Hong Kong Bank - Set for an Even Tougher 2009

The operating environment for Hong Kong banks is likely to worsen in 2009 as the rising corporate failures, particularly SMEs and export related sectors, will result in higher credit cost for banks. We expect to see limited loan growth and lower NIM as banks are both cautious in lending as well as deploying the excessive funds in higher yielding products.

The fee income, one of the growth engines for HK banks' earnings in the past, will disappear as stock brokerage income and wealth management product sales worsen in a contracting economy.

Besides earnings deterioration, Hong Kong banks are also subject to further write-down from its investment portfolio where a lot of their excess liquidity was placed in overseas investments and the market bond prices deterioration will result in significant book value erosion.

Hang Seng Bank: In our view, HSB is less likely to cut the dividend since the bank had a good track record of paying out stable dividend on a progressive DPS policy – HSB did not cut its dividend during the Asian crisis. Moreover, HSB has in the past paid out over 100% of earnings as dividends – in 1999 and 2002, HSB has paid out dividends more than the earnings (e.g., retained earnings) during those years as the payout ratio was 189% and 104%, respectively.

BOCHK: BOCHK pays dividends based on payout ratio policy. Since its listing in 2002, the bank has maintained a stable dividend payout ratio of about 60-70%. A cut to the payout ratio is unlikely, but BOCHK's DPS will be more sensitive to changes to earnings. That said BOCHK is one of the best positioned banks in the sector in terms of capital strength. Its tier 1 ratio of 11.5% in 1H08 ranked high as compared with the sector average of 10.2%. In our view, both BOCHK and HSB have the capacity to raise tier 2 even under the current environment. Recently, to beef up its capital amid the current financial crisis, BOCHK has tapped in tier 2 funding of US$2.5bn from its parent at lower than market interest cost.

Bank of East Asia: BEA also pays dividends based on a payout ratio, but we believe the bank is susceptible to a dividend cut in this downturn given high earnings uncertainty. Due to relatively low profitability, the bank has a high sensitivity to bad debt provisions in a rising credit risk environment. As compared with peers, its balance sheet is relatively stretched due to its strong growth in China in recent years. Its tier 1 ratio of 9.4% falls at the lower end of the sector's average.

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