70114906 barclays capital hong kong banks

7/31/2019 70114906 Barclays Capital Hong Kong Banks

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EQUITY RESEARCH 10 October 20

HONG KONG BANKS

A lose-lose situationHong Kong banks are facing unprecedented risks from the development of the offshore

RMB market. We see rising foreign exchange risk, liquidity risk, operational risk, and

regulatory risks. Asset quality risks are also rising. Regardless of the direction of the

RMB/USD exchange rate, we believe Hong Kong banks lose. We see either pressure

from continued HK$ liquidity tightening, or asset quality deterioration. We maintain our

cautious view on the sector and prefer the international banks HSBC (1-OW) and

Standard Chartered (1-OW). Hang Seng Bank (2-EW) is our preferred local exposure.

Offshore RMB drag: The offshore RMB market has created new business opportunities

for Hong Kong banks. However we believe these are being rapidly overshadowed by

rising risks and unintended consequences associated with offshore RMB development.

HK$ liquidity has continued to tighten, despite a slowdown in offshore RMB deposit

growth. RMB product development has been largely dependent on RMB appreciation.

More recently, RMB deposit growth has moderated after increasing regulatory

tightening on so called arbitrage lending. Leakage of RMB back to China and

competition from regional peers is a risk to RMB liquidity accumulation in Hong Kong.

Ultimately, we believe Hong Kong banks will be under pressure regardless of FX

currency movements:

RMB appreciation vs USD (China growth intact) = Tighter HK$ liquidity

USD appreciation vs RMB (China hard landing) = Higher credit costs

Asset quality risk rising: Hong Kong banks are highly exposed to Mainland-related

lending (e.g. 42% of loans for BEA). Our base case is for a soft landing in China and agradual uptick in credit costs to 7 bps, 19bps and 26bps for FY11/12/13E. In a bear

case scenario for FY13E, where credit costs reach long-term historical average levels of

100bp, we expect downside from our base case of -38% for earnings, -4% for book

value and -3% for ROE (pg29). We believe Hang Seng Bank is most defensive against a

potential deterioration in asset quality due to its strong risk management track record

(peak credit cost of 121bps during 1998 Asian financial crisis) and high breakeven

credit cost (due to its high pre-provision return on assets, ignoring contribution from

Industrial Bank).

Cut FY11/12E earnings by up to 15% and lower PTs by 13% on average. This reflects

pressure on funding cost, credit growth and market-related fee income. We prefer the

bigger, liquid international banks HSBC and Standard Chartered. Among the localbanks, we like Hang Seng Bank (2-EW) for its strong, proven risk management track

record. BOCHK (2-EW) is more susceptible to the risks of offshore RMB, in our view. Key

risks include: 1) pace of global economic recovery; and 2) sector corporate action.

Barclays Capital does and seeks to do business with companies covered in its research reports. As aresult, investors should be aware that the firm may have a conflict of interest that could affect theobjectivity of this report.

Investors should consider this report as only a single factor in making their investment decision.

This research report has been prepared in whole or in part by research analysts based outside the USwho are not registered/qualified as research analysts with FINRA.

PLEASE SEE ANALYST(S) CERTIFICATION(S) AND IMPORTANT DISCLOSURES BEGINNING ON PAGE 50.

SECTOR UPDATE

Asia ex-Japan Banks

2-NEUTRALUnchanged

For a full list of our ratings, price target andearnings changes in this report, please seetable on page 2.

Asia Ex-Japan Banks

Sharnie Wong

+852 290 33457

[email protected]

Barclays Bank, Hong Kong

Tom Quarmby

+852 290 [email protected]


Leon Qi

+852 290 33994

[email protected]



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Barclays Capital | Hong Kong Banks

10 October 2011 2

Summary of our Ratings, Price Targets and Earnings Changes in this Report (all changes are shown in bold)

Company Rating Price Price Target EPS FY1 (E) EPS FY2 (E)

Old New 07-Oct-11 Old New %Chg Old New %Chg Old New %Chg

Asia ex-Japan Banks 2-Neu 2-Neu

Bank of China (Hong Kong) Ltd. (2388 HK / 2388.HK) 2-EW 2-EW 16.76 20.90 20.00 -4 1.93 1.92 -1 1.80 1.70 -6Bank of East Asia Ltd. (23 HK / 0023.HK) 3-UW 3-UW 24.95 29.60 21.70 -27 2.33 2.29 -2 2.19 1.93 -12

Dah Sing Banking Group Ltd. (2356 HK / 2356.HK) 2-EW 2-EW 6.92 9.30 7.80 -16 0.91 0.91 - 0.96 0.82 -15

Dah Sing Financial Holdings Ltd. (440 HK / 0440.HK) 2-EW 2-EW 20.60 37.40 31.60 -16 3.58 3.42 -4 3.89 3.35 -14

Hang Seng Bank Ltd. (11 HK / 0011.HK) 2-EW 2-EW 92.75 123.30 115.70 -6 8.70 8.40 -3 10.00 8.62 -14

Wing Hang Bank Ltd. (302 HK / 0302.HK) 3-UW 3-UW 61.50 68.90 61.40 -11 6.91 6.84 -1 5.99 5.64 -6

Source: Barclays Capital Share prices and target prices are shown in the primary listing currency and EPS estimates are shown in the reporting currency.

FY1(E): Current fiscal year estimates by Barclays Capital. FY2(E): Next fiscal year estimates by Barclays Capital.

Stock Rating: 1-OW: 1-Overweight 2-EW: 2-Equal Weight 3-UW: 3-Underweight RS: RS-Rating SuspendedSector View: 1-Pos: 1-Positive 2-Neu: 2-Neutral 3-Neg: 3-Negative
http://my.barcapint.com/ERG/displayCompany.jsp?ticker=2388.HKhttp://my.barcapint.com/ERG/displayCompany.jsp?ticker=0023.HKhttp://my.barcapint.com/ERG/displayCompany.jsp?ticker=2356.HKhttp://my.barcapint.com/ERG/displayCompany.jsp?ticker=0440.HKhttp://my.barcapint.com/ERG/displayCompany.jsp?ticker=0011.HKhttp://my.barcapint.com/ERG/displayCompany.jsp?ticker=0302.HKhttp://my.barcapint.com/ERG/displayCompany.jsp?ticker=0302.HKhttp://my.barcapint.com/ERG/displayCompany.jsp?ticker=0011.HKhttp://my.barcapint.com/ERG/displayCompany.jsp?ticker=0440.HKhttp://my.barcapint.com/ERG/displayCompany.jsp?ticker=2356.HKhttp://my.barcapint.com/ERG/displayCompany.jsp?ticker=0023.HKhttp://my.barcapint.com/ERG/displayCompany.jsp?ticker=2388.HK


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10 October 2011 3

INVESTMENT SUMMARY

The potential return on investment from future offshore RMB business opportunities is

subject to a high degree of risk and regulatory uncertainty, in our opinion. In this report,

we discuss the potential risks and unintended consequences of RMB internationalisation.

In light of uncertainty over the global economic outlook, we also look at sensitivities todeterioration in asset quality and exposure to European countries.

Risks of RMB internationalisation

We believe that the market has underestimated the risks associated with RMB

internationalisation.

Liquidity risk HK$ and offshore RMB leakage

The first negative consequence was partial cannibalisation of the HK$ deposit base (flat YTD

2011) by rapid offshore RMB deposit growth (+93% ytd). Next, we believe the offshore RMB

deposit base is under threat due to:

Tough regulatory stance on repatriation of funds to mainland China, which may

dampen corporate demand for offshore RMB. This is already evident through the

moderating offshore RMB deposit growth in the past few months, since the Peoples

Bank of China (PBOC) and Hong Kong Monetary Authority (HKMA) voiced concerns on

arbitrage lending in June.

Gradual leakage to mainland China (onshore RMB) through corporate trade-related

remittances and individual transfers (limit of HK$80,000/day).

Macro risk

The growing pool of offshore RMB has been partially driven by underlying business

justifications (e.g. genuine trade in RMB), but to a larger extent has been driven by customer

expectations on RMB appreciation, in our view. The events of recent weeks highlight that

RMB appreciation may not be a certainty and may be subject to high market volatility.

Asset quality issues may arise if there is uncertainty over local and Mainland economic

growth (potentially resulting in RMB depreciation vs the USD).

Customers and potentially banks may suffer losses on products structured on RMB

appreciation. These sophisticated products could well be highly geared and have long

tenors.

Regulatory risk unknown return on investment

The scope and pace of offshore RMB development is driven by the regulators in mainland

China. This uncertainty makes it difficult for the banks to calculate or estimate a return oninvestment despite making heavy investments in IT and human resources.

Asset quality risks

Markets are increasingly pricing in higher credit costs on the back of European debt

concerns and fears of a China hard landing. Our base case is on the assumption of a soft

landing in China, and we expect a gradual normalisation of sector credit costs to 7bps,

19bps and 26bps for FY11/12/13E (from 3bps in FY10).


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10 October 2011 4

If credit costs normalize from the current lows to the long-term historical average credit

cost levels for each bank by FY12E (by FY13E for BOCHK, after de-risking its loan book from

the very high credit losses in 1999), we estimate that in FY12E and FY13E:

Earnings will be lower by 16% and 38%, respectively

Book value will be lower by 2.1% and 4%, respectively

Return on equity will be lower by 1.1% and 3.1%, respectively

Hang Seng Bank is most defensive against a potential deterioration in asset quality, in our

view, due to its strong risk management track record (peak credit cost of 121bp, lowest

among peers) and high earnings buffer, with a break-even credit cost of 278bps. Hang Seng

Banks FY12E pre-provision profit (which excludes contribution from Industrial Bank) is

enough to withstand a seven-fold increase in its long-term historical credit cost of 28bps.

