EUR 850.00 For Business Accounts Only

Morningstar | No Change in Thesis for Bank of East Asia; Profitability Improvement Maintained

We maintain our fair value estimate of HKD 28.60, representing a fair price/book value of 0.9 times and fair price/earnings of 11.8 times. We expect return on equity to average 7.8% over the next five years with steady improvement over our explicit forecast period. We continue to believe the risk-to-reward has improved over the last year from an improvement in the bank’s operation as its cost base is lowered and the settlement of non-performing loans for its China book. A decline in the bank’s share price, in line with weaker equity market, further improves the risk-to-reward with the bank trading at a 12% discount to our fair value estimate. However, our 3-star rating is unchanged as we require a larger margin of safety given the bank’s high uncertainty rating.

Operationally, the bank is continuing to perform well. Cost to income ratio is expected to remain steady on 2017 with higher operating expense attributable to rising payment to its online partner. The bank is partnering with mainland online platforms such as WeChat and Ant Financial in offering unsecured personal loans. The higher expense is more than offset by the higher interest rate on the loans, typically 15%-20%, with one third returned to the online platforms as commission. While the higher interest rate is reflective of higher risk for unsecured financing, management noted the small size of each loan, which averages between CNY 5,000 to CNY 8,000 and a robust credit score system for the two platforms. The bank also cross-checks the credit scores against other external metrics and considers the direct lending to individuals as less risky than peer-to-peer lending. Management noted the bank remains on track to achieve a contribution of 30% of retail loans to its China portfolio by 2020.

Loan growth for China in the second half was flat on asset quality concerns, while the Hong Kong loan growth guidance of mid- to high-single-digits was maintained. The latter was driven by real estate loans and the bank’s loan growth rate is higher than system as the bank de-risked its portfolio over the last few years. This is reflective of our view the bank is positioned for growth, though we note a slowing residential real estate market will likely see softer mortgage growth in 2019 but offset a greater appetite for corporate loan growth.

The higher interest on the retail loans contributed to an improvement in net interest margin in China for the second half. An easing in liquidity condition was also supportive and combined with flat net interest margin in Hong Kong, overall net interest margin for the group is expected to be slightly higher for the full year. Net interest margin was flat as higher loan spreads were offset by lower investment yield from its debt portfolio. In line with the system, there was a shift in current and savings account, or CASA, to higher interest time deposit, but the impact was less for the bank as CASA makes up a smaller proportion of its deposit base.

Net fee income and commission income in the second half will be lower than the first half as weaker capital markets would have resulted in lower demand for wealth management products and securities and brokerage revenue. This was within expectations and already factored into our forecast. Asset quality remains strong with non-performing loans improving, though credit cost is higher in the second half. This is mainly driven by an one-off benefit of an adjustment to its model assumptions in the first half, though the bank also applied more conservative real estate price and macroeconomic assumptions. Capital position remains strong with the common equity Tier 1 ratio expected to be stable at 15%.