EUR 850.00 For Business Accounts Only

Morningstar | Bank of East Asia Reports a Positive 1H Result. See Updated Analyst Note from 29 Aug 2018

Bank of East Asia reported a positive first-half result with stronger performance in Hong Kong offsetting a continued challenging operating environment in China. We revise our fair value to HKD 28.60 from HKD 24 as we lower our long-term capital structure assumption as the decline in risk weights resulted in an improvement in the bank's capital ratio. Our new capital structure assumption translates into common equity Tier 1 ratio closer to the high end of management's comfort level range of 14% to 15%. Our fair value represents a fair price/book value of 0.9 times and fair price/earnings of 11.8 times. The bank's share price has declined from a peak of HKD 35 in July to current price of HKD 29 and has underperformed against both the Hang Seng Index and Hang Seng Finance Index over the same period. With the bank's current share price close to our new fair value, we require a larger margin of safety and our 3-star rating reflects this.

While our last positive recommendation on the bank was early 2016, we acknowledge the risk to reward has improved given the weaker share price and more importantly, an improvement in the bank’s fundamentals. Our main concern was credit quality for the bank's China book, which was settled in 2017 and reaffirmed in this result with a decline in an absolute level of impaired loans in China. The bank's overall operation is more efficient with the near completion of a cost reduction program. This has resulted in the bank's cost/income ratio declining to below 50% from 60% in 2015. While this is still higher than local peers, we do note that Bank of East Asia has a larger geographic footprint. Singapore banks with cost/income ranging between 40% and 44% may be better comparable given their larger regional footprint. Management noted further costs decline is possible for its China operation as its cost base remains high.

As operations in China become more efficient in the medium term and with credit quality no longer a concern, the bank can again focus on growth. As highlighted earlier, the strategy for the Chinese market is on retail banking. While this may be a challenge given larger SOE banks' sizable deposit base and branch network, we believe the strategy is lower risk relative to its focus on corporates. The retail segment will also result in higher capital efficiency. For a foreign bank, BEA maintains one of the largest branch networks and is behind only to HSBC and Standard Chartered. There were little details on its overall strategy, as earlier guided for, but technology-based partnership such as previously announced with WeBank may help penetrate a client segment of the market, relative to the SOE banks.

As previously noted, the bank's Pillar 3 disclosure in the first quarter showed a meaningful improvement in capital ratios as a change in models resulted in a decline in risk-weighted assets. The application of greater detailed assumptions including the location of the credit risk, for example, China or non-China loans, the type of borrower being state-owned enterprise or private, was approved by the Hong Kong Monetary Authority. For the half, risk-weighted assets declined by 12% against last year with risk-weighted asset intensity, or risk-weighted assets/total assets declined to 59% from 68% earlier. The improvement led to an increase in common equity Tier 1 ratio to 15.3% from 13.2% with overall capital adequacy ratio rising to 20.5% from 17.8%.

Net interest margin increased slightly with weaker margins in China offsetting improvements in Hong Kong. Funding costs at the system level in Hong Kong have picked up since the first quarter. Composite interest rate--weighted average interest rate on deposits and wholesale funding--increased to 63 basis points in July from 38 basis point in March. The interbank rates in Hong Kong maintained its upward trajectory in the second quarter with average 1-month Hibor in July at 1.81%, compared with 0.79% at the end of March. We believe rising funding cost will benefit banks in Hong Kong with sizable deposits, as competitors more reliant on wholesale funding will see their borrowing cost rise more quickly. This will ease competition pressure on lending spreads in the overall market, as is the case over the last few years as lenders focused on higher-quality corporates. Still, liabilities yield should head north as depositors switch from savings deposit into time deposits, on higher fixed rates. Year to June savings deposit balance on a system level declined by 4.6% while time deposit increased 7.2% in the same period. The smaller-than-peer deposit base remains a challenge for BEA but deposit growth was reasonable in the first half and its mix of current and savings account improved. In contrast, an environment of deleveraging in China resulted in tighter credit, resulting in funding pressure for the bank. In line with previous periods, net interest margin declined 22 basis point to 1.53%.

Higher net interest income was also supported by a 5.8% increase in loan growth in Hong Kong, which was in line with system loan growth of 5.5%. Corporate loan growth was weak in the first half as the bank assessed the credit quality of its existing Hong Kong book. This was offset by stronger increase in mortgages. Management noted an acceleration is possible in the second half, with higher lending towards corporates. We note system loan growth in the second half may decelerate slightly as concerns over trade weighs on business confidence. We maintain our loan growth assumption of 6% for the full year. We also anticipate more moderate growth for net fee and commission income, as higher net fee and commission income was mainly driven by securities brokerage. Turnover in the domestic equity market soften last quarter, and in July and August as uncertainty over global trade translated into implementation of trade tariffs.