Hong Kong Banks：Own a piece of the Rock

HONG KONG BANKS | OVERWEIGHT Please read the analyst certification and other important disclosures on last page Hong Kong Banks 24 January 2011 Own a piece of the Rock Hong Kong banks are among the best capitalized banks globally and operate in one of the least leveraged banking systems. This is illustrated by both an ultra-low loan-to-deposit ratio and tangible leverage. The system is underpinned by an environment conducive to capital inflows, a robust real-estate market backed by ultra-low loan-to-value ratios, a tight labour market and an abundance of savings. The rapid evolution of the Renminbi market in Hong Kong is breathing new life into the system and provides another engine of sustainable long-term growth. These factors all combine to foster an environment of stability and growth which will continue to benefit the local banks for the foreseeable future. The main risk is inflation and persistent negative real interest rates. While these forces have a destabilizing potential by reducing real wealth and limiting lending spreads, overall dynamics are favorable. Hong Kong is one stable rock. We initiate with an Overweight sector weighting; BOC Hong Kong (Holdings) Ltd. is our top pick. AnalystAnalystAnalystAnalystssss Adam Chan, CA (852) 2533 2439 adamchan@ccbintl.com Silvia Fun (852) 2533 2480 silviafun@ccbintl.com Head of Financials Paul Schulte (852) 2533 2742 paulschulte@ccbintl.com Hong Kong Banks 24 January 2011 2 Table of Contents I. Summary of conclusions ........................................................................................................... 3 II. Valuation summary................................................................................................................... 8 III. Industry outlook....................................................................................................................... 9 Financial stabillity IV. Financial stability – Capital flows........................................................................................... 27 V. Financial stability – Real estate.............................................................................................. 33 VI. Financial stability – Deposits................................................................................................. 40 VII. Financial stability – Linked Exchange Rate System............................................................. 42 VIII. Financial stability – RMB liberalization................................................................................ 46 Companies BOC Hong Kong (2388 HK) ....................................................................................................... 53 Bank of East Asia (23 HK).......................................................................................................... 57 Dah Sing Banking Group (2356 HK) .......................................................................................... 61 Hang Seng Bank (11 HK) ........................................................................................................... 65 Wing Hang Bank (302 HK)......................................................................................................... 69 Hong Kong Banks 24 January 2011 3 I. Summary of conclusions Hong Kong banks are more than adequately capitalized in terms of CAR and Tier-1 and are head and shoulders above global peers in terms of tangible capital. Loan-to-deposit ratios (LDR) for Hong Kong banks (FX & HK$) are also among the lowest globally at 61%, offering abundant liquidity. Deposit franchises are becoming more and more valuable in the global banking landscape and this is a core strength of Hong Kong banks. The growth of Hong Kong as the offshore RMB market has proceeded faster than expected. Local banks have RMB120b in retail deposits (2.2m retail accounts) and RMB160b in corporate deposits (117,000 accounts) accounting for 4.8% of system deposits. Renminbi stock and bond issuance will rise dramatically and should remain well-bid, given the lopsided demand (RMB280b in deposits compared with RMB80b in offshore bond issuances to date). We estimate total loan-to-value for the system to be as low as 40%, one of the lowest for any advanced economy globally. Banks able to reduce their ‘fear filters’ will be able to benefit at the expense of the competition in terms of share. In addition, affordability (debt service as a percentage of income) continues to be well below 1997 peaks. We expect the rebound in fee income (particularly brokerage and wealth management) to continue given our bullish macro outlook for Hong Kong. While we expect margin pressure to persist (given continued low rates in the US), the combination of strong fee income, loan volume growth and a continued be