Hong Kong banks' exposure to China in focus as BEA kicks off earnings season

Reuters - UK Focus

* BEA H1 net profit hits record HK$3.58 bln vs HK$3.38 blnyr ago

* BEA says asset quality to remain under pressure in H2

* HK banks have increased their mainland exposure in recentyrs (Adds details from press briefing)

By Saikat Chatterjee

HONG KONG, Aug 1 (Reuters) - The first of Hong Kong's bankskicked off earnings on Friday with the biggest family-run lenderposting a record interim profit after giving more loans tomainland borrowers, renewing investor focus on credit lines toChina and the risks they pose.

Bank of East Asia, which reported a 6 percentincrease in first-half net profit to HK$3.58 billion ($462million), said it would take steps to mitigate credit risks inChina where it expected asset quality to remain under pressurein the second half of the year.

The growing exposure of Hong Kong banks to the mainland inrecent years has grabbed headlines about their ability toscrutinise credit risks against the backdrop of a slowingChinese economy. Rating agencies and supranational bodies suchas the International Monetary Fund have openly voiced concern.

Long praised by investors for their sound risk management,Hong Kong's mid-sized banks are increasingly becoming moreexposed to any blowup in default risk as they hunt for newopportunities in the mainland amid sluggish growth at home.

"Hong Kong banks' exposure to China has been rising for awhile, and we would be cautious of any sharp rise in exposurebecause they may not have the requisite expertise to analyse theunderlying credit risks on the ground," said Frank Tian,portfolio manager and part of a team that manages $25 billion inequities at Aberdeen Asset Management (Other OTC: ABDNF - news) .

Data from the Hong Kong Monetary Authority (HKMA), thecity's de-facto central bank, shows a sharp rise in cross-borderbusiness. By the end of 2013, the exposure of Hong Kong banks tocorporate borrowers constitutes a fifth of their total assetscompared with around 5 percent in 2007.

While the HKMA has repeatedly said a significant share ofthe non-bank mainland exposure is backed by guarantees and issymbolic of a strong financial centre, the fact remains theability of a Dah Sing Bank or a Wing Hang Bank (HKSE: 0302-OL.HK - news) to absorb big losses is far less than their foreigncounterparts such as Standard Chartered (HKSE: 2888.HK - news) or HSBC.

For example, Bank of East Asia, a medium-sized city lender,would require only roughly 15 percent of its net loan book goingsour to wipe out its entire equity base, according to its 2013annual earnings.


Bank of East Asia said loans to customers in mainland Chinaedged up 9.5 percent to HK$207 billion at the end of June fromend-December. Those loans comprised roughly half of its totalloan book.

Bad debts as a percentage of total loans rose to 0.44percent in the first half from 0.39 percent at the end of 2013.

"A tipping point may be reached if the yuan depreciates verysharply or if loan books are expanded aggressively," saidAberdeen's Tian.

Under an extreme scenario presented by the IMF in May, ifthe default rate in the mainland banking system's interbankobligations hits 80 percent, the losses would wipe out all thecapital in the city's banking system.System-wide, non-performing loans as a percentage of their totalloan book remains below 1 percent so far.

Bank of East Asia said at an earnings briefing on Friday itexpects to see more stress in China's property sector due tomaturing products from trust companies, which pool money fromrich people and companies to make high-interest loans and arepart of the China's vast and opaque shadow banking system.

Shares (Frankfurt: DI6.F - news) of the bank closed 0.6 percent lower on Friday, inline with a 0.9 percent drop for the benchmark Hang Seng Index.


To be sure, the city's lenders are among the bestcapitalised in the world with average capital adequacy ratios ofmore than 15 percent and system wide NPLs at 0.04 percent.

Even in its China business, much of the credit risk in themainland is towards state-owned enterprises and to financenon-mainland companies' operations within China. Trade financethanks to the growing internationalisation of the yuan has alsogrown.

"This means high default rates are unlikely," said WilliamFong, investment director of Asian equities at Barings AssetManagement in Hong Kong which manages $2.8 billion of assets.

Notwithstanding their growing China exposure, Hong Kongbanks command some of the highest price-to-book ratios withinthe region due to their sound risk management techniques whichsaw them escape the 2008 financial crisis unscathed.

That said, investors are wary that banks which have expandedtheir footprint aggressively in China - whether for tradefinance or corporate lending - may be most at risk at a timewhen other foreign banks have pulled back.

While this is an opportunity for the banks and theircorporate customers, it also entails risks, with future creditperformance likely to be different from past experience, Moody'sstrategists wrote in a March report. ($1 = 7.7498 Hong Kong Dollars) (Reporting by Saikat Chatterjee; Editing by Anne Marie Roantreeand Ryan Woo)

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