A confluence of factors, both economic and regulatory, has led to improving
fundamentals in the HK bank space. Loan growth will likely return to a more
measured 6-7% YoY trend in FY13, down from FY11’s rapid 20% pace.
Meanwhile, banking system liquidity is improving, allowing NIM’s to increase,
though margins are far from FY08 levels. Asset quality remains benign and is
unlikely to be tested severely in the face of a Chinese economic recovery. At the
same time, banks have kept dividend payouts cautiously low, allowing capital to
accumulate in preparation for Basel III. Fee income opportunities are abundant.
Valuations attractive in sub debt, senior is rich
Following the recent sell off in which BCHINA LT2 widened by 50bps, we have
seen the re-emergence of value in the HK bank bullet LT2 space. Bonds are
trading 30-40bps wide of normal relationships to HK corporates and offer good
value versus similar rated EM banks, causing us to affirm our OW-30% on
BNKEA and BCHINA bonds. We upgrade our recommendation on CINDBK 2020
LT2 bonds to OW-70% given improvement in core credit metrics, but remain
cautious on DAHSIN given the rapid jump in China NPL’s in 1H12. We continue to
see value in WINHAN UT2 bonds which offer 150-210bps pickup to callable LT2
bonds for a good credit. We add coverage of the CINDBK 2022 (call ’17) with an
OW-70% recommendation, with bonds just -12bps inside 3 yr longer maturity
bullet 2020’s. Senior bonds, however, are rich vs EM peers and implied recovery
rates. We downgrade our recommendation on BCHINA 16’s to UW-30%.
Basel III – Ready or not, here it comes
HK’s has adopted Basel III and banks will need to be compliant from Jan 1st,
2013. We highlight key differences between HK Basel and the proposals from the
Basel Committee in areas of unreleased gains/losses, deferred tax assets,
connected party exposures and trade finance. Banks in Hong Kong will be
required to include “point of non-viability” conversion / write-down clauses in the
terms of their capital instruments, on and after 1 January 2013. The trigger point
for principal loss absorption on new capital instruments complying under
additional Tier 1 is when the CET1 breaches 5.125%.
What would happen if Hong Kong’s property market busts?
Lending to the property sector, in one way, shape or form, constitutes 15-43% of
bank loans. We ask ourselves what would happen in the face of another market
crash and how well capitalized are banks? In our view, BNKEA remains the most
vulnerable followed by DAHSIN given higher exposure to property development
loans. In our base case, we estimate NPL’s would rise to up to 4% of loans and in
several cases, wipe out more than a year of pre-provision profits. Capital ratios
are sufficient to prevent capital raisings immediately but could trigger coupon
skips on the BNKEA Tier 1 (UW-30%).