Hong Kong banks risk to claims on Western European countries (ex-UK) is limited to 4.3% of

assets, on average, on our estimates. All banks in our coverage universe have immaterial

exposure to peripheral European countries. For BOCHK, we estimate that a worse-case

scenario where a 100% writedown is taken on Euro-denominated trading and AFS securities

would result in a 13.3% hit to equity.

Earnings revision and valuation

We lower our earnings forecasts for the Hong Kong banks by up to 15% for FY11-13E, on

the back of lower credit growth and margin and slightly higher credit cost assumptions. Our

estimates are 2-20% below Bloomberg consensus profit estimates on average.

Based on our blended valuation methodology approach, the sector offers 22% absolute

upside potential based on fair value. However, in the near term, share price performance

may be affected by market volatility. We estimate there is still 46% potential downside for

Hong Kong bank shares vs historical trough P/B multiples (refer to Figure 1).

We prefer HSBC and Standard Chartered, both rated 1-OW, for their international presence,

global business/markets exposure, and sensitivity to rising rates in Asia. Of the local banks

we still prefer Hang Seng Bank (2-EW).

Figure 1: Hong Kong banks blended valuation approach (FY12E) and price target summary

HK$ / Share HSB BEA BOCHK WHB DSF DSBG

DDM 107.48 16.78 16.51 30.39 14.71 4.14

GGM 126.75 16.15 17.54 49.70 16.67 4.82

Historic PE 134.29 29.06 19.83 58.33 41.80 10.18

Historic PB 152.52 31.82 19.17 92.14 55.55 15.56

Historic PPOP 88.17 30.40 17.64 69.54 33.34 7.38

Normalised ROE 80.53 5.02 21.92 47.57 19.51 -2.40

Normalised EPS 120.47 22.49 27.34 81.91 39.44 4.66

BLENDED VALUATION 115.70 21.70 20.00 61.40 31.60 7.80

Historical 1 yr forward trough P/B multiples1.7x

(Aug-98)

0.6x

(Mar-09)

0.7x

(Mar-09)

0.4x

(Sep-98)

0.3x

(Nov-08)

0.4x

(Oct-08)

Price at historical trough P/B 72.0 15.2 8.5 22.0 16.4 4.8

% potential downside to trough -38% -30% -58% -64% -48% -39%

PRICE TARGET (HK$ / Share) 115.70 21.70 20.00 61.40 31.60 7.80

Current price (HK$ / Share) 92.75 24.95 16.76 61.50 20.60 6.92

Dividend (HK$ / Share) 5.60 1.05 1.11 1.99 1.01 0.25

12-month Total Shareholder Return 31% -9% 26% 3% 58% 16%

Source: Barclays Capital estimates


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10 October 2011 6

UNINTENDED RISKS OF RMB INTERNATIONALISATION

The market has underestimated the risks from offshore RMB development, in our

view, including liquidity (HK$ and offshore leakage), regulatory and operational risk.

Banks are heavily investing to prepare for RMB growth but return on investment isunknown due to regulatory restrictions and timing uncertainties.

Structural headwinds lie ahead from the development of offshore RMB even if we

disregard future currency directional trends and repatriation rules.

We lower system RMB deposit estimates to Rmb800bn, RMB1.4trn and RMB2trn for

FY11/12/13E (from Rmb1trn, Rmb1.8trn and Rmb2.5trn previously), respectively.

Is the market underestimating the risks from offshore RMB?

The rapid rise of the offshore RMB market has created many business opportunities for the

Hong Kong banks, but comes with greater risks from a macro, micro and regulatory

standpoint. We believe that the market is aware of the potential upside (i.e. tapping newcustomer relationships, developing RMB as an asset class, reserve currency and trading

currency) but has underestimated the risks (i.e. HK$ liquidity drain, offshore RMB leakage).

The Hong Kong banking sector is heavily investing in preparation for future offshore RMB

opportunities. Mainland companies are expanding globally, and the banking sector believes

they cannot afford to be left behind. However, there is no way of determining the long-term

profitability or return on investment due to uncertainty over the scope and timing of

regulatory changes. Should investors continue to put up with near-term pain for long term

gain?

In addition, the banking sector is facing a dilemma between creating an offshore RMB

centre vs wanting quicker and easier repatriation of funds into China. To become thepremier offshore RMB centre, a large pool of liquidity needs to be retained in Hong Kong,

but at the same time, the banks are fighting for regulations to ease repatriation of funds to

China. We see no near-term solution.

We will turn more positive once the use of offshore RMB is driven by business needs rather

than currency expectations.

Why are the banks investing in offshore RMB?

Banks are investing heavily in developing offshore RMB business, despite near-term losses,

because:

the internationalisation of Chinese companies gives them an opportunity to follow their

clients in going global and tapping new business relationships; and

internationalisation of the RMB as an asset class and increasingly used as a reserve

currency by other countries

RMB is increasingly used as an international trade currency. IMF has projected that

China will contribute to more than one-third of global growth by 2015. The RMB trade

settlement scheme launched in 2009 has allowed for shortened settlement cycles and

corporates to better manage foreign exchange risk in conducting cross-border trade.


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10 October 2011 7

Overseas Direct Investment (ODI) to be conducted in RMB under a pilot scheme

introduced in January 2011 and potential regulatory changes to Foreign Direct

Investment (FDI) rules and RMB fund remittance to China.

Potential opportunity to generate incremental profits

Over the past two years, we have seen a rapid rise in the development of the offshore RMB

market. The first step was the development of the RMB deposit pool in Hong Kong which

now stands at RMB609bn, ~10% of system deposits.

Figure 3: HK system deposits of all authorised institutions

System deposits, August 2011 Balance ytd growth m/m growth

Total HK$7,344bn 7.0% -0.5%

HK$ HK$3,619bn 0.1% -2.0%

FC (ex RMB) HK$2,980bn -11.4% -19.2%

RMB Rmb609bn 93.4% 6.4%

Source: CEIC, Barclays Capital

Figure 4: Offshore RMB deposits in Hong Kong

64

66

71

81

86

90

104

130

149

217

280

315

371

408

451

511

549

554

572

609

0

100

200

300

400

500

600

700

Jan-1

0

Fe

b-1

0

Mar-10

Apr-10

May-1

0

Jun-1

0

Jul-10

Aug-1

0

Sep-1

0

Oct-10

Nov-1

0

Dec-1

0

Jan-1

1

Fe

b-1

1

Mar-11

Apr-11

May-1

1

Jun-1

1

Jul-11

Aug-1

1

Rmb bn

0

2

4

6

8

10

12%

RMB deposits (LHS) As % of total deposits (RHS)


Next, outlets for the use of offshore RMB were developed, including dim sum bonds, trade

settlements and wealth management products.

RMB trade settlements Banks in Hong Kong now handle 84% of the Mainlands trade

settled in RMB. In August 2011, the scope of the RMB trade settlement scheme was

expanded to cover the entire Mainland.

RMB financing Dim sum bond issuances have grown exponentially, reaching

Rmb149bn in 1H11. However, demand for RMB lending remains low as most customers

prefer to borrow in USD/HKD at lower interest rates with no currency appreciation. RMB

lending was only RMB5bn at June 2011,


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10 October 2011 8

RMB wealth management The first R-IPO, Cheung Kongs Hui Xian REIT, was launched

in April 2011. In addition, R-QFII quota of RMB20bn was announced in August 2011.

Despite the rapid growth of offshore RMB investment opportunities, there is still abundant

idle CNH liquidity which is placed with PBOC (via BOCHK as the clearing bank in Hong

Kong) and generates a low yield of 62.9bps for most banks and 72bps for BOCHK as the

clearing bank.

Future potential developments in the pipeline include:

Formalization of the use of RMB in foreign direct investment in the Mainland.

Repatriation of RMB is currently subject to regulatory approval on a case by case basis.

The aim is to establish a standardized process and allow automatic repatriation up to a

certain threshold or when meeting certain criteria.

Extending access to the Shanghai interbank bond market for more financial institutions

or increasing the quota.

Expanding the scale of dim sum bonds by allowing mainland companies (other than

government entities and banks) to issue in Hong Kong.

Develop more sophisticated RMB products, e.g. RMB exchange traded products, RMB

commodities contracts, RMB interest rate derivatives and risk management products.

Allow Chinese investors to buy ETFs linked to Hong Kong stocks.

Simplify approval procedures and implement favourable policies for Hong Kong under

the Closer Economic Partnership Arrangements (CEPA), to realize full liberalization of

trade between the two sides.

Risks and unintended consequences of RMB internationalisation

With any opportunity comes risk. The most evident consequence of the development ofoffshore RMB is tighter HK$ liquidity conditions (discussed in Hong Kong Banks: Liquidity

Squeeze, dated 11 April 2011). In addition, we believe that offshore RMB growth will slow

from its exponential growth pace (+93% y-t-d) due to the current leakage to onshore RMB

and the expected widening of repatriation channels to mainland China. As such, we lower

our Hong Kong system RMB deposit growth estimates to RMB800bn, RMB1.4trn and

RMB2trn (from RMB1bn, RMB1.8bn and RMB2.5bn previously), for FY11/12/13E

respectively.


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10 October 2011 9

Figure 5: Offshore RMB deposits in Hong Kong

0.1 0.10.3

0.60.8

1.1

1.4

1.72.0

0.0

0.5

1.0

1.5

2.0

2.5

2H09

1H10

2H10

1H11

2H11E

1H12E

2H12E

1H13E

2H13E

RMBtrn

0%

50%

100%

150%

200%

250%

300%

System offshore RMB deposits (LHS)

h/h growth (RHS)

Source: CEIC, Barclays Capital estimates

In summary, the system deposit base (both HK$ and RMB) could come under pressureresulting in a lower money multiplier going forward.

