This article comes from Pengyuan International.
On September 2, Pengyuan International awarded China Merchants Bank Co., Ltd for the first time (China Merchants Bank Co., Ltd., referred to as "China Merchants Bank", 03968.HKmaire 600036.SH) international scale 'Amuri' long-term principal rating and 'Amuri 2' short-term principal rating, with a stable outlook.
The rating takes into account bbb' 's independent individual credit score (SACP), reflecting China Merchants Bank's strong retail business, consistent outstanding profit performance, industry-leading provisions and ample liquidity coverage. The operating results of China Merchants Bank in the first half of 2020 show that the outlook for the rest of 2020 may still be challenging. Nevertheless, we believe that the credit status of China Merchants Bank will still meet our expectations for this rating in the next 12 to 24 months. In addition, considering the size of China Merchants Bank and its relevance to the market, we regard it as a strategically important entity in China's financial system. In view of this, we believe that the public sector has a strong willingness to provide emergency liquidity and capital support to China Merchants Bank when necessary.
However, while China's economy has recovered strongly in recent months, there are still significant risks in the banking sector's lending business. With the regulation of credit approval and loan recognition standards, we pay particular attention to the formation of non-performing loans (NPL) in the coming quarters. We will also closely monitor the migration of SML to non-performing loans to assess the possibility of a surge in credit costs in 2021. The orderly transition to the new regulatory framework for wealth management products (WMP) is also an important consideration for future ratings.
The stable outlook reflects our view that China Merchants Bank has a strong return on capital and provision coverage, which will provide a sufficient buffer for the bank in the context of a tightening external market environment.
If China Merchants Bank's capital and reserve buffers deteriorate sharply due to the formation of a large number of non-performing loans, we will consider downgrading China Merchants Bank. On the contrary, if China Merchants Bank's capital position improves significantly, we will consider upgrading the bank's rating. However, in view of the adverse macro factors, we believe that such a situation is less likely to happen in the next one to two years.
Key rating point of view
Positive factors
A strong retail business. China Merchants Bank has a sound national retail business, which brings it a stable and low-cost capital base, as well as better loan assets. From 2017 to 2019, the bank's retail deposits accounted for an average of 35 per cent of the total deposit base, which was significantly higher than that of other joint-stock commercial banks and only slightly lower than that of state-owned banks. Over the same period, China Merchants Bank's retail loans accounted for 53% of total loans, much higher than the industry average. We believe that the penetration of China Merchants Bank's retail business is a sustainable competitive advantage, which will help the bank to continue to improve its profitability.
Profit performance has always been outstanding. The average return on assets and average return on equity of China Merchants Bank have always been better than those of its domestic and international counterparts. We believe the bank is highly profitable mainly because of its retail-oriented lending business, its lighter asset business model and its emphasis on fee income. Given China Merchants Bank's adequate capital and sound provisions, this outstanding performance is particularly impressive. Another advantage is that the bank's stock market performance is relatively strong, giving management more flexibility to raise common stock if necessary.
Industry-leading provision and liquidity coverage. China Merchants Bank continues to increase its provision coverage, from 179.0% in 2015 to 426.8% in 2019. At current levels, China Merchants Bank has sufficient provisions for scenarios where the non-performing loan ratio is 4.1 per cent, while the bank's actual problem loan ratio (non-performing loans plus concern loans) is 3.3 per cent. We believe that in a challenging macro environment, this provides a much-needed capital buffer for China Merchants Bank. In fact, China Merchants Bank is one of the few banks in China with sufficient provisions to deal with problem loans. Similarly, the bank has been trying to increase its liquidity position, increasing its liquidity coverage from 119.7 per cent in 2015 to 171.5 per cent in 2019.
A strategic role in China. Although China Merchants Bank still fails to meet the inclusion requirements of global systemically important banks (G-SIB) in the foreseeable future, we believe that if China Merchants Bank fails (hypothetically), it is very likely to bring significant risks to the financial system. Our assessment is based on the fact that China Merchants Bank (by assets) is the largest joint-stock commercial bank in China and the seventh largest bank in China's domestic banking system. In addition, we consider the relevance of banks (interbank assets / liabilities), alternatives (fiduciary / custodial assets, etc.) and complexity (illiquid assets). Therefore, we believe that the public sector has a strong willingness to provide support when China Merchants Bank is in trouble.
Negative factors
Transition to a new regulatory framework for financial products. By the end of 2019, among all the state-owned banks and joint-stock banks in China, the risk exposure of wealth management products of China Merchants Bank accounted for the highest proportion of the balance sheet, accounting for more than 40% of its deposit base. Although we believe that regulators may extend the transition period of the new regulations by one to two years from the end of 2020, wealth management products may still involve significant compliance risks. We believe that the ability of China Merchants Bank to transition to the new regulatory system in an orderly manner is an important consideration for rating.
It is vulnerable to the influence of China's economy. As the seventh largest bank in China, the financial performance of China Merchants Bank is bound to be affected by high fluctuations in the industry. In a major adverse downward cycle, we also have concerns about China Merchants Bank's potential exposure to non-performing loans. In particular, we note that about 35% of concern loans moved to the non-performing loan category in 2019. While we are optimistic about the level of provision of banks, we believe that their asset classification can be more cautious.