Core views

The Bank of Hangzhou's 1H24 performance was in line with expectations. While the decline in interest spreads narrowed and the scale continued to increase, the decline in core revenue slowed and the quality of revenue improved. The release of profits of more than 20% was maintained through provisions to make up for the apology. Asset quality is generally stable, but retail asset quality continues to deteriorate and requires continued attention. Looking forward to the future, the Bank of Hangzhou has significant location advantages and a foundation of government-related business, and its revenue performance may be better than that of its peers driven by scale. With the support of steady asset quality and generous “family base”, there is some room for profit release. It is expected to maintain profit growth of about 20% in the short term, and it is expected to maintain a stable position in the first tier of the industry.

occurrences

On August 28, the Bank of Hangzhou released its 2024 semi-annual report: achieved operating income of 19.34 billion yuan, a year-on-year increase of 5.4% (1Q24:3.5%); realized net profit to mother of 9.996 billion yuan, an increase of 20.1% (1Q24:21.1%). The 2Q24 defect rate was 0.76%, the same quarter-on-quarter; the 2Q24 provision coverage rate fell 6.1pct quarter-on-quarter to 545.2%.

Brief review

1. Net interest income changed from negative to positive, and revenue quality improved month-on-month. Combined investment income continued to increase, and Bank of Hangzhou's 1H24 revenue growth rate rebounded slightly. 1H24 Hangzhou achieved revenue of 19.34 billion yuan, a year-on-year increase of 5.4%, and the revenue growth rate increased 1.9 pcts from quarter to quarter. Specifically, net interest income increased slightly by 0.5% year-on-year, and changed from negative to positive from -1.9% in 1Q24. The net interest spread decline was narrower compared to the same period last year. It is expected to be related to the reduction in deposit-side listed interest rates and the drop in high-cost deposit pressure after manual interest payments were banned. In the case of fee reduction and concessions, revenue still fell 9.9% year on year, but the decline was narrower than in 1Q24 (-16.4%). As net interest income and revenue both improved month-on-month, the year-on-year decline in Bank of Hangzhou's 1H24 core revenue narrowed from 4.5% in 1Q24 to 1.2%, and revenue quality improved month-on-month. Furthermore, investment income from transactional financial assets continued to grow at a relatively rapid rate. Investment income increased 55.4% year over year, driving overall non-interest income growth of 14.4%, which strongly supported revenue. With a narrowing decline in core revenue and a high increase in investment income, the Bank of Hangzhou's 1H24 revenue growth rate bucked the trend and rebounded slightly.

Under the overall sound quality of assets, profits continued to be released by “making up for profit” through fewer provisions, and profit growth remained above 20%. Bank of Hangzhou's net profit from 1H24 increased 20.1% year-on-year, and currently ranks first among listed banks that have disclosed their semi-annual reports. In terms of performance attributions, provision estimates, scale growth, and other net income contributed positively to profit of 13.3%, 9.8%, and 6.3%, respectively; while narrowing interest spreads and falling earnings were the main drag factors, contributing negatively to net profit of 9.5% and 1.3%, respectively.

Looking forward to the future, in the macroeconomic context of insufficient demand for effective credit and fee cuts and concessions, core revenue growth is “easy to fall”. After the central bank is concerned about interest rate risks on long-term bonds, investment income growth is likely to gradually decline, and support for revenue has weakened, and the Bank of Hangzhou's revenue is still under some downward pressure. However, considering the economic foundation of the Jiangsu and Zhejiang regions leading the country, the Bank of Hangzhou has a clear location advantage, and its revenue performance may be better than that of its peers, driven by scale. Supported by steady asset quality and a strong “home base”, there is some room for profit release. It is expected to maintain profit growth of around 20% in the short term, and it is expected to remain in the first tier of the industry in the medium to long term.