1. Tightening HK$ liquidity limiting loan growth and pressuring marginHK$ liquidity has tightened considerably since 2009, which is reflected in the rising HK$

loan to deposit ratio (LDR) due to partial cannibalisation of the HK$ deposit base by

offshore RMB (10% of system deposits) and strong demand for HK$/USD lending, leading

to a growing mismatch between loans and deposits and making asset-liability management

(ALM) increasingly difficult for the Hong Kong banking sector.

System RMB deposits have grown 93% y-t-d, vs no growth for HK$ deposits and an 11%

decline in all other foreign currency deposits including the USD. At the same time, the

corporate loan portfolio rebounded sharply in 2010 as the local, Chinese and globaleconomies proved far stronger than earlier expectations, in part due to aggressive fiscal

stimulus by most governments. More recently, sustained low HK$ (and US$) lending rates

led to continuously high demand for corporate credit, a large portion of which we believe is

investment in China, where the cost of funds is considerably higher.


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10 October 2011 10

If we exclude the two largest banks, HSBC and Standard Chartered, which are in a muchbetter liquidity position (in terms of LDR), we estimate that system LDR is already close to

75%, the operational maximum, since banks are required to maintain a minimum liquidity

ratio of 25%.

Tightening HK$ liquidity has also led to a price war on HK$ time deposits, especially in the

3-6M time deposit space where deposits taken now will straddle the year-end (December).

Our channel checks show that the 6-month HK$ time deposit rate offered to a new

customer with a HK$1m deposit has risen by 74bp to 1.5% in 3Q11 (refer to table below). In

addition, the proportion of time as percentage of total system deposits continues to rise.

Figure 8: Survey of HK$ time deposit rates on HK$1m deposit balance

1M 1M 1M 3M 3M 3M 6M 6M 6M

HK$ deposit rates 29-Jun 24-Aug 27-Sep 29-Jun 24-Aug 27-Sep 29-Jun 24-Aug 27-Sep

HSBC 0.01% 0.02% 0.02% 0.01% 1.25% 1.25% 0.05% 0.05% 0.05%

STAN 1.30% 0.20% 0.50% 1.25% 1.25% 1.60% 0.75% 1.35% 1.80%

BOCHK 1.00% 0.73% 0.75% 0.67% 0.79% 0.77% 0.65% 1.15% 1.65%

HSB 0.40% 1.70% 0.80% 0.90% 1.25% 1.30% 0.18% 0.20% 1.50%

BEA 1.22% 1.05% 1.26% 1.28% 1.27% 1.37% 1.17% 1.38% 1.62%

DBS HK 0.70% 0.60% 0.60% 1.50% 1.50% 1.25% 1.60% 1.70% 1.80%

WHB 0.85% 0.10% 1.05% 1.10% 0.20% 1.50% 1.25% 1.50% 1.76%

DSBG 0.09% 1.29% 1.35% 1.05% 1.45% 1.56% 0.18% 1.55% 1.80%

WLB 0.10% 0.10% 0.10% 1.00% 1.00% 1.35% 1.05% 1.05% 1.50%

Average 0.63% 0.64% 0.71% 0.97% 1.11% 1.33% 0.76% 1.10% 1.50%


Figure 6: Hong Kong system loan to deposit ratio Figure 7: China, HK and HK loans for use offshore y/y gth

67

85

75

40

50

60

70

80

90

Aug-0

8

Nov-0

8

Fe

b-0

9

May-0

9

Aug-0

9

Nov-0

9

Fe

b-1

0

May-1

0

Aug-1

0

Nov-1

0

Fe

b-1

1

May-1

1

Aug-1

1

%

System LDR

HK$ LDR

System (ex RMB deposits only)

16.427.0

45.6

-20-10

010

2030

4050

6070

Aug-0

4

Aug-0

5

Aug-0

6

Aug-0

7

Aug-0

8

Aug-0

9

Aug-1

0

Aug-1

1

%

ChinaHK totalHK loans for use outside HK

Source: CEIC, Barclays Capital Source: CEIC, Barclays Capital


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10 October 2011 11

Figure 9: System time deposits as % of total deposits

45.0

45.5

46.0

46.5

47.0

47.5

48.0

48.5

49.0

Aug-1

0

Sep-1

0

Oct-1

0

Nov-1

0

Dec-1

0

Jan-1

1

Feb-1

1

Mar-11

Apr-11

May-11

Jun-1

1

Jul-11

Aug-1

1

%

33.0

33.534.034.535.035.5

36.036.537.0

37.5%

Total time as % of system deposits (LHS)

HK$ time as % of total HK$ deposits (RHS)


2.

Offshore RMB leakage to China and regional centres

We believe that there is leakage from the offshore RMB deposit base to onshore RMB as

investors seek higher returns in the onshore RMB market where the rate on a 3M time

deposit is 3.1% (vs


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10 October 2011 12

Banks have also called on formalising regulations over grey areas in the interaction

between onshore and offshore RMB, e.g. rules on moving deposits between Hong Kong

banking operations and Mainland banking subsidiaries.

4. Rising operational risks - RMB appreciation not a certaintyThe offshore RMB market is new to regulators, investors, bank management, bank staff andalso customers.

Operational risks arise with bank staff, who are responsible for transacting, dealing, and

selling new products to customers, from simple offshore RMB deposits to complex

structured products. Time needs to be taken to train the workforce so they can acquire the

knowledge of the dynamics of the products they are selling and also the risks.

From the customers perspective, a recent survey conducted by Cimigo in September 2011,

showed that investor education is one of the most important areas for improvement. In

terms of offshore RMB developments, RMB appreciation has been viewed as a certainty by

many investors and they may not be fully aware of the risks involved. This creates

operational and reputational risks for the banks (as weve learnt through the Lehman

minibonds debacle).

FX volatility in recent weeks has proved that there is always risk to every investment

decision. USD appreciated against many currencies (including the CNH) as investors sought

safety on concerns on a global economic slowdown. Risks arise when there is unwanted

foreign currency volatility; some wealth management products have been structured to take

advantage of RMB appreciation and are highly leveraged and often of long tenor. As past

experience has shown with accumulators (bull market product popular in 2007) and

Lehman mini-bond products, customers as well as the banks may suffer significant losses

when things turn sour.

Banks do not take foreign exchange risk, meaning that they are not directly exposed to

unwanted movements in RMB. However, they do take counter-party positions with clients

who have a genuine FX trade need. Unwanted/extreme FX volatility may result in customer

default.

Figure 10: CNH/CNY sv USD volatility in recent weeks Figure 11: Lehman minibond write-offs post-2008 crisis

6.3

6.35

6.4

6.45

6.5

6.55

14-J

ul-11

21-J

ul-11

28-J

ul-11

4-A

ug-1

1

11-A

ug-1

1

18-A

ug-1

1

25-A

ug-1

1

1-S

ep-1

1

8-S

ep-1

1

15-S

ep-1

1

22-S

ep-1

1

29-S

ep-1

1

6-O

ct-1

1

CNY Curncy CNH Curncy

0

500

1,000

1,500

2,000

2,500

3,000

3,500

BOCHK

DSF

/DSBG

WHB

CHB

BEA

ICBCA

HK$m

0%

1%

2%

3%

4%

5%

6%

Lehman mini-bonds exposure (LHS)As % of FY08 equity (RHS)

Source: Bloomberg, Barclays Capital Source: [Source].


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10 October 2011 14

FUTURE CAPITAL OUTFLOWS COULD THREATEN LIQUIDITY

Potential capital outflows could erode Hong Kongs deposit base by 9.4%, resulting in

even tighter liquidity.

The HKMA has asked the banks to conduct a stress test if they can withstandpotential capital outflows, which is likely to occur if US interest rates rise and USD

strengthens against HK$, as weve seen in recent weeks of volatility.

HKMA asks banks to conduct stress test for capital outflows

In May 2011, the HKMA asked the banks to conduct a stress test, assuming customer

withdrawals of HK$690bn over the next year, due to concerns that the banks balance

sheets have grown too fast (Bloomberg, 27 May 2011). Banks should assume that more

than half of the HK$1.38trn of customer deposits in local and foreign currencies added

since late 2008 will flow out in 6-12 months. Since May, system deposits have risen by

HK$1.5trn, +26% since September 2008.

If HK$690bn of deposits flow out of Hong Kong, system deposits of HK$7.3trn (at August

2011) will be eroded by 9.4%. The system loan to deposit ratio would rise from 67% (at

August 2011) to 74%.

Norman Chan, chief executive of the HKMA, explained that an increase in US interest rates

or strengthening of the US dollar may lead to a reversal of the capital flows, and US dollar-

funded carry trades will exacerbate the impact of a reversal in the flows of funds on the

financial market, making it more volatile.

When US-dollar interest rates rise or the US dollar strengthens, investors will no longer use

the US dollar to fund their carry trades. When they unwind these US dollar-funded carry

trades and take a long position in the US dollar, the US dollar might appreciate considerably,

resulting in funds flowing out of the Hong Kong dollar.

On the contrary, if capital flows reverse resulting in strong outflows from HK$, asset prices

may fall and interest rates will go up according to the Currency Board system.

Chan noted that Hong Kong had not seen any large capital flows in or out of the territory

during the market turmoil in recent weeks, unlike earlier phases of quantitative easing in the

United States that saw waves of hot money pour into Hong Kong.


