EUR 850.00 For Business Accounts Only

Morningstar | 00023 Updated Star Rating from 17 Jun 2019

A downgrade of four legacy, property loans in non-Tier 1 cities in China will result in the Bank of East Asia booking a post-tax impairment loss of HKD 2.5 billion to HKD 3 billion. The four legacy loans totalling HKD 6.2 billion occurred before 2016, prior to the bank’s earlier focus on de-risking its loan portfolio in China. Management said the impairment is a conservative assessment, with recognition ahead of the 90 days overdue threshold and collateral covering loans outstanding. The bank also said the remaining legacy, non-tier 1 property loans are for HKD 10 billion, or 2% of total loans.

We increase our credit cost assumption to account for the higher impairment, resulting in a decline in our fiscal 2019 net profit forecast to HKD 3.6 billion from HKD 6.5 billion. While the credit cost is expected to normalise in the second half, we conservatively increase our credit-cost assumption in the medium term. Our fair value of HKD 26 is unchanged, offset by time value of money and we see the bank as slightly undervalued. The impairment is a surprise given the bank’s previous large writedown of its China portfolio. While the bank continues to pay the price for its aggressive pursuit of growth in China, we maintain our view that the bank is on a better footing because the China loan portfolio has been progressively written down and the remaining legacy loans are small in the context of the group’s loan portfolio. The current focus on retail in China is likely to result in less risky growth, relative to its previous growth strategy in corporates. Still, the average return on equity of 7% will see the bank continuing to generate a return below its cost of capital, reflected in our no-moat rating for the bank.

The underlying assets backing the property loans are retail malls and offices. Management cited a deterioration in economic conditions and the effects of e-commerce. Overall retail sales growth during the year to April in China was 7.2%, slowing from 8.7% year to March. Management said this is an one-off event and the overall China loan book remains strong. The impairment will not alter the bank’s risk appetite in China and its strategy to focus on the retail segment. Apart from the impairment, the underlying core banking operation is strong, with the first half expected to be profitable. The latter is supported by a widening net interest margin. The capital position remains prudent, with the Common Equity Tier 1 ratio and Total Capital Adequacy Ratio expected to be above 14.5% and 19% respectively.