HK Bank Stock Could Return Over 20pct

21-Jan-2017 Intellasia | Barrons | 6:00 AM Print This Post

Since Election Day, Bank of America shares (ticker: BAC) have jumped 33 percent. Those of BOC Hong Kong (2388.HK), which is majority-owned by Bank of China (3988.HK), are up 13 percent since then. That could be a buying opportunity.

Hong Kong’s currency, the Hong Kong dollar, is pegged to the US dollar. That gives BOC Hong Kong, also called BOCHK, exposure to US monetary policy-and many of the same factors that have recently sent BofA shares soaring.

Morgan Stanley on Tuesday raised its price target on BOCHK shares to 35 Hong Kong dollars from HKD31, which helped them rise 3 percent on Wednesday, to HKD30.45. From here, that implies a potential return over the next year of 20 percent including dividends.

BOCHK is the second-largest bank in Hong Kong behind HSBC (HSBC). Its connection with its parent gives it a large base of Chinese companies as customers, and stable deposits. It also gets preferential treatment from China’s government in securing cross-border settlement business, like the Shanghai-Hong Kong Stock Connect, which allows investors in each market to trade in the other.

Hong Kong banks are generally well-capitalised with high returns on equity, but as with most banks in developed markets, profits have been suppressed in recent years by ultralow interest rates. Banks make money on the spread between what they pay depositors and what they charge borrowers. After deposit rates got stuck near zero, further declines in lending rates squeezed profit margins.

That’s starting to change. In the US, the Federal Reserve raised its federal-funds target rate in December 2015 for the first time in seven years, and did so again this past December. Since last summer, the 10-year Treasury yield has climbed to 2.3 percent from 1.5 percent, while the three-month Hibor, or Hong Kong Interbank Offered Rate, has risen to 1 percent from 0.6 percent.

Meanwhile, deposit rates remain low across Hong Kong, and money is still flowing in, with deposits up 10 percent year-over-year as of November. That means banks will be able to lend at better spreads. Moreover, since the bulk of Hong Kong mortgages made in recent years are linked to Hibor, profits are likely to improve quickly.

In a Tuesday report, a team of analysts at Morgan Stanley predicted that net interest margins for Hong Kong banks will rise 0.35 percentage points over two years, and noted that if the Fed hikes rates twice this year and twice next, NIMs in Hong Kong could rise 0.5 to 0.6 percentage points. That might not sound like much, but it’s adding to a low base. Since 2000, Hong Kong NIMs have collapsed to 1.36 percent from over 2.2 percent.

As a result, earnings for BOCHK could come in ahead of consensus expectations over the next year. Shares trade at 12 times this year’s earnings forecast. Morgan Stanley predicts $1.42 in dividends this year, for a yield of 4.6 percent. It’s also bullish on HSBC and a third name, Hang Seng Bank (11.HK), but highlights BOCHK for its modest valuation and solid growth potential. It sees earnings per share for BOCHK rising 19 percent this year and 18 percent next year.

There are three key risks for investors. One is that China’s economy weakens, cutting into the prosperity of BOCHK customers. Another is that China uses its close relationship with BOCHK to do something unfriendly to shareholders, like nudge it to buy troubled assets at high prices. A third risk has to do with those rising rates. The reason US bank stocks have soared since Election Day is that Donald Trump is generally viewed as an inflationary force. He’ll get the economy growing faster, the thinking goes, which will push prices higher and force the Fed to hike. (He’s also expected to cut regulation and corporate taxes.)

Trump has criticised the Fed for keeping rates so low for so long. But he has also said the dollar is too strong. Those two views are at odds with each other; the dollar’s strength stems from rising rates. So it’s not clear what Trump wants. If the economy fails to heat up, rates could stall. Even if the economy does heat up, Trump could push to keep rates low. Fed Chairwoman Janet Yellen’s term expires in a year.

Assuming China remains stable and rates rise as expected, however, BOCHK should outperform.


Category: Hong Kong

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