15/55


10 October 2011 15

Figure 13: Capital inflows into HK$ Figure 14: Deposit growth in Hong Kong

0

100200

300

400500

600

700800

900

Aug-0

7

Dec-0

7

Apr-08

Aug-0

8

Dec-0

8

Apr-09

Aug-0

9

Dec-0

9

Apr-10

Aug-1

0

Dec-1

0

Apr-11

Aug-1

1

HK$bn

0

2

4

68

10

12

14%

Aggregate bal ance & exchange fund bill s (LHS)

As % of M2 (RHS)

HK$648bn

since4Q08

5.0

5.5

6.0

6.5

7.0

7.5

2Q08

3Q08

4Q08

1Q09

2Q09

3Q09

4Q09

1Q10

2Q10

3Q10

4Q10

1Q11

2Q11

Aug-1

1

HK$trn

0%

2%

4%

6%

8%10%

12%

14%

16%

Total deposits (licensed banks) (LHS)

y/y growth (LHS)

+HK$1.5trn since 4Q08, +26%



16/55


10 October 2011 16

IMPACT ON ASSET QUALITY FROM GLOBAL ECONOMIC SLOWDOWN

Markets are increasingly pricing in higher credit costs on the back of European debt

concerns and fears of a China hard landing.

In the 2008 Asian financial crisis, NPLs peaked in September 1999, a year after HongKong banks share prices troughed in August 1998.

We assume a gradual normalisation of sector credit costs to 7bp, 19bp and 26bp for

FY11/12/13E (from 3bp in FY10), respectively, based on the assumption of a soft

landing of the Chinese economy.

Hang Seng Bank is most defensive against a potential deterioration in asset quality, in

our view, due to their strong risk management track record (peak credit cost of

121bp, lowest among peers) and high earnings buffer with a break even credit cost

of 278bps.

China hard landing fears intensifyingFears of a hard landing in China have once again intensified. While our base case remains a

soft landing led mainly by an investment slowdown, we see increasing downside risk from

the situation in Europe and at home.

We think benchmark interest rates will likely be on hold and the yuan will continue to

strengthen at a relatively fast pace, while selective easing may help reduce financing pains

for SMEs, property developers and local governments.

In the near term, we expect investors to remain cautious, as the European debt situation will

likely worsen before it improves. But we think signs of a soft landing would benefit risky

assets, including equities.

Global recession is the biggest risk we see facing the Chinese economy, as this could lead to

the first hard landing (GDP growth of 5.5-6.5% in 2012) in more than 20 years. However, even

if a hard landing were to occur, a meltdown (ie, full-blown fiscal and financial crisis) of the

Chinese economy is unlikely, given relatively healthy balance sheets in China.

Chinese policymakers would likely respond quickly to an external recession, through

expansion of monetary and fiscal policies and a reversal of housing policies, which we

would expect to be supportive of investment and commodities.

The ultimate test for China lies with fiscal sustainability. For now, we believe the

government still has enough room to stretch policy to prevent a systemic meltdown of the

economy.

The latest escalation of hard landing fears was triggered by developments in a number of

areas. Most importantly, indecisiveness on the part of European policymakers is seen as

significantly increasing the risks of debt and banking crises. Our base case is that

policymakers will eventually act effectively to prevent a major crisis or a global recession.

The first necessary step is to resolve the Greek situation in an orderly manner. The existing

proposal, however, is probably insufficient as it still leaves Greece with a debt service burden

that is too large to manage successfully. Both Spain and Italy are fundamentally solvent, but

investor confidence has deteriorated so much that the situation is unlikely to stabilise

without outside assistance (see Global Outlook: A treacherous path, 22 September 2011).

Excerpt from Are hard landing

fears overpriced?, dated 28

September 2011, by our China

economist, Yiping Huang

Risks of European debt and

banking crises have risen
https://live.barcap.com/go/publications/content?contentPubID=FC1749173https://live.barcap.com/go/publications/content?contentPubID=FC1749173


17/55


10 October 2011 17

China is often mentioned in discussions of resolution of the European debt problems.

Chinese policymakers have made it clear that they are not ready to rescue Europe, but

would be willing to support Europe as a part of internationally coordinated efforts, such as

those through the European Union, IMF and the G20.

The US Federal Reserves latest gloomy assessment of the economic outlook accompanying

its operation twist has perhaps also dented market sentiment. In particular, many

investors have said the Feds action will not be sufficient to stimulate growth or to reduce

unemployment. All these factors raise concerns about a double-dip in the global economy

and have cast a shadow on the outlook for Chinese exports and other economic activity.

China also has a number of home-grown problems, many of which have worsened lately.

First, due to government restrictions on purchases, house prices have started to stabilise oreven decline in a large number of cities across the country in recent months (Figure 4). The

government is considering extending the restrictions to many second- and third-tier cities.

Chinas property sector already showed clear signs of a bubble, illustrated by very high

price/income ratios, very low rental yields and very high vacancy ratios, especially in the

large metropolitan cities. For some investors, declines in house prices could be the

beginning of a major meltdown, similar to those observed in Japan in 1989, Hong Kong in

1997 and the US in 2008.

Second, a downturn of the housing market could hit property developers hard, especially their

funding situation. According to media reports, the China Banking Regulatory Commission

(CBRC) recently ordered trust companies to review risks in their lending to Greentown, a

prominent property developer in the southeast province of Zhejiang. According to thecompany CFOs conference call on 23 September, Greentown has the highest leverage ratio in

the industry and about 20% of its borrowing is from the trust companies. Falling property

prices, declining transaction volumes and rising funding costs could push many property

developers into insolvency or cause liquidity traps, as happened in the late 1990s.

Third, in the past few weeks a number of owners of small and medium enterprises (SMEs) in

Zhejiang have reportedly fled1, as they were no longer able to repay their debts. Many SMEs

are struggling to cope with a downturn in business activity and a rise in funding costs,

1 http://news.xinhuanet.com/fortune/2011-09/27/c_122091400.htm , 27 September 2011

China will support Europe as a

part of the international efforts

Figure 15: Top 3 downside risks to EM assets Figure 16: Sharper correction in H share and red-chip stocks

What is the biggest downside risk to EM assets in

the next three months?

0%

10%

20%

30%

40%

A double-dip

recession in

the global

economy

Europe's debt

crisis

China's hard

landing

A sharp

increase in

central

economies'

bond yields

60

65

70

75

80

85

90

95

100

105

110

Jan-11 Feb-11 Apr-11 Jun-11 Jul-11 Sep-11

Hang Seng Index

Hang Seng H-share Financial Index

Hang Seng Red Chip Index

Jan11=100

Source: Barclays Capital, The Q3 Global Macro Survey Source: Bloomberg, Barclays Capital

Rising concerns about a double-

dip in the global economy

Domestically, house prices showsigns of a correction

Property developers at risk of

insolvency

Some SME owners have

reportedly fled as they are no

longer able to repay debts


18/55


10 October 2011 18

especially the latter as most have relatively high proportions of financing from outside the

banking sector. Despite still relatively low official bank deposit and lending rates, market rates

have ratcheted up rapidly this year due to the credit tightening. According to surveys by the

local branch of the Peoples Bank of China (PBOC), the average lending rate in Wenzhous kerb

market have risen by 2.8ppts since the beginning of the year to above 17% in September.

Fourth, the formal financial system, especially the banking sector, has seen increasing

disintermediation. Money began to leave the banks amid tight credit and significantly

negative real deposit rates. Deposits in the four largest banks declined by CNY420bn in the

first two weeks of September2, evidence of unstable deposits (Figure 5). In the meantime,

banks off-balance-sheet activities and development of wealth management products have

grown rapidly, which was an effective way for banks to bypass liquidity controls and interest

rate regulations. Off-balance-sheet lending was CNY2.1trn in H1, almost half of the official

new lending of CNY4.5trn (Figure 6). The expansion of these activities has prompted the

PBOCs efforts to monitor total social financing, instead of only bank credit, and to bring off-

balance-sheet transactions under the reserve requirement regulations.

Finally, according to the National Audit Office, total outstanding debt from local

governments and their affiliated entities totalled CNY10.7trn, or about 27% of GDP. Most of

this borrowing financed investment projects, especially infrastructure (Figure 7). But there is

already a serious overcapacity problem in areas of infrastructure, especially highways,

railway and airports. Land sales used to account for between 30% and 50% of the local

governments revenues, so recent declines in house prices are likely to reduce those

revenues significantly. Should local governments become unable to service these debts, the

levels of banks nonperforming loans could grow very rapidly.

The more pessimistic market participants see very high risks of crisis and collapse from

these developments. While we do not share such a view, we agree that the risks have

increased significantly during the past few weeks.

2http://cn.reuters.com/article/chinaNews/idCNCHINA-4953720110922, 22 September 2011

Figure 17: A-H premium widened recently Figure 18: Domestic housing prices appear to have stabilised

80

90

100

110

120

130

140

150

160

170

180

Sep 08 Mar 09 Sep 09 Mar 10 Sep 10 Mar 11 Sep 11

A-H Premium index (%)

44

10

16

41

13

36

11

23

39

12

19

36

22

27

17

26

16

12

0

5

10

15

20

25

30

35

40

45

50

Increase Unchanged Decline

Mar Apr May Jun Jul Aug

# of cities

(Existing home price, % m/m)

Source: Bloomberg, Barclays Capital Source: CEIC, Barclays Capital

Banking sector disintermediation

has accelerated

Ballooning local government

debt has worsened the dynamics


19/55


10 October 2011 19

The biggest risk is another global recessionA recession in the global economy, which is not our base case, could be significant enough

to cause a hard landing for the Chinese economy, due to its high dependency on trade

connections and its much more limited policy flexibility.

Recently, we cut our GDP forecasts to 9.1% for 2011 and 8.4% for 2012 (Figure 9).However, while many analysts downward revisions of GDP forecasts for China on weaker

external demand, our expectation for growth moderation next year reflects a slowing of

investment. Barclays Capital expects global GDP growth of 3.7% in 2012, compared with

3.6% in 2011. In other words, significantly weaker external demand is not our base case.

