CITIC SEC: The banking sector is entering the later stages of the risk cycle, and is expected to revalue towards high certainty equity assets in the second half of the year.

CITIC SEC recently released a research report stating that, fundamentally speaking, the stabilization of interest rate differentials and positive medium-term income may help maintain a good level of revenue growth for banks in the second half of the year. Benefiting from the proactive provision for impairment in the first quarter, sector profit growth is expected to increase quarter by quarter throughout the year. Looking ahead to 2026-2027, the banking sector is entering the tail end of the risk cycle, with the first-order derivative of ROE already improving. It is anticipated that the industry ROE will stabilize in the range of 8%-9% in the coming years, which will help boost sector valuation. Currently, some large-cap targets have a static dividend yield of over 5% and a static PB ratio of 0.5-0.60x. In the second half of the year, there is potential for a revaluation from "high dividend defensive assets" to "high certainty equity assets." Some key points from CITIC SEC's report include: Asset Allocation: Focus on structure. 1) Credit: Light on volume, heavy on structure. It is predicted that the incremental RMB credit in 2026 will be around 14.6 trillion yuan (compared to 16.3 trillion yuan the previous year), leading to a slight decrease in the year-end social financing balance growth rate to around 7.4%. The focus of credit structure will continue to be on important economic provinces and major projects. The decline in credit growth is a result of economic structural adjustments and financial structure evolution, with influences from new economic developments, businesses going global, and debt substitution. 2) Investments: Core variables are base effect and floating profit reserves. With an increase in overall bond financing in society, banks continue to play an important role in accepting and allocating various types of bonds. When considering floating profit reserves and base effect, it is predicted that in 2026, listed banks' investment business strategies will be stable, with other non-interest income growth falling to the range of (-5%, 0). Liability Management: Focus on reducing costs. 1) Reducing costs to increase efficiency remains the main theme of liability management. With overall liquidity in a positive trend due to exchange factors, this provides a time window for commercial banks to optimize their liability structure. 2) Continuing expiry of deposit stock and structural conversions. With expectations of continued appreciation of the RMB exchange rate, as well as an active capital market promoting the non-banking process, it is expected that corporate and non-banking deposit growth will be positive, while individual deposit growth will continue to decline. 3) Focus on optimizing liability varieties and maturity structures. In terms of variety, interbank deposits have increased, while the use of interbank CDs has decreased actively, leading to a reduction in interbank liabilities. As for maturity structure, short-term fixed deposits continue to transition to long-term fixed deposits, contributing to a decrease in deposit costs. Interest rate spread outlook: Approaching stabilization. 1) Interest rate policy: Limited room for adjustment within the year. Analyzing the relationship between PPI and OMO rate cuts since 2013, it is noted that out of 17 rate cuts, 15 occurred during periods of negative PPI growth. With current inflationary expectations, the likelihood of policy interest rates and subsequently loan and deposit interest rates decreasing within the year is low. 2) Deposit costs: Core variable for interest rate spread stabilization. Considering that the high interest deposits are still in the middle to later stages, along with the continuous shortening of interest spreads between existing and new deposits, the annual reduction in deposit interest rates may still be around 15-20bps. 3) Loan rates: Progressively entering a stable phase. With a decrease in LPR rate adjustments and stable terminal rates, the key condition for loan profitability entering a stable phase is in place. Combining trends in new loan rates and existing loan profitability, it is estimated that the year-on-year reduction in loan profitability in 2026 may narrow to around 15bps. 4) Interest rate spread outlook: The annual decrease in interest rate spreads may narrow to 1-2bps. In a neutral scenario where quarterly policy rates and LPR rates are not adjusted during the year, it is predicted that the net interest rate spread of listed banks in 2026 may decrease by 1-2bps. Asset Quality: Solidify core assets. 1) Book quality: Overall stability in corporate quality while retail quality remains under pressure. While the overall industry's non-performing loan ratio continues to improve, the quality of corporate and retail loans remains differentiated. 2) Outlook on key risk areas: Stable growth in non-performing assets. Retail credit remains a key risk area in 2026, with leading indicators such as the "current employment sentiment index" and second-hand housing price index showing signs of recovery. Combined with increased risk management by banks, the retail risk industry is expected to move out of the risk cycle. 3) Outlook on credit costs: Strengthening provisions with a marginal increase in broad credit costs. Considering that industry revenue growth is expected to remain at a good level this year, banks are laying a strong financial foundation for provisions. It is anticipated that the industry's broad credit costs will show a marginal increase throughout the year, with a projected increase in asset impairment losses of 13%-15% in 2026 (compared to only 0.9% in 2025). Performance Outlook: Uptrend. 1) Improvement in sector profit growth expected to improve quarter by quarter. With the low base effect of other non-interest income in the first quarter fading, subsequent quarter revenue growth may see a slight decline. Benefitting from the proactive provision for impairment in the first quarter, annual profit growth may show a trend of improvement quarter by quarter, with a projected growth rate of around 4.5% for listed banks in 2026. 2) Trends of improvement and differentiation in individual banks may continue. Analysis shows that business structure, provisioning base, and base factors are core variables leading to financial performance differentiation among listed banks this year. It is predicted that amid overall sector profit improvement, large banks will likely maintain a trend of sustained profit growth, commercial banks will see a slower recovery in revenue, and regional factors and non-interest performance will be critical factors for performance differentiations among city commercial and rural commercial banks. Risk Factors: Significant downturn in macroeconomic growth; Unexpected deterioration in bank asset quality; Unfavorable changes in regulatory and industry policies; Significant adverse changes in interest rate environment; Companies failing to meet expected strategic advancements. Investment Strategy: High certainty equity assets, ongoing revaluation. The average static dividend yield of bank A shares is around 4.3%, with some large-valued targets having a dividend yield of over 5% and an average static PB ratio of 0.60x. Looking ahead to 2026-27, the banking sector is entering the tail end of the risk cycle, with the first-order derivative of ROE already improving. Anticipated industry ROE is expected to stabilize in the range of 8%-9% in the coming years, boosting sector valuation. Some large-valued targets currently have a static dividend yield of over 5% and a static PB of 0.5-0.60x, with potential for revaluation from "high dividend defensive assets" to "high certainty equity assets" in the second half of the year, offering significant absolute return potential after experiencing substantial outflows of funds.