CITIC SEC: Reassessing business model helps boost bank valuation, there is still room for further increase in the future.

CITIC SEC released a research report stating that reevaluating the value of the bank's business model is the core driver of valuation upside. From the perspective of existing assets, the current valuation is too pessimistic about the degree of net asset loss. The bank estimates that the current valuation of banks reflects loan loss levels exceeding 10 trillion yuan, which is better than the expected reality. From the perspective of incremental assets, the risk level of new assets in the next three years (2025-2027) will significantly ease, although the decline in interest margins will still lower ROE (the bank expects the banking industry ROE to fall to 8.3% in 2026), the easing of credit risk will enhance the long-term stability of ROE and aid in valuation upside. The market style implies a significant premium for safe assets, and the bank predicts that the advantage of the banking sector in terms of net asset security and ROE stability will continue to attract allocation demand, and changes in fund allocation behavior will continue to evolve. Based on the repositioning of bank business model risk expectations and growth expectations, coupled with a scenario analysis of the economic and policy environment in 2025, the bank believes that there is still certainty for valuation upside in the banking sector. The main points of CITIC SEC are as follows: Prospects for 2025: Consensus on low economic sentiment. 1) Expanding balance sheet: Steady growth. Mirroring the stabilizing growth of social financing, the bank expects the asset growth of listed banks in 2024/25 to be 7.9%/8.2%, and bond investment and retail loans may be the focus areas for bank allocation. 2) Pricing: Slowdown in the decline of interest margins. Combining repricing and the pace of interest rate cuts, the bank expects the net interest margin to decrease by 17bps/15bps in 2024/25, with one-off impacts of loan repricing still existing in Q1 2025. 3) Costs: Reduction in costs and increased efficiency remain the focus. Expenses continue to be saved, and the bank expects business and management expenses of listed banks in 2024 to maintain low single-digit growth; credit costs may exhibit some rigidity, mainly due to high retail credit costs with a lagging cycle attribute. 4) Profit: Slight improvement year on year. The bank predicts revenue growth of listed banks in 2025/26 to be +0.0%/+3.3%, and net profit growth to be +2.0%/+4.0%. In-depth analysis of bank credit assets: Decrease in risk level. As of 2024H1, according to central bank data, the total assets of commercial banks were 36.2 trillion yuan, with the household sector at 8.2 trillion yuan, urban investment sector at 8.1 trillion yuan, government sector at 5.5 trillion yuan, general public sector at 4.8 trillion yuan, manufacturing sector at 2.6 trillion yuan, and public real estate at 1.2 trillion yuan. 1) Real estate sector, policy bottom line sets risk bottom line. Since 2024, a number of real estate policies have been optimized, and in 2024, the non-performing loan ratio of real estate developers has shown a decline for the first time. 2) Manufacturing sector, structural optimization enhances quality resilience. In recent years, fixed asset investment has focused on high-end manufacturing industries such as TMT and equipment manufacturing, and with the rapid credit delivery, asset quality is resilient. 3) Urban investment sector: Debt-to-equity swaps help to converge risks. Urban investment debt financing is in a converging trend, and the progress of debt-to-equity swaps helps to steadily improve the quality of urban investment. 4) Retail sector: Still volatile but stabilizing. Currently, sensitive retail credit risks are fully exposed, and the bank predicts that the probability of future defaults will not exceed that of 2022-2024, with the future level of housing prices becoming a key variable. Prospects for the bank business model: ROE decreases but stability increases. 1) Optimization of asset structure will significantly increase net asset security. In the next 3 years (2025-2027), the bank predicts that the proportion of risk-free government bonds in incremental assets will increase significantly to around 30%, which is markedly higher than the current proportion (2024H1: 15.2%); meanwhile, the credit risk assets in incremental assets will be significantly better than those in existing assets in terms of entities, regions, and industries. 2) The optimization of asset risk expectations points to a decrease in asset returns, but the stability of ROE increases. There will still be downward pressure on net interest margins, but optimization of incremental assets and stabilization of existing asset risks will help lower credit costs, resulting in a stable and controllable ROE that converges to a medium economic growth rate (6%-8%). View from the funding perspective: Investor behavior cannot be ignored. A significant change in 2024 is in the behavior of institutional investors, where passive fund standardization has become an important force driving the overall rise in bank stocks. Looking ahead to 2025: 1) Passive funds are not expected to redeem on a large scale given the current undervaluation of the market, implying a safety cushion for the increase in bank stock valuations in 2024; 2) With declining interest rates, low-volatility stable products remain attractive to low-volatility stable funds, as residents favor stable equity returns, insurance company OCI account ratios rise, and the marginal balance of active fund allocation styles all contribute to the inflow of dividend-type banking stock funds. The bank believes that in order to realize the dividend logic of CKH HOLDINGS, there is room for the implied equity value to increase; the above breakdown of bank credit assets implies an increase in the value of bank equity, and in 2025, the fundamentals and funding of the banking sector are expected to resonate in the same direction. Risk factors: Significant decline in macroeconomic growth; unexpected deterioration in bank asset quality; unexpected changes in regulation and industry policies; and failure of companies to execute development strategies as expected.