But we think the investment slowdown is likely to continue, judging from trends in three key

investment areas: infrastructure, manufacturing and housing (Figure 10). Growth in

infrastructure investment has already slowed from its extraordinary pace in 2009-2010 to

around 5-6% currently, as many of the projects planned under the stimulus policy are

completed. With significant short-term overcapacity in many infrastructure areas, and the

financial burdens these projects placed on both the government and the financial system,

we expect infrastructure investment to remain slow or to weaken further.

Manufacturing investment picked up in the past year or two, on recovery of the global

economy. But this is likely to falter again given a dimming outlook. Various purchasing

manager indices have been weak in the past months, hovering around 50 (Figure 11).

Heightened concerns about Europes debt crisis also cast a shadow on export markets.

Housing investment, which accounts for about a quarter of Chinas total fixed asset

investment, could be a wild card for the investment picture. Social housing is a compulsory

policy for local governments and, therefore, will likely be implemented as planned. Thecommercial part of housing investment, however, could weaken substantially. The current

boom, starting from late 2009, really followed the surge in housing prices from the second

quarter of that year. Now that house prices have begun to decline, housing investment is

likely to decelerate sharply, especially as some developers run into financial difficulties.

These factors are behind our expectation of slower economic growth next year in China.

When investment growth moderates, consumption growth is also likely to slow. Although

consumption could stay relatively more resilient, it is simply unrealistic to expect

consumption to fill the gap of slowing investment and, therefore, to support GDP growth at

Global recession could cause a

China hard landing

Our base case does notassume significantly

weaker external demand

Figure 19: Banks deposits have become more unstable Figure 20: Off-balance sheet lending has grown rapidly

-1000

-500

0

500

1000

1500

2000

2500

3000

Aug-05 Aug-06 Aug-07 Aug-08 Aug-09 Aug-10 Aug-11

0

5

10

15

20

25

30

35New increased Deposit (CNY bn)

Deposit growth (RHS,%y/y)

-2

0

2

4

6

8

10

12

14

16

2002 2005 2008 1H2011

Other forms of financing

Corporate bond and equity financing

Bank off-balance sheet lending

Bank loans

CNY trn


Our base case expects growth in

infrastructure investment to

remain slow or weaken

manufacturing investment to

falter

and private housing

investment to decelerate

Consumption growth unlikely to

fill the gap of slowing investment


20/55


21/55


10 October 2011 21

If we apply these numbers, which we think are reasonable estimates, Chinese growth could

slow to 4.5% in 2012 in the unlikely scenario of another global recession.

Of course, the Chinese government would respond quickly in such a scenario for fear of

slow growth causing major economic and political instability. Unfortunately, policymakers

freedom is far more limited now than it was three years ago. Monetary expansion would be

much less aggressive. Over 20082009, the authorities not only cut interest rates butdoubled new credit extended from CNY5trn to almost CNY10trn. In contrast, today liquidity

conditions are still relatively loose and we think any additional easing would be limited.

Although the fiscal system is relatively sound, potential contingent liabilities in the form of

future nonperforming loans in the banking sector and bad asset investments by local

governments have probably increased significantly. As well, fiscal policy is already running

a modest deficit this year, which would also limit the scope for additional expansion.

Without a doubt, we think the Chinese authorities could still do a number of things to

mitigate the potential impact of a global recession, including:

Cutting the reserve requirement ratio, which is at 21.5% for larger banks;

Reducing interest rates as inflation pressures ease;

Easing the restrictions on housing purchases; and

Increasing fiscal spending on rural infrastructure and strategic industries.

We estimate that all of these stimulus measures could add 1-2ppt to Chinas growth,

implying that GDP growth could be supported at 5.5-6.5% in 2012 in the case of another

global recession. This would undoubtedly be viewed as a hard landing by both the market

and the public, especially as growth might be even slower in some areas.

Such a steep decline in growth, from 9% to 5%, would probably cause some difficulties,

such as falling corporate profitability, deteriorating asset quality and intensifying social

tension. But the consequences might not be as bad as some have feared. We used to think

that China needed a minimum of 8% GDP growth. The rationale was that China needed to

create 10mn new jobs per year (8mn new job market entrants plus 2mn from industry

restructuring) to maintain social stability. But those calculations were based on 1990s data,

and the demographic transition since then implies that the number of new job market

entrants is much smaller today. In fact, the labour force is expected to start to decline from

2015. Therefore, we would argue that the minimum required pace of GDP growth today

should be seen as much lower than 8%.

The government would

respond quickly, but

monetary and fiscal policy

flexibility is far more limited now

GDP growth could be at 5.5-

6.5% in 2012 a hard landing

But China may not need 8%

growth to support employment


22/55


10 October 2011 22

Figure 23: Baseline GDP growth to slow to 8.4% in 2012 Figure 24: driven by investment growth slowdown

GDP contribution (pp) 2009 2010 11H1 2011F 2012F

Consumption 4.4 3.8 4.6 4.2 4.1

- Pvt consumption 3.1 2.8 3.4 3.0 3.0

- Govt consumption 1.3 1 1.2 1.2 1.1

Gross capital investment 8.4 5.6 5.1 5.0 4.4

Net exports -3.6 1.0 -0.1 -0.1 -0.1

Real GDP 9.2 10.4 9.6 9.1 8.4

0

5

10

15

20

2530

35

40

45

Aug-06 Aug-07 Aug-08 Aug-09 Aug-10 Aug-11

-50

0

50

100

150

200

250

Manufacturing Real estate Railway (RHS)

YTD, %y/y YTD, %y/y



23/55


10 October 2011 23

Orderly normalisation of credit cost as our base case

Hong Kong and Mainland Chinas economies are highly interrelated. Our base case

credit cost estimates are on the assumption of a soft landing for the Chinese

economy.

As such, we expect a gradual normalization of credit costs upwards for the sector,

7bps, 19bps and 26bps for FY11/12/13E from 3bp in FY10.

We find that Hang Seng Bank has the most defensive risk profile against potential

deterioration of asset quality. Hang Seng Banks FY12E pre-provision profit is enough

to withstand a seven-fold increase in its long-term historical credit cost of 28bps.

Strong cross-border ties driving Mainland-related credit growth

Low HK$ (and US$) lending rates and tightening of credit in mainland China have attracted

continuous high demand for corporate credit, a large portion of which we believe is cross-

border trade related or investment in China, where the cost of funds is considerably higher.

While credit growth has been broad-based, the fastest areas of growth have been in

wholesale and retail trade, trade finance and loans for use outside Hong Kong (mainly in

China).

Figure 25: China and Hong Kong loans y/y growth Figure 26: HK system loan mix by sector 1H11

16.4

27.0

45.6

-20

-10

0

10

20

30

40

50

60

70

Aug-0

4

Aug-0

5

Aug-0

6

Aug-0

7

Aug-0

8

Aug-0

9

Aug-1

0

Aug-1

1

%

China HK total HK loans for use

Mortgages

17%

Other retail

5%

Property

19%

Trade and

trade

finance

14%

Overseas

24%

Other corp

use in HK

21%



24/55


10 October 2011 24

Figure 27: HK system loan growth by type y/y growth June 2011

14%19%

16%

24%

59%

44%

28%

0%

10%

20%

30%

40%

50%

60%

70%

Mortgages

Other

retail

Property

Othercorp

useinHK

Tra

dean

d

tra

de

finance

Overseas

Tota

l


Because of close trade and investment ties between the Mainland and Hong Kong, aslowdown in the Mainland economy will result in a normalization of credit costs in Hong

Kong, in our view. If we look at lending by Hong Kong banks, direct and indirect, to

corporates for use in China, BEA has the highest exposure to Mainland-related corporates

(48%) followed by BOCHK (38%).

Figure 28: Direct China and potentially China-related lending as % of total loans 1H11

42%

22% 20%

8% 8%

3%

9% 10%

16%7%

4%

7%4%

6%

4%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

BEA BOCHK WHB HSB DSB

Use in China Trade finance Wholesale and retail trade, manufacturing

Source: Company data, Barclays Capital estimates

* assuming that trade finance, wholesale and retail trade and manufacturing loans are potentially Mainland related.

Low asset quality risk in the mortgage book

Despite growing negative sentiment and our forecast decline in residential property prices

(25-30% by end-2013), we believe asset quality will remain healthy. The Hong Kong

mortgage market is characterized by abundant equity and healthy underwriting standards.

Moreover, where higher (80-90% LTV) mortgages exist, they have been insured by the

Hong Kong Government through the Hong Kong Mortgage Corporations (HKMC)

mortgage insurance programme. The single driver of mortgage delinquency risk in Hong

Kong is unemployment, in our view. The unemployment rate at August 2011 stands at a

mere 3.5%.


25/55


26/55


10 October 2011 26

A look back in history share price performance vs asset quality trends

At the height of the Asian financial crisis in 1998, Hong Kong banks share prices (weighted

average of HSB, BEA, DSF and WHB) declined by 71% between June 1997 and August 1998,

from peak to trough. However, non-performing loans peaked a year later, after the share

price trough, in September 1999.

We expect a normalization of credit costs from the current lows, taking into account a

global economic slowdown and rising HK$ interest rates in Hong Kong. YTD11, Hong Kong

banks share prices have declined by 36% and does not currently factor in a hard landing of

the China economy, in our view.

BOCHK and Dah Sing have historically had the most volatile credit cost experience, while

HSB and BEA have historically experienced relatively more stable asset quality.

