Why Q1 was only the beginning of a 'divergence' in China's banking sector

Weak franchise banks greatly underperformed during the quarter.

According to Jefferies, from an industry perspective, operational trends seem encouraging on asset quality, margin, capital and B/S growth side. However, it is very clear that 1Q is just the beginning of sector divergence, as weak franchise banks meaningfully underperformed the strong ones on margin and revenue.

Here's more from Jefferies:

Sector overview confirms our positive view on China banking sector, particularly on stabilizing NPL and margin. (1) BS wise, deposit/loan/asset growth were 4.1%/3.9%/2.8% in 1Q. Non-deposit funding, mainly NCDs and funds from other financial institutions, dropped 1%; (2) NIM dropped 25bp YoY to 2.00%, but sequential decline was tiny at 1bp only; (3) Net interest income and net fee income dropped 1% and 3% YoY respectively, due to margin compression, tax reform and tight control on WMPs; (4) NPL ratio dropped 2bp to 1.64%. Credit cost rose 10bp YoY to 109bp, pushing up NPL coverage ratio by 4ppts to 164%.

Company divergence gets amplified. Though the impact of new CBRC regulations have not yet fully played out given they were announced during end-March to mid-April, we already saw clear operation divergence among strong funding banks and the weak funding ones. The strong ones, i.e. Big 4 + CMB, managed to lift NIM 4bp in 1Q, which is a clear contrast to the 20bp sequential NIM decline from the weak ones, i.e. BCOM, Citic Bank, MSB and CEB. Strong banks also demonstrated clear deposit acquisition, as they grew deposit 5.3% in 1Q on average, vs. weak one's 0.7%.

Potential future trends could include, in our view, (1) B/S growth differential among banks to further widen, driven by not deposit but wholesale funding. A few weak banks may see negative B/S growth in the next few quarters; (2) weak banks to substantially squeeze operating expenses and credit cost to dress up the bottom line; (3) most strong banks, on the other hand, will lift credit costs to further build loan loss reserve cushion; and (4) a few weak banks may have to raise equity in the next 1-2 years.