A. Effective credit control in 1H2008 but with growing performance for listed banks

1. Macro-economy growth rate declined as expected

As released, in 1H2008, GDP growth rate for China declined to 10.4% from former high level, CPI descended from 8.4% to 7.1%, and the Monitoring Signals of Macro-Economic Climate Index dropped to 114.9(normal at 100). In general, the danger of heated economy has relieved, which goes back to “Green district”. We believe the possibility of soft-landing for China economy has increased and the sustained development ability is strengthening, which both are beneficial to long-term development of banking.

2. Effective Credit-scale control

As end of June, loans balance of RMB reached 28.62 trillions, adding 14.12% YOY, 1.98 and 0.74 percentages lower than that of 2007 and May,2008. Meanwhile, loans increment of RMB was 33.24 billion in June, 119 billions less than that of June 2007, and that increment in first 6 months was 245.25 billions, 89.9 billions less than that of 1H2007. In sum, loans increment in June and first 6 months accounted for 9.16% and 67.56% of the whole 2008 year, in line with controlling steps of PBOC.

3. Listed banks announced estimated improvement of performance

Many listed banks have published estimated improvement of performance, which show the growth rate is still high. Furthermore, scale enlargement, NIM widing, intermediary business growing and downturn tax rate were key factors underpinning increased performance.

B. Tighten monetary policy keeping on but with little adjustment, NIM will turn around

1. Tighten monetary policy will keep on

Recently the government put on some economy forums, and the media emphasis that decision-making will adjust from inflation-control to economy-growing. From the beginning of August, PBOC has loosen credit-scale about 5% for state-owned commercial banks and 10% for regional commercial banks. Loosened policy is indeed beneficial to performance of banks, and may lessen NPL increment. However, we believe the policy-adjustment is just a minute-adjustment, supporting some sides and suppressing other sides, which indicate the tighten policy won’t be changed easily.Generally speaking, tighten monetary policy will be reflected as following: Firstly, loans scale has been adjusted up a little, but the growth rate will be only 15-16%, lower than 16.56% of 2007; Secondly, before tip at 20%, the statutory reserve requirement ratio may climb up continuously; lastly, a base interest rate rate hike is still possible in 2H2008. Recently, the pressure has been relaxed a little, because oil price has slumped from its top and America is not intended to raise the rate to control its inflation. What’s more, PBOC is also going to slow down its steps of RMB revaluation, which will take effect on rate-hike decision.

2. Net interest margin may turn around

Benefited from loans price renegotiation in 1Q2008, NIM for most listed banks began to rise significantly. However, from 2Q, the renegotiation has completed at large, NIM may be mostly influenced by negative factors: Firstly, the time structure change for deposit and loan. It is opposite between medium to long term trend of loans and timed deposit. As showed on Figure7-8, although the medium to long term trend hasn’t changed from 2006, the proportion for time deposit had also decreased down by 2007, which is best for banking operation. However, the loans medium-to-long trend continued, but the proportion for time deposit went up again, which added interest burden for banks. Looking into that, we find the proportion for medium-to-long term loans only climbed up 1.1 percentages, meanwhile the proportion for time deposit added 3.24 percentages. Then taking account of deposit rate spread between short and medium-to-long term larger than the rate spread between short and medium-to-long term loans, and the loan-to-deposit ratio decreased over 3 percentages, we think timed deposit take more negative effect on NIM. By quarter, although the NIM went up in 1Q, it may had turn around in 2Q.

Secondly, from the view on price-negotiation capability for banks, tighten credit policy will cut back capital supply, then drive the up-floating loans up. However, From the 1Q data released by PBOC, the proportion for down-floating loans had descended by different degree, but only the proportion for up-floating loans for banking corporation had increased, which showed the strengthen of price- negotiation capability for banks had not been obvious.

On the points of loans demand, the data in 1Q tell us that the demand was being at top, but the index was also near to history tip. And taking account of the simulating effect of snow disaster , we think the demand was not as high as it appeared. What’s more, viewed by ration loans expense on GDP, we can find that the ratio was highest as 8.6% in 1996-1997, but the normal level remained on 5-6%. At present, the ration reached 8% again. The burden may not be accepted by enterprises. Especially, the GDP growth rate is slowing. Therefore, we think the loans demand won’t be as high as before, which possibly will influence the price-negotiation capability.

In sum, we believe the NIM will turn around, but the decrease is not sharp, let NIM still be expected to maintain above 2.5%.