Figure 32: HK banks* share price performance in 1997-99 Figure 33: HK banks* share price performance YTD11

-

20

40

60

80

100

120

Jul-97

Oct-97

Jan-9

8

Apr-98

Jul-98

Oct-98

Jan-9

9

Apr-99

Jul-99

Oct-99

-71%

60

65

70

75

80

8590

95

100

105

110

Dec-1

0

Jan-1

1

Fe

b-1

1

Mar-11

Apr-11

May-1

1

Jun-1

1

Jul-11

Aug-1

1

Sep-1

1

-36%

Source: Bloomberg, Barclays Capital

* Weighted average of Hang Seng Bank, Bank of East Asia, Dah Sing Financialand Wing Hang Bank.


* Weighted average of Hang Seng Bank, Bank of East Asia, Dah Sing Financialand Wing Hang Bank.

Figure 34: HK system non-performing loans ratio Figure 35: HK system bad debts expense as % of total assets

0.610

2

4

6

8

10

12

Ju

n-9

7

Ju

n-9

9

Ju

n-0

1

Ju

n-0

3

Ju

n-0

5

Ju

n-0

7

Ju

n-0

9

Ju

n-1

1

%

Special mentionGross NPL3M+ overdue and rescheduled

Peak gross NPL 10.61% in Sep-99

0.03

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

Jun-9

7

Jun-9

9

Jun-0

1

Jun-0

3

Jun-0

5

Jun-0

7

Jun-0

9

Jun-1

1

%

Peak at 1.29% in Dec-98



27/55


10 October 2011 27

Figure 36: Historical credit cost (bad debts expense/loans)

17 4

647

139

292

148

130

76

55

3 7 19

261

324

15

2

-12

-21

-24

-200

-100

0

100

200

300

400

500

600

700

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011E

2012E

2013E

bps

SECTOR BEA BOCHK

HSB WHB DSF


In terms of earnings defensiveness against deteriorating asset quality, BOCHK and HangSeng Bank rank highest, with the highest break even credit cost hurdle, i.e. credit cost which

would wipe out pre-provision earnings. However, BOCHK also has the worst historical loss

experience represented by its high long term historical average credit cost of 92bps.

On balance, taking into the historical loss experience, risk profile and the defensiveness of

earnings against a future uptick in credit costs, we find that Hang Seng Bank is the most

defensive relative to peers.

Hang Seng Banks pre-provision profit is enough to withstand a 7 fold increase in its long

term historical credit cost of 28bps.

Figure 37: Breakeven credit cost (PPOP/avg loans) FY12E Figure 38: Long term avg historical credit cost (1994-2010)

345

195 183

154115

345

278

187167 167

-

50

100

150200

250

300

350

400

BOCHK HSB WHB BEA DSBG

bps

Breakeven credit cost Breakever credit cost (inc associate)

92 74 52 51 28

121

(FY98)

155

(FY98)

253

(FY99)

281

(FY02)

628

(FY99)

0

100

200

300

400

500

600

700

BOCHK DSBG BEA WHB HSB

bps

LT average Historical peak

Source: Barclays Capital estimates * Long term average of FY1994-2010 except for BOCHK which uses 1999-2010.BOCHK was listed in July 2002.Source: Company data, Barclays Capital


28/55


10 October 2011 28

Figure 39: Breakeven credit cost / long term average credit cost FY12E

7.0

3.8 3.63.0

1.6

10.0

3.8 3.6 3.22.3

-

2.0

4.0

6.0

8.0

10.0

12.0

HSB BOCHK WHB BEA DSBG

x

ex associate contribution inc associate contribution



29/55


10 October 2011 29

Credit cost bear case scenario

If credit costs normalize from the current lows to the long-term historical average credit

cost levels for each bank by FY12E (by FY13E for BOCHK, after de-risking their loan book

from the very high credit losses in 1999), we estimate that in FY12E and FY13E:

Earnings will be lower by 16% and 38%, respectively

Book value will be lower by 2.1% and 4%, respectively

Return on equity will be lower by 1.1% and 3.1%, respectively

Figure 40: Credit cost bear case scenario analysis

FY12E FY13E

Credit cost Base case Bear case Change Base case Bear case Change

BOCHK 0.15% 0.46% 0.31% 0.27% 0.92% 0.65%

HSB 0.19% 0.28% 0.09% 0.19% 0.56% 0.37%

BEA 0.22% 0.52% 0.30% 0.28% 1.04% 0.76%WHB 0.20% 0.51% 0.31% 0.30% 1.02% 0.72%

DSBG 0.32% 0.74% 0.42% 0.45% 1.48% 1.03%

Simple average 0.22% 0.50% 0.29% 0.30% 1.00% 0.71%

EPS Base case Bear case Change Base case Bear case Change

BOCHK 1.68 1.52 -10% 1.80 1.44 -20%

HSB 8.62 8.40 -3% 9.78 8.84 -10%

BEA 1.93 1.56 -19% 2.04 1.01 -50%

WHB 5.14 4.15 -19% 5.12 2.68 -48%

DSBG 0.82 0.58 -29% 0.95 0.34 -64%

Simple average 3.64 3.24 -16% 3.94 2.86 -38%

BVPS Base case Bear case Change Base case Bear case Change

BOCHK 13.2 12.8 -3.1% 14.0 13.5 -3.9%

HSB 42.5 41.4 -2.5% 45.9 44.5 -3.0%

BEA 25.5 25.2 -1.1% 26.6 25.7 -3.5%

WHB 59.1 57.6 -2.6% 62.5 59.2 -5.3%

DSBG 12.3 12.1 -1.4% 13.0 12.4 -4.6%

Simple average 30.5 29.8 -2.1% 32.4 31.0 -4.1%

ROE Base case Bear case Change Base case Bear case Change

BOCHK 12.7% 11.8% -0.9% 12.9% 10.7% -2.2%HSB 20.3% 20.3% 0.0% 21.3% 19.9% -1.4%

BEA 7.6% 6.2% -1.4% 7.7% 4.0% -3.7%

WHB 8.8% 7.3% -1.5% 8.3% 4.6% -3.7%

DSBG 6.6% 4.8% -1.8% 7.4% 2.7% -4.6%

Simple average 11.2% 10.1% -1.1% 11.5% 8.4% -3.1%


For BOCHK, the biggest difference in loan mix between FY99 and 1H11 is an increase in

offshore related lending, most likely China-related trade and investment exposure. We


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10 October 2011 30

believe that BOCHK has de-risked its loan book since FY99 (where credit costs reached

6.3%) and has established a much stronger franchise since listing in 2001, especially among

Mainland-related corporates and individuals. Therefore, our bear case scenario analysis

assumes that BOCHK will reach its long-term average credit cost of 92bps by FY13 (rather

than FY12 for peers).

Risks to stake in Mainland associates

Hang Seng Banks 12.8% stake in Industrial Bank has been growing in size owing to IBs fast

growing balance sheet (asset growth of 31% for CAGR 2005-10). IBs profit contributes

20% to HSB net profit and investment in IB accounts for 17% of assets.

We estimate that Industrial Bank will need to raise capital at some point to fund futuregrowth. If IB boosts FY12E capital from 7.5% to 10%, we estimate that it will amount to

Rmb43bn, of which HSBs share will amount to HK$6.7bn. This will result in a reduction of

HSBs FY12E Tier 1 CAR from 10.5% to 8.7%, on our estimates.

Figure 41: BOCHK loan mix FY99 Figure 42: BOCHK loan mix 1H11

Comm Prop

23%

Other retail

(inc CC)

6%

Other

comm

15%

Trade

finance

6%

Offshore

8%

Mortgages

(inc HOS

PSPS)

26%

Wholesale and

retail t rade,

manufactur'g16%

Comm Prop

15%Offshore

27%

Trade

finance

9%

Other

comm

12%

Other retail(inc CC)

3%

Wholesale and

retail t rade,

manufactur'g

7%

Mortgages

(inc HOS PSPS)

27%

Source: Company data, Barclays Capital Source: Company data, Barclays Capital


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10 October 2011 31

Figure 43: Potential capital dilution if Industrial Bank issues Rmb43bn of capital in FY12E

FY10 FY11E FY12E

Industrial Bank, Rmb mn

Profit (Bloomberg consensus) 18,521 22,809 26,950

Assets 916,911 1,964,599 2,289,720Equity 91,995 103,677 127,725

ROE 20% 22% 21%

ROA 2.0% 1.2% 1.2%

Tier 1 Capital 87,858 107,187 131,122

RWA 991,702 1,339,301 1,740,575

Tier 1 CAR 8.9% 8.0% 7.5%

To boost Tier 1 to 10% Industrial will need to raise Rmb42,936mn, equivalent to HK$52,415m

HSB's 12.8% stake amounts to HK$6,709 m

Hang Seng Bank, HK$m

Tier 1 Capital 33,898 34,937 38,916

RWA 313,437 336,533 368,928

Tier 1 CAR 10.8% 10.4% 10.5%

If HSB participates fully in IBs rights issue, FY12E Tier 1 CAR will fall to 8.7%



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10 October 2011 32

In terms of asset quality risk, credit costs will need to rise beyond ~3% before IBs pre-

provision profit is fully wiped out. If this does occur, HSBs PTP will decline by 20% in FY11E

and 24% in FY12E.

