The recent rally in the Hong Kong banks signals the first phase in the
normalisation of ROE expectations and valuation multiples, in our view.
Underpinning this renewed confidence has been macro data pointing
to relatively benign trends in NPL formation, encouraging trends in
economic leading indicators and an easing of perceived risk relating to
the banks’ treasury portfolios. In short, we believe this rally has been
all about balance sheet relief.
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We now expect a period of consolidation. With the exception of Dah Sing,
the Hong Kong banks trade above book value, implying balance sheet
relief is largely priced in. In our view, for further material upside to
emerge, pre-provision operating profit (PPOP) needs to rebound to
levels that support upside to ROE and EPS growth. This still appears
some way off. Low risk appetite among the banks is resulting in
lacklustre balance sheet growth, margins remain under pressure in the
low interest rate environment and fee income continues to contract.
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We have adjusted our forecasts to reflect the positive effect of a
shallower-than-expected provisioning cycle, partially offset by weaker
momentum in PPOP. We prefer to remain conservatively positioned in
the sector; hence our preference among the large banks remains:
1) BOCHK (upgraded to OUTPERFORM from Neutral with a new HK$15
target price, from HK$10); 2) Hang Seng Bank; 3) BEA (downgraded to
UNDERPERFORM from Neutral with a new HK$20 target price, from
HK$16). Among the small caps, we prefer ICBC Asia and Dah Sing.