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Elevator Pitch

I assign a “Neutral” rating to Hong Kong-listed bank BOC Hong Kong (Holdings) Limited (OTCPK:BHKLY) (OTCPK:BNKHF) [2388:HK].

BOC Hong Kong’s asset quality is expected to hold up better than peers because of its favorable customer structure with a lower exposure to SMEs and food & beverage and tourism companies. BOC Hong Kong is also targeting a mid-to-high single digit loan growth for FY2020, and Southeast Asian markets are expected to be the bank’s medium-to-long term growth driver.

On the flip side, BOC Hong Kong’s net interest margin is expected to be under pressure this year, with the Hong Kong Monetary Authority cutting its benchmark interest rate from 1.50% to 0.86% in mid-March 2020. Market consensus expects the bank’s net interest margin to decline from 1.59% in FY2019 to 1.41% in FY2020. As such, a “Neutral” rating for BOC Hong Kong is fair.

BOC Hong Kong’s valuations are undemanding. It trades at 0.84 times P/B, which represents a discount to its historical five-year and 10-year mean P/B multiples of 1.41 times and 1.64 times respectively. The stock is also valued by the market at 8.7 times consensus forward next twelve months’ P/E, versus its five-year and 10-year average consensus forward next twelve months’ P/E multiples of 10.6 times and 11.4 times respectively. BOC Hong Kong offers a consensus forward next twelve months’ dividend yield of 5.7%.

Readers are advised to trade in BOC Hong Kong shares listed on the Hong Kong Stock Exchange with the ticker 2388:HK, where average daily trading value for the past three months exceeds $45 million and market capitalization is above $32 billion. Investors can invest in key Asian stock markets either using U.S. brokers with international coverage, such as Interactive Brokers, Fidelity, or Charles Schwab, or local brokers operating in their respective domestic markets.

Company Description

Established in September 2001 as a merger of 10 Hong Kong banks and listed on the Hong Kong Stock Exchange in July 2002, BOC Hong Kong is the second largest commercial bank in Hong Kong after HSBC Holdings (HSBC) [5:HK], and a 66%-owned subsidiary of Bank of China Limited (OTCPK:BACHF) (OTCPK:BACHY) [3988:HK].

BOC Hong Kong’s three key business segments, personal banking, corporate banking and treasury, accounted for approximately 28%, 38% and 30% of the company’s profit before tax in FY2019 respectively. The bank’s insurance and others business segments combined contributed the remaining 4% of its FY2019 profit before tax.

BOC Hong Kong is a market leader in Hong Kong’s banking & finance industry in many ways. The bank was ranked first in Hong Kong in terms of new mortgage loans in FY2019, and it was also the largest IPO receiving bank in the city last year. BOC Hong Kong handled approximately 70% of offshore RMB clearing volume globally, by virtue of being “one of the three note-issuing banks and the sole clearing bank for RMB business in Hong Kong” according to the company’s FY2019 results press release.

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Asset Quality In The Spotlight

In challenging times like these, banks’ asset quality is in the spotlight, and investors have less to worry when it comes to BOC Hong Kong.

BOC Hong Kong’s classified or impaired loan ratio increased from 0.19% in FY2018 to 0.23% in FY2019, which the bank attributed to “the internal credit rating downgrade of a Mainland corporate and a few Southeast Asian corporates.” But the bank noted in its FY2019 results announcement that the company’s classified or impaired loan ratio was “well below the market average” thanks to “prudent risk management.” Specifically, BOC Hong Kong’s delinquency and rescheduled loan ratio for its residential mortgage loans was only 0.01% in FY2019 compared with the market average of 0.03%. Similarly, BOC Hong Kong’s charge-off ratio for card advances was 1.40% last year, below that of the market average of 1.57%.

While the coronavirus outbreak and its associated economic effects are likely to have a negative impact on banks’ asset quality in general, BOC Hong Kong’s asset quality is expected to hold up better than peers because of its favorable customer structure. At the company’s FY2019 earnings call on March 27, 2020, BOC Hong Kong noted that “SME (small and medium-sized enterprises) loans including those vulnerable sectors (food & beverage and tourism), account for a small proportion of our loan portfolio” and “we have not seen large number of corporates experiencing repayment issue.”

Outside of its home market, Hong Kong, the non-performing loans ratio for BOC Hong Kong’s Mainland China business was a relatively low 0.21%. Notably, state-owned enterprises accounted for more than half of the bank’s Mainland China loans, while the bank highlighted that its Mainland China corporate clients were mostly “leading players in their own industry” as per management comments at its FY2019 earnings call on March 27, 2020. BOC Hong Kong also disclosed at the recent earnings call that the non-performing loans ratio for its Southeast Asian subsidiaries was “still better than the markets’ averages.”

In addition, BOC Hong Kong has a relatively high provision coverage ratio of 219%, and the bank is well-capitalized with a Tier-1 capital ratio of 19.90% and a total capital ratio of 22.89%.

Pressure On Net Interest Margin

Market consensus expects BOC Hong Kong’s net interest margin to decline from 1.59% in FY2019 to 1.41% in FY2020. This is not unexpected, as the Hong Kong Monetary Authority cut its benchmark interest rate from 1.50% to 0.86% in mid-March 2020 following in the footsteps of the Federal Reserve.