Figure 44: Industrial Banks associate contribution to Hang Seng Bank

Hang Seng Bank, HK$m 2007 2008 2009 2010 2011E 2012E 2013E 2014EAssociate pre-tax profit contribution (P&L) 1,122 1,807 1,748 2,661 3,755 4,519 5,220 5,808

HSB's PPOP 18,365 16,501 14,026 14,475 14,626 14,933 16,866 18,409

HSB's pre tax profit 21,107 15,878 15,400 17,345 18,518 18,847 21,376 23,258

Investment in associate (BS) 6,177 8,870 10,226 15,666 19,027 22,605 25,881 28,534

HSB's total assets 745,999 762,168 830,668 916,911 1,003,342 1,072,988 1,137,400 1,205,144

HSB's assets ex associate 739,822 753,298 820,442 901,245 984,316 1,050,382 1,111,519 1,176,610

HSB's equity 56,456 51,626 62,148 70,012 75,446 81,214 87,758 94,884

Associate contribution to HSB's PTP 5.3% 11.4% 11.4% 15.3% 20.3% 24.0% 24.4% 25.0%

Investment in associate as % of HSB's assets 0.83% 1.16% 1.23% 1.71% 1.90% 2.11% 2.28% 2.37%Investment in associate as % of HSB's equity 10.9% 17.2% 16.5% 22.4% 25.2% 27.8% 29.5% 30.1%


Figure 45: Industrial Banks breakeven and actual credit cost (bad debts charge/avgloans)

2.61%

3.46%

3.87%

2.95%

3.37%

2.50%

1.54%1.15%

2.29%

2.22%

0.46%0.85%0.71%0.66%

0.09% 0.30%0.76%

2.33%

0.42%0.54%0.83%

0.0%

0.5%

1.0%

1.5%2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

2004 2005 2006 2007 2008 2009 2010

Breakeven credit cost Actual credit cost NPLs/loans

Source: Company data, Barclays Capital


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10 October 2011 33

Exposure to European investment securities

Hong Kong banks risk to claims on Western European countries (ex UK) is limited to

4.3% of assets, on average. All banks in our coverage universe have immaterial

exposure to peripheral European countries.

For BOCHK, a worse-case scenario where a 100% writedown is taken on Euro-

denominated trading and AFS securities would result in a 13.3% hit to equity.

While the risk of contagion is always present, depending on how the events of the European

debt crisis unfold, we believe the risk to the Hong Kong banks are limited since cross-border

claims on Western Europe (ex UK) account for only 4.3% of assets. Cross-border claims

include loans and receivables, interbank and investment securities.

The Hong Kong banks have been reducing exposure to European countries since the

beginning of FY10 when European debt concerns first arose. In 1H11, cross border claims

on Western Europe ex UK declined by 13% h/h. Most local banks have been increasing

exposure to RMB-denominated securities.

Figure 46: Cross-border claims on Western Europe ex UK 1H11

Western Europe ex UK cross border claims, HK$m Banks

Public sector

entities (PSE) Others Total

HSB 32,321 6,802 13,452 52,575

BOCHK 42,673 18,878 5,502 67,053

BEA* 24,194 0 1,494 25,688

WHB 3,461 1,045 177 4,683

DSBG* 5,996 89 2,727 8,812

Total 108,645 26,814 23,352 158,811

As % of assets Banks PSE Others Total

HSB 3.3% 0.7% 1.4% 5.4%

BOCHK 2.3% 1.0% 0.3% 3.7%

BEA 4.0% 0.0% 0.2% 4.3%

WHB 2.0% 0.6% 0.1% 2.6%

DSBG 4.2% 0.1% 1.9% 6.2%

Total 2.9% 0.7% 0.6% 4.3%

As % of equity Banks PSE Others Total

HSB 44% 9% 18% 71%

BOCHK 33% 15% 4% 52%

BEA 47% 0% 3% 50%

WHB 21% 6% 1% 29%

DSBG 43% 1% 19% 63%

Total 38% 9% 8% 56%

h/h % growth Banks PSE Others Total

HSB -22.1% 2.0% 35.2% -9.5%

BOCHK -24.6% 34.0% 10.3% -11.4%

BEA -18.3% n.a. -68.9% -25.4%

WHB -25.1% -22.6% 11.3% -23.6%

DSBG 19.0% 0.0% -3.1% 11.0%

Total -20.9% 20.8% 2.8% -12.9%

Source: Company data, Barclays Capital* Note BEA and DSBG includes cross border claims on the UK.


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10 October 2011 34

All the local Hong Kong banks in our universe have said that their exposure to peripheral

European countries is immaterial. For BOCHK, of the HK$20bn in Euro-denominated

investment securities, only HK$1bn relates to euro peripheral countries. Even if we assume

an impairment charge for the full exposure, this will only affect FY11E profit by 5%.

From BOCHKs currency risk disclosure in 1H11, a full writedown of Euro-denominated

trading and AFS securities will result in a 13.3% hit to equity.

Figure 47: Investment securities by type and by currency 1H11

HK$m Trading and FVPL AFS HTM

Loans and

receivables Total

Accounting method MTM through P&L

MTM through

reserves At amortised cost At amortised cost

Sovereign 14,322 80,206 21,248 115,776

Public Sector entities 281 39,341 8,611 48,233

Banks and other FI 24,003 173,926 29,155 15,381 242,465

Corporate 9,731 21,590 4,178 35,499

Total 48,337 315,063 63,192 15,381 441,973

RMB 1,571 24,628 17,795 43,994

USD 13,881 160,954 23,877 198,712

HK$ 32,676 77,546 10,911 4,004 125,137

Euro 129 17,099 1,706 1,431 20,365

Yen 1,333 2,055 3,388

Pound 272 8 9,688 9,968

Other 80 33,231 6,840 258 40,409

Total 48,337 315,063 63,192 15,381 441,973

Total assets 1,830,379Total equity 129,623

Euro denominated securities as % of assets 0.01% 0.93% 0.09% 0.08% 1.1%

Euro denominated securities as % of equity 0.1% 13.2% 1.3% 1.1% 15.7%

Source: Company data, Barclays Capital


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10 October 2011 35

EARNINGS REVISIONS AND VALUATION

We lower our earnings forecasts for the Hong Kong banks by 2-10% for FY11 and FY12,

respectively, on the back of lower credit growth, margin and slightly higher credit cost

assumptions; we are now 2-20% below Bloomberg consensus profit estimates.

Based on our blended valuation methodology approach, the sector offers 22%

absolute upside potential to our fair value. However, in the near term, share price

performance may be affected by market volatility. We estimate there is still 46%

downside potential for Hong Kong bank shares vs historical trough P/B multiples.

We prefer HSBC and Standard Chartered, both 1-OW, for their international presence,

larger and global business/markets exposure, and sensitivity to rising rates in Asia.

We lower our PT for the remaining local Hong Kong banks by 13% (on average) and

still prefer Hang Seng Bank (2-EW).

Revising down profit estimates by 2-10%

We have made adjustments to our earnings forecasts for the Hong Kong banks, mainly

reflecting:

Our base case 100bps hike in Prime rate in 1H13 (in line with Barclays Capital

economics teams US Fed Fund rate hike forecasts).

Lower loan growth estimates of 12.1%, 7.9% and 6% (from 8% to 17.7% previously),

and mortgage growth to +5%, -6.6% and -7.6% (from -5% to 10% previously), for

FY11/12/13E respectively.

Persistently low interest rates in FY12 and 1H13 and lower margin assumption of

1.63%, 1.54% and 1.61% for our three consecutive forecast years (from ~1.6-1.7%

previously). We cut our offshore RMB deposits estimates to Rmb800bn by end-2011(12% of system deposits), 1.4trn by end-2012 and 2trn by end-2013 (from 1/1.7/2.5trn

previously). We factor in a spread on RMB business of just 5bps since most RMB

deposits are held by the PBOC currently. There is upside to our margin estimate if

positive offshore RMB developments occur in the near term.

Lower fee income growth of 11%, 8% and 11% for FY11/12/13E, respectively,

reflecting weaker investor sentiment and resulting in lower wealth management,

brokerage and investment banking income.

Figure 48: Earnings revision summary Net profit forecasts

New New Old Old Change

HK$m FY11E FY12E FY11E FY12E FY11E FY12E

BEA 5,020 4,286 5,116 4,832 -1.9% -11.3%

BOCHK 20,323 17,974 20,400 18,984 -0.4% -5.3%

HSB 16,063 16,479 16,650 19,109 -3.5% -13.8%

WHB 2,053 1,693 2,075 1,800 -1.1% -5.9%

DSBG 1,113 999 1,115 1,175 -0.2% -15.0%

DSF 1,000 982 1,049 1,138 -4.6% -13.7%

Sector 45,573 42,414 46,405 47,038 -1.8% -9.8%


Our profit forecasts for the sector on average are now 2% to 20% below Bloomberg

consensus for FY11, FY12 and FY13, respectively.


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10 October 2011 36

Figure 49: Barclays Capital vs Bloomberg consensus net profit forecasts

Net profit Barclays estimates vs Bloomberg consensusHK$m FY11E FY12E FY13E FY11E FY12E FY13EBEA 5,020 4,286 4,514 5.4% -15.7% -22.2%

BOCHK 20,323 17,974 19,255 -0.6% -9.7% -15.2%

HSB 16,063 16,479 18,697 -3.5% -11.3% -11.3%

WHB 2,053 1,693 1,686 4.2% -14.5% -23.6%

DSBG 1,113 999 1,165 -5.6% -25.0% -23.3%

DSF 1,000 982 1,130 -14.1% -24.7% -23.2%

Sector simple average -2.4% -16.8% -19.8%

Source: Bloomberg, Barclays Capital estimates

We expect sector average ROE to rise to 15.7% in FY11 (from 15.2% in FY10) due to

significant one-offs (e.g. BOCHKs Lehman write-back, property revaluation gains) before

normalising to 13.7% in FY12 and 14.1% in FY13, mainly as a result of persistent margin

pressure and a slight uptick in credit costs.

Figure 50: Hong Kong banks ROA & ROE (excludes HSBC and Standard Chartered)

0

5

10

15

20

25

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011E 2012E 2013E 2014E

%

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0%

ROE (LHS) ROA (RHS)

Source: Company Reports, Barclays Capital estimates

The DuPont-style analysis below highlights the decomposition of profitability. The increase

in sector leverage is mainly a result of rapid growth of offshore RMB deposits, which boosts

bank assets (balances with central bank) and liabilities but does not affect equity.