3．Intermediary business making performance growing

In 2008, the enlargement of funds agent business slowed significantly because of slump capital market, and add the worry about slowing growth rate of intermediary business. However, we think the growing speed will still be high as 30-50%, and make performance growing continually. The key factors are following:Firstly, because of increased resident wealth and strengthened financing intent, although the enlargement for high-risk securities and funds is slowing, other financing productions such as banking and insurance also own a wide market;Secondly, the disaster such as snow and earthquake drive the insurance market up by a large degree, banks also benefit from it. In 1H 2008, insurance agent business for some banks even go up 100% or above.Thirdly, compared with 20-30% proportion of some international peers, intermediary business for mainland banks still own great room.As a matter of fact, the issue of mainland financing productions are speeding up. By July, the planed recruitment fund scale has accounted 92% for that of 2007.

4．NPL may bottom but with limited upwards room for NPL ratio

As released by CBRC recently, NPL and NPL ratio both decreased in 1H 2008 for commercial banks. The NPL balance reached 1.24 trillionS by June, 25.92 billions lower than 2007, and the ratio was just 5.58%, 0.59 percentage lower than 2007. Categorized by kinds of banks, the NPL was cut back mostly for banking corporation, whose NPL ratio is only 1.65%.By quarters, the decrease for the first and second quarter were respectively 22.77 and 3.1 billions, the latter was lower than the former obviously. We also believe the decrease for NPL in 2Q mainly came from NPL write-down, excepted for which the NPL was actually upwards.The most worry for the market is the fluctuation of property price, which is anticipated to influence the assets quality of banks and drive NPL up. However, we expect the degree is not big. Based relative estimation, the NPL ratio for property developing loans is lower than 4% at nowadays property price. Even taking account of 30% downwards price, the ratio only increase about 2.7 percentages. The stress test by BoCom also show us that the performance and assets quality will get obvious negative effect only by 40% downwards price.Taking Shenzhen as an example, although the property price slide down sharply, the director of Shenzhen CBRC still talked that, by June, with the cautious standard, namely loans overdue 90 days is gauged as doubtful account, the NPL ratio for residents of state-owned banks was just 0.79%, 0.11 percentage higher than 2007.Generally speaking, we are cautious about macro-economy and enterprises’ profit, while the NPL ratio and cost on credit will increase, but with small degree. For listed banks, property relative loans of CITICB, BoCom and ICBC are lower than average peer level, but that of BOC will suffer more from it.

5.Assets quality won’t worsen significantly

Assets quality for mainland banks have improved steadily for past few years. Compared with international banks, the capital adequacy ratios for mainland banks have reached middle level, among which the banks listed in HK are better in assets quality and own stronger capital to react to risks. In future, because we judge the property price isn’t be sharp slide, the assets quality also won’t worsen significantly.

C. Unstable financial situations may suppress market performance

1. Performance growing up rapidly

We think the credit scale of banks will still expand above 15%, and the NIM will maintain at a comparatively high level, meanwhile the intermediate business will grow up continually, we believe, the growing trend of banks’ performance will hold, but with a slow rate, respectively at about 50% and 20% in the next two years.

2. Limited impact on performance but highly suppressed confidence from Sub-prime crisis

The sub-prime crisis has evolved to finance crisis, the Freddie Mac and Fannie Mae crisis has become more attentive after sub-prime debt allowances.Because the two-F debentures are quasi-governmental, and the American government has taken all kinds of measure to save the two companies, the tense situations have buffered.With regard to mainland banks, BOC suffer mostly from the crisis, but with not grave degree. Other banks suffer less. In general, the influence on mainland banks from American crisis is limited.However, what we wanna highlight is the slump property price in US, if it doesn’t stabilize, a variety of risks will break out continuously, which will keep market confidence down, and clamp the financial stock price down..

3. Evaluation seems a little high

By the end of July, the P/E and P/B for mainland and Hongkong banks both seem a little high in global world. Although the evaluation have the support from growing economy, the unstable financial situations won’t end in short term, and confidence-rebuilding need a long time. Therefore, we are cautious about mainland banks, giving “Market perform” rating.

However, in medium-to-long term’s view, we think finance is the center of economy and Chinese economy is anticipated to be optimistic, banking stocks will outperform market at last. Moreover, ICMB, BoCom and MB each has its own advantages, deserving close attention.By comparison, ICMB has most all-round networks and operates more conservatively, which give it stronger anti-cycle capability. BoCom has developed clear strategy, whose credit structure is also better because property relative loans proportion is smaller. What’s more, the virtues of CMB lie in the retail business and innovation business. It operates more elastically when seeking scale and profit.