from 2Q23 due to participation in Hangzhou United Agricultural Commercial Bank, it is expected that short-term performance will remain under pressure. ② The provision coverage rate is less than 400%, mainly because the original provision calculation standards in the bank were higher than the new risk classification regulations, so provision coverage for new non-performing loans declined, affecting the overall provision coverage performance. ③ Credit growth is steady due to bill impulse, but physical demand is still weak. 1Q24 added 11.9 billion dollars in credit. Assuming that the credit increase in 2024 is comparable to 2023 (40.9 billion), the corresponding increase accounts for 29% (24%/32% for 1Q22/1Q23, respectively), and the pace of credit investment is in line with expectations. However, the credit structure in the first quarter (decline in retail sales, bill impulse) still shows that demand from regional entities is weak. In the future, more attention will be paid to retail, science, innovation, and inclusive credit boosting the structure.

Asset-side credit performance fell short of expectations, and the narrowing of interest spreads mainly stemmed from a positive contribution to improving deposit costs. ① The first-quarter notes had an impact, and the credit structure was relatively poor, but considering the existing advantages of Shanghai and agriculture in the two major fields of science and innovation and inclusive finance, focus on the next phase of structural optimization: 1Q24 loans increased 6.1% year-on-year (2023:6.1%), corresponding to an increase of 11.9 billion dollars in 1Q24. Looking at the structure, 1Q24's share of public credit increased by 6.5 billion dollars, an increase of 20% in 2023 (1Q 23:47%), and retail credit decreased by 5.7 billion dollars; in addition, 1Q24 notes increased by 11 billion dollars, reflecting that demand for credit is still weak, and we need to pay attention to the improvement of the credit investment structure in the future. ② Under the poor credit structure in the first quarter, we estimate that 1Q24 interest spreads fell 2 bps month-on-month, mainly due to debt-side cost optimization: we estimate that the debt-side cost ratio fell 7 bps month-on-month. Among them, under weak effective credit investment in 1Q24, deposits increased by 4.9 billion yuan, a year-on-year decrease of 13.7 billion dollars, and the share of deposits in total debt fell to 77.4%; it is expected that the decline in debt-side costs will benefit on the one hand from deposit product structure optimization and deposit heavy pricing; on the other hand, the decline in market capital interest rates will help improve market-based debt costs.

Risk disturbances at the end of retail are compounded by the impact of new regulations, and asset quality indicators fluctuate slightly. The 1Q24 defect rate increased 2 bps to 0.99% month-on-month, and the attention rate increased by 4 bps to 1.27% month-on-month. It is expected to be affected by the rising risk of declining retail customers. This is also a common risk in the industry; the annualized defect generation rate corresponding to write-back disposal increased marginally to 0.82% (2023:0.44%), but the absolute level is still low. The 1Q24 provision coverage rate was less than 400%. We determined that it was mainly due to the bank's original asset impairment accrual standards being higher than the new risk classification regulations, which led to a decline in provision coverage for new generation poor responses, affecting overall provision performance. It is expected to be a one-time disruptive factor.

Investment analysis opinion: The overall performance of the first quarter report was slightly lower than expected. The pace of annual revenue and profit growth became the core principle of valuation repair. We expect the Shanghai Agricultural Commercial Bank to achieve steady, safe, and sustainable scale expansion as scheduled, consolidate growth potential on the basis of a high dividend advantage, and maintain the buying rating. Credit costs were raised and interest spreads were lowered based on prudential principles, and the 2024-2025 net profit growth rate was lowered to 5.8% and 6.9% (originally 15.7%, 16.5%), and the net profit growth rate forecast for 2026 was added to 8.0%. The current stock price corresponds to 0.56 times 2024 PB. Considering that the company's current stock price corresponds to a dividend rate of 5.4% for 2024 and announced the 2024 mid-term dividend, it still has predictable steady returns and maintains a buying rating under the current market strategy where high dividends still dominate.

Risk warning: Economic recovery fell short of expectations, asset quality deteriorated beyond expectations; improvements in demand for science and innovation, inclusive small and micro businesses, and retail sales were significantly lower than expected; end-of-line risks such as retail sales exceeded expectations.