Huachuang Securities' Banking Industry Investment Strategy for 2025: Expectation of Improved Bank Asset Quality Shifts to Bottom Line Risk Thinking

Huachuang Securities released a research report stating that, after September 24th, a series of policies aimed at boosting the economy were intensively implemented. From the press conference of the three financial regulatory bodies to the Politburo meeting, and then to the NPC Standing Committee, it will take some time for the policies to transmit to economic data verification, but the intensive introduction of these policies is beneficial for stabilizing bank asset quality improvement expectations, and also signals stable credit growth for CKH HOLDINGS. The current dividend yield of the banking sector is 5.16%, with a PB ratio of 0.5X, still below the 17.8 percentile of the past 10 years, corresponding to EROE of 10% and 9.6% in 2024/2025, still having allocation value. Key points from Huachuang Securities are as follows: New balance of supply and demand in 2025: Expect slower growth of assets and liabilities and weakened price constraints. 1) It is expected that the credit growth in 2025 will be slightly weaker than that in 2024, but social financing growth will be better than in 2024. Considering the regulatory direction of "squeezing out fake credit" and "reducing amount and improving quality" have not changed, and banks have shifted their focus from the past "scaling" mindset, it is expected that the new credit scale in 2025 will be slightly lower than in 2024, with a total credit scale of 18-19 trillion expected for the year, and the growth rate will slow to 7.0% - 7.4%. However, considering the background of "broad fiscal policy" in 2025 and the low base of this year, it is expected that the growth rate of social financing will be better than this year. In terms of pace, it is expected that the credit release pace in 2025 will be more forward-leaning, with the market share concentrating towards large banks. 2) Deposit listed interest rates on the liability side are expected to continue to decline, and high-quality liabilities growth of small and medium-sized banks face tests. In a low-interest rate environment, bank deposits may face pressure forcing "deposit switching to asset management products" and liquidity tiering pressure forcing "deposits switching to state-owned banks and smaller banks". However, the current size of liabilities is not the main factor restricting the expansion of assets, and the core contradiction of asset expansion is still weak effective demand. 3) Channels for capital replenishment for high-quality banks are becoming more streamlined. With the implementation of new capital regulations and the expected expansion of the senior law, it is conducive to the long-term capital conservation of high-quality banks. The urgency for banks to supplement capital through internal profits has temporarily decreased. At the same time, the issuance of special national bonds to supplement the capital of the six major banks, it is expected that the overall capital replenishment pressure for high-quality banks in 2025 will marginally slow down, and the channels for capital replenishment for high-quality banks will become more streamlined. 4) Static calculation of interest spread in 2025: There is still downward pressure, but the narrowing of the interest spread decline. Based on static calculations, considering the impact of existing interest rate adjustments on the net interest spread of listed banks in 2025, the decline in interest spread remains under pressure, but the overall decline will narrow. 5) The conservatism of the balance sheet should be higher than the flexibility of the income statement. Considering the current regulation emphasizing "maintaining a reasonable level of interest spread for banks", and the expected expansion of the senior law combined with the issuance of special national bonds to supplement the capital of large banks, the urgency for banks to rely on internal profits to supplement capital has relatively decreased. We believe that interest spread is not the main factor currently restricting the long-term stable operation of the banking industry. The healthy stability of the balance sheet is more important than high-speed profit growth. With the growth of assets slowing down and the background of the bond market rebounding, while non-interest income growth slows down, it is expected that there will still be pressure on the year-on-year growth of banks' operating income in 2025, but the healthy balance sheet of banks ensures that credit costs remain low and stable, expecting banks' net profit in 2025 to be relatively flat compared to 2024. Reassessment of bank risks in 2025: Focus on changes in risk expectations with bottom-line risk thinking. 