In the past decade, BOC Hong Kong’s net interest margin has declined to as low as 1.32% in FY2016. To avoid a repeat of that, BOC Hong Kong’s strategy is to “deploy our funds in high yielding assets, while continuing to drive deposit growth and control deposit cost” as per the company’s comments at its FY2019 earnings call on March 27, 2020.

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BOC Hong Kong’s CASA or Current Accounts Savings Account increased by +4.2% YoY in absolute terms from HK$1,061 billion in FY2018 to HK$1,107 billion in FY2019, and the bank’s CASA ratio (CASA as a percentage of total deposits) declined slightly from 55.9% to 55.1% over the same period. Looking ahead, BOC Hong Kong is looking to promote its cash pooling and payroll services more aggressively to drive CASA growth.

Loans growth, especially high-yielding loans, which is also a key factor in net interest margin, is discussed in the next section.

Mid-to-high Single Digit Loan Growth Target For FY2020 With Southeast Asian Markets Being Long-Term Driver

BOC Hong Kong has guided for a mid-to-high single digit loan growth in FY2020, versus a +10.2% YoY loan growth last year.

In FY2019, BOC Hong Kong’s corporate loans and personal loans grew +4.6% and +17.2% YoY to HK$515 billion and HK$409 billion respectively. The bank’s personal loans segment is unlikely to grow as fast this year, with mortgage loans expected to be affected by a weak property market in Hong Kong as a result of the current coronavirus outbreak. On the positive side of things, BOC Hong Kong expects a growth in cross-border loans this year, driven by “the implementation of various national strategic initiatives” and “new infrastructure projects” in Mainland China.

More importantly, Southeast Asia is expected to be a key growth driver for BOC Hong Kong in the medium-to-long term. BOC Hong Kong’s loans from its Southeast Asia banking entities grew by a strong +26.7% YoY to HK$50.4 billion in FY2019, but Southeast Asia still accounted for under 5% of the bank’s total customer loans last year. BOC Hong Kong has built up its presence in Cambodia, Laos, Indonesia, Thailand, Malaysia, and Vietnam in the past five years by acquiring its parent Bank of China Limited’s Southeast Asian assets.

Valuation And Dividends

BOC Hong Kong trades at 0.84 times P/B based on its share price of HK$24.15 as of April 15, 2020. As a comparison, the stock’s historical five-year and 10-year mean P/B multiples were 1.41 times and 1.64 times respectively. BOC Hong Kong’s 15-year historical trough P/B multiple was 0.70 times registered in March 2009 during the Global Financial Crisis.

BOC Hong Kong is also valued by the market at 7.9 times trailing twelve months’ P/E and 8.7 times consensus forward next twelve months’ P/E. In contrast, the stock’s five-year and 10-year average consensus forward next twelve months’ P/E multiples were 10.6 times and 11.4 times respectively. BOC Hong Kong has traded as low as 4.4 times trailing twelve months’ P/E and 5.9 times consensus forward next twelve months’ P/E during the 2008-2009 Global Financial Crisis.

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Market consensus expects BOC Hong Kong’s ROE to decline from 11.5% in FY2019 to 10.0% in FY2020.

BOC Hong Kong offers a trailing twelve months’ dividend yield of 6.3% and a consensus forward next twelve months’ dividend yield of 5.7%. The company is paying out HK$1.537 in dividends per share for FY2019, which implies a +7% YoY growth in absolute terms and a dividend payout ratio of 50%. BOC Hong Kong has a dividend policy of paying out between 40% and 60% of its earnings as dividends every year.

At the company’s FY2019 earnings call on March 27, 2020, BOC Hong Kong emphasized that “we still have the capacity to maintain the level of our dividend payout” despite “the existing environment.” Market consensus expects BOC Hong Kong’s dividends per share to decline by -9.4% YoY to HK$1.39 in FY2020, which is still equivalent to a 50% dividend payout ratio.

Valuation Metrics For BOC Hong Kong’s Hong Kong Banking Peers

Stock Trailing P/B Multiple Trailing Twelve Months’ P/E Multiple Consensus Forward Next Twelve Months’ P/E Multiple Trailing Twelve Months’ Dividend Yield Consensus Forward Next Twelve Months’ Dividend Yield

Consensus Forward One-Year ROE

The Bank of East Asia, Limited (OTCPK:BKEAF) (OTCPK:BKEAY) [23:HK] 0.45 19.0 11.1 2.7% 4.1% 4.3%
Hong Kong-listed Hang Seng Bank Limited (OTCPK:HSNGY) (OTCPK:HSNGF) [11:HK]. 1.47 10.7 12.0 6.0% 6.1% 12.5%
Dah Sing Banking Group Limited [2356:HK] 0.38 4.7 6.9 6.3% 4.4% 6.7%

Source: Author

Risk Factors

The key risk factors for BOC Hong Kong include a deterioration in asset quality, lower-than-expected net interest margin, weaker-than-expected loans growth, and a cut in dividend payout ratio going forward.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.