2. The decline in net interest spreads has narrowed: downward pressure on the asset side is still strong, and cost pressure on the debt side underpins interest spreads. 1H24 Bank of Hangzhou's net interest spread was 1.42%, down 14 bps year on year (1Q 24:16 bps). Compared with 2H23, down 4 bps month-on-month, the decline in interest spreads narrowed. The net interest spread (estimated value) for 2Q24 was 1.4%, down 3 bps from quarter to quarter. Looking at both asset sides, 1H24 Hangzhou Bank's yield on interest-bearing assets was 3.72%, down 10 bps month-on-month from 2H23, 21 bps year-on-year, and 2.21% interest-bearing debt cost ratio, down 5 bps month-on-month from 2H23, and 10 bps year-on-year. Looking at it now, with LPR declining and demand insufficient, the downward pressure on asset-side interest rates is still strong. However, with the implementation of policies prohibiting manual interest payments and lowering interest rate listings on deposits, debt-side cost pressure has lowered interest spreads, and the Bank of Hangzhou's interest rate reduction has gradually narrowed.

The asset-side structure continues to be optimized, and the scale of credit continues to increase rapidly. The infrastructure sector and science and innovation loans are the main credit investments. 2Q24 Bank of Hangzhou's assets increased 13.8% year on year. Among them, loan and bond investment increased by 16.5% and 16.1%, respectively, accounting for 45.4% and 47.6% of total assets, respectively. At the same time, the asset size of the lower yielding sector fell sharply by 36.8% year on year, and the asset structure continued to be optimized. Looking at credit investment, infrastructure and government-related businesses are still the main loan investments of major banks in Hangzhou. Among them, loans for major infrastructure, leasing and commercial services increased by 23.2% and 23.4%, respectively, accounting for 43.3% and 18.5% of the total loan increase in the first half of 2024. Under Hangzhou's “double 100 billion” project and the policy plan for developing new infrastructure such as computing power, the Bank of Hangzhou, as a local legal entity, can still maintain a good foundation in infrastructure credit requirements and project reserves. In addition, the Bank of Hangzhou is also actively developing a new financial circuit for science and innovation. Manufacturing loans increased 25.3% year-on-year, accounting for 13.9% of the total loan increase in the first half of the year. In terms of price, Bank of Hangzhou's credit investment is mainly in the infrastructure category, and the pricing level is relatively low. Combined with insufficient credit demand and another drop in LPR, the Bank of Hangzhou's 1H24 loan interest rate continued to drop by 15 bps to 4.35% compared to 2H23 compared to 2H23. Meanwhile, bond interest rates were generally in a downward range in the first half of the year, and the yield on bond investment fell 16 bps to 3.37% compared to 2H23.

Debt-side cost control is strong, and retail demand deposits are growing well. In 2Q24, bank deposits in Hangzhou increased 13.7% year on year and 3.4% quarter-on-quarter, and deposit size continued to grow at a relatively rapid pace. Structurally, the trend of deposit fixed-term deposits continues, but the growth trend of retail demand deposits has improved markedly. In 2Q24, Bank of Hangzhou corporate fixed term deposits and retail time deposits increased by 24.6% and 29%, respectively. The share of time deposits increased 4.6pct quarter-on-quarter to 52.1%. In terms of current deposits, the Bank of Hangzhou relies on its strong political business advantages and has built up a solid foundation of public deposits through settlement, financial deposits, etc. However, due to factors such as cleaning up manual interest payments in the second quarter, corporate demand deposits fell 7.9% from quarter to quarter, accounting for a decline of 4.7 pct to 38.1%. However, retail demand deposits showed good growth. In 2Q24, retail demand deposits increased 13.7% year over year and 9.2% quarter over quarter. In terms of deposit costs, as the benefits of lower interest rates on deposit listings gradually became apparent, compounded by the withdrawal of high-cost deposits such as manual interest payments, the Bank of Hangzhou's 1H24 deposit cost fell 7 bps to 2.08% compared to 2H23, strongly supporting interest spreads.