1) Acceleration of bad debt transformation, stable expectations of bank asset quality under bottom-line risk thinking. With the implementation of the 10 trillion debt transformation policy in November, although debt substitution will reduce the interest spread of banks, at the same time, under the promotion of debt transformation policy, the effective resolution of local government hidden debts, improvement in asset quality of related bank assets, and cost savings in credit can offset the impact of the decline in interest income. We estimate that if the scale of hidden debt replacement is 2.8 trillion yuan each year from 2024 to 2026, with commercial banks holding 80% of the total (referring to the proportion of local government bonds held by commercial banks at the end of September 2024), a pessimistic assumption would impact the net interest income of banks by about 650 billion yuan, affecting the interest spread by 3 basis points and the profit by 2% in 2025. 2) Expected risk disturbance factors in 2025: Focus on fair stability and core concern for changes in retail asset risks. In 2024, the fluctuation of bank asset quality showed the characteristics of "corporate non-performing loan rate and net generation declining, with a slight increase in retail risk at a low level", with the non-performing net generation of commercial banks in the first half of 2024 at 0.35%, a year-on-year decrease of 0.4%. Considering that the current relevant countercyclical adjustment policies have been accelerating in succession, including the debt substitution of urban investment bonds, the extension of the 16 real estate finance policies, refinancing and continued lending to small and micro enterprises, we expect the overall net generation of non-performing loans in the banking industry in 2025 to fluctuate at a low level under the policy bottom line of "no systemic risk". If there is a deterioration in expectations for the change in non-performing net generation, we will focus on the transmission of changes in asset prices to retail risk and improvements in the retail credit environment, such as the improvement of residents' income, improvements in the consumption environment, etc. Bank fundamentals in 2025: Resilience in the basics. 1) Under policy protection, the bank's foundation becomes more stable: Considering the slowdown in scale growth and the weakening of growth in non-interest income, the overall industry will still face certain revenue pressures in 2025, but it is expected that the narrowing of interest spread will further reduce, and under policy protection, the stability of asset quality will be maintained, solidifying the industry's fundamentals. 2) Banks with suitable assets can benefit more from policy with greater flexibility in bank basics: Consider the background of debt transformation, regional banks benefiting from local economic development and expectations of improvement in fundamentals brought about by debt substitution. Focus on the elasticity of middle-income business of banks with outstanding investment banking capabilities or sufficient reserves of high-quality customers. Focus on the performance elasticity brought about by advanced technology and excellent customer retention to bank business optimization. Bank investment strategy in 2025: Setting sails for a new voyage. In the first ten months of 2024, the absolute and relative returns of banks were 24.7% and 11.3%, respectively (relative to the Shanghai and Shenzhen 300), derived from stable bank performance and dividend payouts, combined with a market environment that leans more towards defensive styles and pursuit of certainty. Recommended stock selection based on two main themes + one.The topic.1) Banks with high dividend yields and high asset quality margins still provide absolute returns. We suggest focusing on state-owned large banks and small to medium-sized banks with high reserve coverage ratios, such as Bank Of Jiangsu (600919.SH) and Shanghai Rural Commercial Bank (601825.SH). 2) Against the backdrop of economic recovery, banks with a high proportion of retail assets have more flexibility in their fundamentals and valuations. We recommend paying attention to China Merchants Bank (600036.SH), Jiangsu Changshu Rural Commercial Bank (601128.SH), Bank Of Ningbo (002142.SZ), Postal Savings Bank Of China (601658.SH), Zhejiang Shaoxing RuiFeng Rural Commercial Bank (601528.SH), and Ping An Bank (000001.SZ). 3) Against the backdrop of debt-to-equity swaps, some regional banks benefit from expectations of improved fundamentals due to local economic development and debt restructuring. We recommend focusing on Bank Of Chongqing (601963.SH), Bank Of Changsha (601577.SH), and Chongqing Rural Commercial Bank (601077.SH). Risk warning: Differences in policy implementation pace, exposure to local government financing vehicles and real estate risks, and banks' credit expansion falling short of expectations. Due to assumptions, the results may have some deviation from reality, and are for reference only.