Chinese Banks Q1 Results Strongly Exceed Expectations, Large State-Owned Banks Lead, Retail Asset Quality Concerns Remain

Overview

UBS released a summary report on China's banking industry for Q1 2026. The report indicates that leading banks, represented by large state-owned banks, delivered strong results in the first quarter, with revenue and profits significantly beating market expectations. This performance was primarily driven by an unexpected rebound in net interest margins and steady growth in fee-based income. However, the report also warns of potential risks in retail asset quality, notably a significant rise in NPL ratios in the credit card sector. Given macroeconomic resilience and reduced expectations for further monetary policy easing, profit outlooks for large state-owned banks may be revised upward. Based on this, UBS continues to recommend large state-owned banks with high-dividend defensive attributes and some high-quality regional banks.

Core views

First, in terms of profitability, large state-owned banks (SOE banks) performed outstandingly. In Q1, their average revenue grew 8.5% year-on-year, the fastest growth since 2021, significantly exceeding UBS's expectation of 4.6%. This outperformance was driven by three factors: first, a rebound in net interest margin (NIM); second, steady growth in fee and commission income (+6.5% YoY); and third, low trading income bases for some banks in the same period last year. Although a 29% YoY increase in impairment loss provisions offset some of the PPOP growth, average net profit growth still reached 3.4%, higher than the expected 1.7%. Second, in terms of NIM trends, large state-owned banks saw an average quarter-on-quarter rebound of 4 basis points. This was mainly attributed to a significant decline in liability costs due to the repricing of time deposits, especially the interest rate reduction after three-year large-denomination certificates of deposit matured, leading to a 3.0% quarter-on-quarter decrease in interest expenses. At the same time, asset yields of large state-owned banks showed greater resilience, with corporate loan yields remaining stable and retail loan balances growing quarter-on-quarter, contrasting sharply with joint-stock banks (JSB), where retail loan balances fell 1%-3% quarter-on-quarter. Third, although the overall NPL ratio appears stable, multiple warning signals have emerged within retail asset quality. First, delinquency ratios for small and micro enterprises or overdue ratios at several banks accelerated; second, credit card asset quality deteriorated comprehensively. For example, at China Merchants Bank, the total credit card NPL generation rate surged 89 basis points quarter-on-quarter to 5.2%, the second highest level since the COVID-19 pandemic; third, some banks may have relaxed NPL recognition standards, leading to high delinquency ratios while the NPL ratio and provision coverage remained stable; fourth, some banks reduced disclosure of detailed asset quality data. These signs indicate that pressure on retail asset quality will be a persistent negative factor, potentially widening the divergence in provisioning and profit growth between large state-owned banks and joint-stock banks. Finally, in terms of investment strategy, UBS believes Q1 results confirm an improvement in the operating environment for China's banking industry. Given strong Q1 GDP growth data reducing expectations for further monetary easing in the near term, 2026 fiscal year earnings growth forecasts for large state-owned banks may be modestly revised up. The institution continues to favor banks with high-dividend defensive attributes, maintaining Buy ratings on Bank of China H-shares, China Construction Bank H-shares, Industrial and Commercial Bank of China H-shares, China CITIC Bank H-shares, and Bank of Ningbo.

Analysis framework

The report adopts an analytical framework of 'fundamental verification + micro-structure decomposition.' First, it verifies marginal changes in industry sentiment through horizontal comparison of financial data among large state-owned banks, joint-stock banks, and regional banks. Second, it deeply decomposes the drivers of NIM, attributing changes to specific moves on the liability side (deposit repricing) and asset side (loan supply-demand and pricing), thereby judging the sustainability of NIM pressure. Finally, going beyond the seemingly stable NPL ratio indicator, it mines high-frequency micro data such as delinquency ratios and NPL generation rates for specific products (e.g., credit cards) to identify potential risks in asset quality early. This step-by-step analysis from macro financial reports to micro asset structures helps investors understand the underlying logic behind earnings outperformance and potential future concerns.

Methodology notes

• Valuation MethodDDM Dividend Discount

  Three-stage DDM

  The report uses this model to derive target prices for H-share banks. Its core logic is that a bank's value equals the present value of all expected future dividends, particularly applicable to large state-owned banks with stable dividends and predictable cash flows.