3. The defect rate is stable and low, and the provision coverage base is sufficient. In terms of key risk areas, real estate risks continue to be exposed and the quality of retail assets is still deteriorating, leading to a slight increase in bad performance, which requires continued attention. In 2Q24, the Bank of Hangzhou's non-performing rate remained flat to 0.76%, and the provision coverage rate fell 6.1pct quarter-on-month to 545.17%. The provision base was sufficient, leaving enough room for the sustainable release of profits. Looking at forward-looking indicators, the focus on loan ratio and overdue rate increased by 13 bps and 8 bps to 0.53% and 0.7%, respectively, compared to the beginning of the year. At the same time, the 1H24 plus write-off failure rate was 0.53%, up 36 bps year on year and 6 bps month-on-month. It is expected to be mainly related to the deterioration in asset quality on the retail side and the continued clearance of real estate risks. Among them, non-performing loans to public real estate continued to increase by 11.8% compared to the beginning of the year, and the non-performing ratio to public real estate increased by 71 bps to 7.07% from the beginning of the year. In terms of retail loans, the non-performing ratio of operating loans and consumer loans increased by 22 bps, 22 bps to 0.91%, and 1.32%, respectively. Against the backdrop of a weak economic recovery, the ability of residents and individual households to repay has not improved significantly, and the quality of retail loan assets still requires continued attention. In terms of restructuring loans, as the size of individual restructuring loans has been disposed of, the size of restructuring loans has decreased by 13% to 2.855 billion yuan compared to the beginning of the year. Of this, 2.524 billion yuan has been classified as non-performing loans, accounting for 88.41% of the total restructuring loans.

4. China Life Insurance's holdings reduction is mainly due to its own asset allocation considerations, and the pace of holdings reduction is expected to be relatively smooth. The Bank of Hangzhou's own fundamentals is still in the first tier of the industry. Currently, under pressure from capital adequacy ratios, it has certain demands for additional capital from external sources such as convertible bonds for equity swaps. On August 20, China Life Insurance, a shareholder of the Bank of Hangzhou, plans to reduce its holdings by no more than 0.11 billion shares, accounting for 1.86% of the company's share capital. It is expected that China Life Insurance will reduce its holdings in the Bank of Hangzhou mainly due to its own asset allocation considerations and “cash out” needs. In the context of the current dominant dividend strategy, insurance capital or diversified allocation with high dividend targets is preferred. However, the Bank of Hangzhou's dividend rate level is relatively low in the industry, but its fundamentals are still at the leading level in the industry. In the current context of weak economic recovery, the valuation premium for individual APLHA stocks has been relatively suppressed to a certain extent. Currently, the Bank of Hangzhou's capital expansion is still at a high level. The 1H24 core tier 1 asset adequacy ratio is 8.63%, and there are still certain demands for additional capital from external sources such as convertible debt-for-equity swaps. As of August 28, the strong ransom price of Bank of Hangzhou's convertible bonds was 15.24 yuan/share, which is still a 15% increase from the current stock price. If convertible bonds are successfully redeemed, the core Tier 1 capital adequacy ratio of 1.27pct can be added under static estimates, which strongly supports the sustainability of the Bank of Hangzhou's scale growth, thereby guaranteeing stable profit release, and it is expected that the dividend rate level will gradually increase in the future.

5. Investment advice and profit forecast: Bank of Hangzhou's 1H24 performance was in line with expectations. As interest spreads narrowed and scale continued to increase, the decline in core revenue slowed and revenue quality improved. The release of profits of more than 20% was maintained through provisions to make up for the apology. Asset quality is generally stable, but retail asset quality continues to deteriorate and requires continued attention. Looking forward to the future, the Bank of Hangzhou has significant location advantages and a foundation of government-related business, and its revenue performance may be better than that of its peers driven by scale. With the support of steady asset quality and generous “family base”, there is some room for profit release. It is expected to maintain profit growth of about 20% in the short term, and steadily rank in the first tier of the industry. Revenue growth in 2024-2026 is expected to be 4.0%, 9.1%, 10.4%, and profit growth rates of 20.5%, 20.6%, and 21.0%. Currently, the Bank of Hangzhou's stock price only corresponds to 0.68 times 24-year PB, maintaining the buying rating and leading position in the banking sector.

6. Risk warning: (1) Economic recovery is falling short of expectations, corporate solvency is weakening, and some enterprises with poor credit levels may be at risk of default, leading to the risk of bad bank exposure and a sharp decline in asset quality. (2) The concentrated exposure of risks in key areas such as real estate and local financing platform debt has had a major impact on the quality of banks' assets and greatly weakens banks' profitability. (3) The strength of the credit leniency policy falls short of expectations, and the rapid economic development in the region where the company operates is unsustainable, thus having a significant adverse impact on the company's credit investment. (4) The effects of retail transformation fell short of expectations, and large-scale fluctuations in the equity market affected the company's wealth management business.