Bank of Communications-A:Concerns on rising investment in local government bonds

NIM continued to contract, dragging down net interest income growth.

    H116 NPAT came in at Rmb37.7bn, up 1% YoY and representing 63%/59% of ourand consensus 2016 earnings estimates. Q216 NPAT was Rmb18.6bn, up 1% YoY. Netinterest income declined 5% YoY; loans increased 7% YoY with NIM dropping 6bpQoQ to 1.95%. Net fee income rose 7% YoY. The annualized credit cost in Q216 was81bp, up from 72bp in Q116. Total assets saw growth of 12% YoY in H116, mainlydriven by the 47% YoY growth in held-to-maturity local government bonds. Mgmtmentioned they will continue to lift up the portion of local govt bond to 7% of totalmarket share.

    Overhang remains on asset quality.

    NPL balance reached Rmb61.4bn, up 2% QoQ, with a 1.54% NPL ratio as of Q216.

    Coverage ratio fell by 79bp to 150.5%. Special-mention loans increased 4% HoH amida slowing economy. The bank has written off non-performing loans by Rmb36bn, andmgmt indicated the scale of NPL reduction in H216 might be even higher than in H116.

    To list broker subsidiary in HK; insignificant contribution to earnings.

    BoCOM's board on August 25 approved the listing of its 100%-owned subsidiary,BoCOM International Holdings, on the Hong Kong Stock Exchange. According to theannouncement, BoCOM will retain its majority shareholding in this subsidiary, i.e. theIPO size is planned to be capped at 28% of the enlarged share capital. The timing ofthe IPO has not yet been confirmed. Based on our calculation, BoCOM Int'l Holding'sassets and NPAT in 2015 (H116 data is not disclosed) came in at HK$8.7bn andHK$0.35bn, representing 0.1% and 0.4% of BoCOM's total assets and NPAT,respectively, which we regard as insignificant for the bank.

    Valuation: Maintain Sell rating with Rmb4.5 price target.

    The stock is currently trading at 0.8x 2016E P/BV. We use a PB/ROE methodology toderive our price target. Our target P/BV of 0.6x is based on a long-term sustainable ROEof 8.5%, a cost of equity of 10.9% and a long-term growth rate of 5%. We maintainour Sell rating.