• Valuation MethodPB valuation

  P/B and ROE Combined Valuation

  The report uses the P/B-ROE framework for A-share banks (e.g., Bank of Ningbo). This method believes a bank's valuation should be positively correlated with its profitability (ROE), with high ROE supporting a higher P/B multiple.

• Industry/Sector Analysis FrameworkVolume-price decomposition

  NIM changes decomposed into volume (scale) and price (yield/cost rate)

  The report decomposes NIM changes into changes in asset yields and liability cost rates. By analyzing the repricing of time deposits (price) and changes in loan balances (volume), it explains why NIM for large state-owned banks rebounded quarter-on-quarter despite rate cuts.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• Bank of China (3988.HK)

  Representative large SOE bank, strong outperformance in earnings, NIM stabilizing

  Strengths

  Fast revenue growth, low liability costs, high dividend yield

  Comparison

  Compared to joint-stock banks, stronger risk resistance and higher earnings stability

  Risks

  Persistently insufficient credit demand due to macro downturn

• China Construction Bank (0939.HK)

  Representative large SOE bank, relatively stable asset quality

  Strengths

  Strong customer base, low operating costs

  Comparison

  Balanced performance among large SOE banks, attractive valuation

  Risks

  Asset quality fluctuations in real estate sector

• Bank of Ningbo (002142.SZ)

  Representative high-quality regional bank, good growth

  Strengths

  Successful retail transformation, high management efficiency

  Comparison

  Higher growth elasticity compared to large SOE banks, but also higher valuation

  Risks

  Macro headwinds dampening medium-term loan demand, trade conflict impacts

• China CITIC Bank (0998.HK)

  Large SOE bank, transformation results emerging

  Strengths

  Growth potential in fee-based income

  Comparison

  Higher degree of marketization compared to traditional large SOE banks

  Risks

  Asset quality deterioration, financing structure deterioration

• Industrial Bank (601166.SH/HK)

  Representative joint-stock bank

  Strengths

  Advantage in interbank business

  Weaknesses

  Retail transformation facing significant competitive pressure

  Comparison

  Greater earnings volatility compared to large SOE banks

  Risks

  Asset quality pressure, greater NIM narrowing pressure

Key data

• Large SOE Banks Q1 Revenue YoY Growth8.5%Fastest growth since 2021, exceeding expectations
• Large SOE Banks Q1 Net Profit YoY Growth3.4%Above UBS expectation of 1.7%
• Large SOE Banks Q1 Average NIM QoQ Change+4bpsBenefiting from lower deposit costs
• Large SOE Banks Q1 Interest Expense QoQ Change-3.0%Mainly due to three-year time deposit repricing
• China Merchants Bank Credit Card NPL Generation Rate5.2%Surged 89bps QoQ, second highest since pandemic
• Industry Mortgage Balance YoY Growth-3.1%Largest decline since 2021, reflecting weak retail demand

Impact & implications

For investors, this report means the most difficult period for China's banking industry may have passed, especially for large state-owned banks, which have achieved significant results in controlling liability costs, demonstrating resilient profitability. However, investors need to be wary of persistently weak retail credit demand and structural deterioration in asset quality, which may suppress the valuation recovery space for joint-stock banks. In a still effective high-dividend strategy environment, large state-owned banks become the preferred defensive allocation due to their more stable asset quality and lower valuation volatility. If macroeconomic data further strengthens, the market may revise up earnings expectations for large state-owned banks, presenting opportunities for valuation enhancement.

Risks

• Asset quality deterioration due to weak macro environment and sluggish real estate market activity
• Capital adequacy ratio risk and dilution risk from refinancing
• Persistent squeeze on bank profitability from low interest rates
• Regulatory risks on capital, liquidity, and off-balance-sheet activities
• Earnings pressure from mid-term interest rate liberalization

What to watch

• Changes in retail credit demand, especially supply and demand for mortgages and credit cards
• Sustainability of the impact of time deposit repricing on NIM
• Changes in macroeconomic policy and monetary easing intensity
• Specific actions by banks in asset quality management and NPL write-offs