We have yet to factor in the benefit from a transition to an internal ratings-based approach

for the smaller banks (BEA, WHB and DSBG thereafter), which should slightly increase

leverage.


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10 October 2011 37

Figure 51: Hong Kong banks: DuPont analysis (weighted)

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011E 2012E 2013E

Net Interest Income 2.10 1.93 1.72 1.71 1.85 1.90 1.89 1.65 1.51 1.36 1.36 1.38

Net Fee Income 0.48 0.47 0.53 0.45 0.50 0.72 0.53 0.53 0.53 0.49 0.50 0.50

FX & Trading 0.12 0.16 0.17 0.17 0.20 0.22 0.12 0.17 0.11 0.14 0.16 0.15

Other Income 0.12 0.16 0.13 0.17 0.11 0.04 -0.09 0.02 0.05 0.04 0.06 0.06

Non-Interest Income 0.71 0.79 0.83 0.79 0.81 0.98 0.57 0.71 0.70 0.67 0.71 0.72

Total Operating Income 2.81 2.72 2.56 2.50 2.65 2.88 2.46 2.36 2.20 2.03 2.07 2.10

Staff & Pensions 0.52 0.52 0.52 0.47 0.49 0.54 0.51 0.52 0.50 0.45 0.47 0.48

Occupancy 0.22 0.21 0.20 0.18 0.19 0.20 0.22 0.22 0.21 0.19 0.19 0.19

Other Expenses 0.18 0.15 0.17 0.22 0.22 0.21 0.25 0.35 0.20 0.17 0.17 0.17

Operating Expenses 0.92 0.88 0.89 0.86 0.90 0.94 0.98 1.09 0.90 0.80 0.84 0.84

Pre-Provision Op. Profit 1.89 1.84 1.66 1.64 1.75 1.93 1.47 1.28 1.30 1.22 1.24 1.26

Impairment Cost 0.36 0.25 -0.11 -0.09 -0.05 0.10 0.68 0.06 0.01 0.03 0.09 0.12

Pre-Tax Profit 1.54 1.59 1.77 1.73 1.80 1.83 0.80 1.21 1.29 1.19 1.15 1.14

Income Tax Expense 0.19 0.17 0.28 0.29 0.31 0.32 0.12 0.23 0.23 0.25 0.24 0.24

Associates 0.00 0.01 0.01 0.03 0.04 0.06 0.07 0.08 0.11 0.12 0.14 0.15

Significant & Minorities -0.06 -0.08 0.18 0.19 0.08 0.15 -0.02 0.09 0.08 0.14 0.01 0.01

Net Profit (ROA) 1.29 1.35 1.68 1.66 1.62 1.72 0.73 1.16 1.25 1.21 1.06 1.06

Leverage 12.0x 12.0x 11.9x 11.4x 11.4x 12.3x 12.6x 12.6x 12.1x 12.9x 12.9x 13.3x

Return on Equity (ROE) 15.4 16.2 20.1 18.9 18.5 21.1 9.2 14.6 15.2 15.7 13.7 14.1



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10 October 2011 38

Price target methodology

Our valuation approach is unchanged; we use an unweighted, blended valuation approach for

the Hong Kong banks (ex HSBC and StanChart). Our approach is intended to capture a number

of differing investment philosophies over the short-, medium- and longer-term outlook for

earnings growth and profitability. Our blended approach incorporates the following standalonevaluation techniques:

Three-stage dividend discount models (DDM) incorporating three years of dividend

forecasts, an eight-year fade to perpetuity growth, and a perpetuity value.

Single-stage (Gordon Growth) model (GGM) incorporating one-year forward ROE,

individual stock cost of equity calculated using the capital asset pricing model and a

perpetuity growth assumption (as used in the three-stage DDM).

Historic price-to-earnings we use a five-year average of one-year forward consensus EPS

estimates to calculate historic P/E and apply this to our one-year forward EPS estimate.

Historic price-to-book we use a five-year average of one-year forward consensus

book value estimates to calculate historic P/B, and apply this to our one-year forward

BVPS estimate.

Historic price-to-pre-provision operating profit (PPOP) we use a five-year average of

one-year forward consensus PPOP/share estimates to calculate historic P-PPOP, and

apply this to our one-year forward PPOP estimate.

Single-stage (Gordon Growth) model (normalised) we replace our one-year forward

forecast ROE with our one-year forward normalised ROE estimate. Cost of equity and

perpetuity growth is consistent with our other modelling.

Normalised P/E we apply historic average normalised P/E (five years of data) to one-

year forward normalised EPS estimates.

We have removed the special premium for market factors previously included for the

smaller Hong Kong banks, which have historically traded at varying levels above

fundamental value.

We believe the Hong Kong banks are currently trading at below fair value due to concerns

over increasing risk of a global economic slowdown or China hard landing. As such, we

incorporate a discount based on historical P/B trough multiples.

Our price targets now incorporate our changes to earnings estimates (lower margin and

market-related fee income, slower lending and uptick in credit costs). In the near term,

uncertainty over global growth could result in further market volatility; the potential

downsides to trough P/B multiples are shown below.


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10 October 2011 39

Figure 52: Hong Kong banks blended valuation approach (FY12E) and price target summary

HK$ / Share HSB BEA BOCHK WHB DSF DSBG

DDM 107.48 16.78 16.51 30.39 14.71 4.14

GGM 126.75 16.15 17.54 49.70 16.67 4.82

Historic PE 134.29 29.06 19.83 58.33 41.80 10.18

Historic PB 152.52 31.82 19.17 92.14 55.55 15.56

Historic PPOP 88.17 30.40 17.64 69.54 33.34 7.38

Normalised ROE 80.53 5.02 21.92 47.57 19.51 -2.40

Normalised EPS 120.47 22.49 27.34 81.91 39.44 4.66

BLENDED VALUATION 115.70 21.70 20.00 61.40 31.60 7.80

Historical trough P/B multiples1.7x

(Aug-98)

0.6x

(Mar-09)

0.7x

(Mar-09)

0.4x

(Sep-98)

0.3x

(Nov-08)

0.4x

(Oct-08)

Price at historical trough P/B 72.0 15.2 8.5 22.0 16.4 4.8

% potential downside to trough -38% -30% -58% -64% -48% -39%

PRICE TARGET (HK$ / Share) 115.70 21.70 20.00 61.40 31.60 7.80

Current price (HK$ / Share) 92.75 24.95 16.76 61.50 20.60 6.92

Dividend (HK$ / Share) 5.60 1.05 1.11 1.99 1.01 0.25

12-month Total Shareholder Return 31% -9% 26% 3% 58% 16%

Note: Closing price as of 7 October 2011. Source: Bloomberg, Barclays Capital estimates

Current 12 month forward P/B multiplies are still 37% on average above trough valuations.

Figure 53: Target, current and trough P/B multiples FY12E

HSB BEA BOCHK WHB DSF DSBG

Target 2.8x 0.9x 1.5x 1.1x 0.6x 0.7x

Current 2.3x 1.0x 1.3x 1.1x 0.4x 0.6x

Trough1.7x

(Aug-98)

0.6x

(Mar-09)

0.7x

(Mar-09)

0.4x

(Sep-98)

0.3x

(Nov-08)

0.4x

(Oct-08)


Reiterate our cautious view on Hong Kong banks

We believe that more sophisticated, international and markets-oriented banks will be the

biggest beneficiaries of RMB internationalisation. We prefer HSBC (5 HK, 1-OW, PT HK$93)

and Standard Chartered (2888 HK, 1-OW, PT HK$231) . Please refer to our recent

publications HSBC: Restructuring, growth and resilience, dated 9 September 2011, and UK

Banks: Chink in the Clouds, dated 8 September 2011.

We have lowered our price targets for the other local Hong Kong banks to reflect slowercredit growth, weaker market-related fee income and lower margin assumptions.

Of the local Hong Kong banks, Hang Seng Bank remains the most defensive, in our view.

We lower out PT to HK$115.7 (from HK$123.2) and maintain our 2-EW rating.We like Hang

Seng Banks strong liquidity position, which will allow it to re-price credit and defend itself

against a downturn in the global economy. It has the best risk management track record

among peers and the best PPOP coverage vs long-term historical credit costs.

For BOCHK, we lower our PT to HK$20 (from HK$20.9) and maintain a 2-EW rating. BOCHK

is more susceptible to the risks associated with RMB internationalisation as the largest


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10 October 2011 40

offshore RMB deposit taker in Hong Kong (33% market share at June 2011). Our view may

change if more beneficial regulations are introduced to assist the Hong Kong banking

industry to execute development of the offshore RMB market.

Bank of East Asia remains our least preferred pick; we maintain our 3-UW rating and

lower our PT to HK$21.7 (from HK$29.6 previously) as we believe Chinas 75% LDR

requirement will continue to be a constraint on BEA Chinas loan growth potential owing toBEAs weaker deposit franchise relative to domestic Chinese banks. In addition, margins will

continue to remain under pressure as BEA attempts to retain and attract more RMB

deposits. A key upside risk is continued buying by Guoco (BEAs second largest shareholder

with 13% stake) which may provide share price support from the downside.

We leave our ratings unchanged for Dah Sing names at 2-EWand Wing Hang Bank at 3-

UW, but cut PTs to HK$7.8 for DSBG (from HK$9.3), HK$31.6 for DSF (from HK$37.4) and

HK$61.4 for WHB (from HK$68.9) reflecting our lower earnings estimates and removal of a

special premium accounting for market factors. DSBG/DSF and WHB will be subject to

higher funding costs on rising HK$ deposit competition and potential migration of demand

deposits in time. On a relative basis, we believe the Dah Sing names have less downside risk,

trading at just 0.4-0.6x FY12E P/B.

A key upside risk t

70114906 barclays capital hong kong banks

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