Summary

In 2010, BOC Hong Kong continued to increase earnings per share to $ 1.53, profit attributable to shareholders to $ 16.196 billion, increased 16.27% yoy. The net interest margin continued to decline, but the group's net interest income still rose by 4.5% to HK $ 18.734 billion, the RMB business contribute positively to the interest income.

The general trend of internationalization of the RMB, as the RMB clearing bank in Hong Kong we expect the Bank of China will continue to be benefited from the central government's policies and the development of a RMB offshore center in Hong Kong, BOC Hong Kong will be the biggest beneficiaries in this trend. Therefore, we maintain a "buy" rating and 12-month target price of $ 28.75.

2010 Performance Highlight

Net interest income increased during the year. Even the market interest rates remain low, and the net interest margin narrowed 20 basis points to 1.49%, the net interest income still rose by 4.5 percent to 18.734 billion HK dollars. The rising renminbi deposits,bring a dilutive effect to net interest margin, but on the whole, net interest income of RMB business to contribute positively.

The growth of loan remain strong, the amount of clients` loan increased by 19.1% total loans reached 613.219 billion, in particular, loans for using outside Hong Kong rose 29.4%. Due to the main result of the domestic macro-control in China . According to the National Bureau of Statistics announced in June, the national consumer price level rose by 6.4% (since July 2008 three-year high).

In order to avoid overheating of the economy, the People's Bank continued to increasing deposit reserve ratio and interest rates in an attempt to control inflation, but also to make domestic enterprises and SME companies to financing difficulties, even make money-strand breaks.

While there is interest rate differential between Hong Kong, Mainland enterprises is attracted to Hong Kong for financing.

We expect the central government will continue the austerity measures,and demand of the corporate loans will continue to rise. BOC will be benefited from that.

BOC Hong Kong's cost to income ratio continued to decline from the 46.6% in 2009 dropped significantly to 34.52% in 2010, mainly due to the Lehman Brothers-related products` spending of 3.278 billion decreased significantly to 89 million in 2010. But the core expense rose by 7.13%, mainly reflecting rising staff costs, which make the core cost to income ratio increased slightly by 0.5%.

We believe that increase follow the overall spending increase in the labor market, while the increasing in costs associated with the bank is still under acceptable level.

RMB business

BOC Hong Kong launched a series of Renminbi-related financial products, such as underwriting the issuance of RMB bonds in Hong Kong. BOC Hong Kong is one of the largest “dim sum debt” issuers in the capital market, as the sixth largest issuer, occupied the market share about 5.1%.

Continued increasing in renminbi deposits conducive to the Bank's “dim sum” debt issuance business (RMB debt issuing in HK), under the domestic macro-control in China, those entreprises suffered from tight liquidity, thus this provide a foundation for “dim sum debt”development, which also benefit to the Bank's business

BOC Hong Kong as Hong Kong's RMB clearing bank, also provide RMB cash clearing services to two Taiwanese banks, BOC play an important role in the economic and trading between China Taiwan and Hong Kong, position abundantly clear.

In addition, BOC got the right to invest in mainland's bonds. As the RMB clearing bank in Hong Kong in past, other banks deposit RMB to BOC, for 0.629% interest, then the BOC deposited that fund into the Shenzhen People's Bank of China for 0.72% interest, for earning modest interest rate spread.

However, since the BOC obtained China authorities to invest in the mainland RMB bond market, situation changed . Depending on the risk, the genera annual return of bond has 2-3%, even 7-8% for corporate bonds, with a adequate risk management, Bank of China can earn a stable income.

We expect the renminbi deposits in Hong Kong will continue to rise, with billions of RMB, BOC Hong Kong can benefit from such interest rate spread.

Dividends and profit forecasts

BOC Hong Kong earned HK $ 1.53 per share in 2010, an increase 13% yoy and HK $ 0.972 per share's dividend. We expect the Bank's dividend payout ratio will remain at 60%, based on RMB business will be continued to improve, we expected the earnings and dividends per share were HK $ 1.75 and HK $ 1.05 respectively in 2011.

Valuation

We believe that BOC's RMB business is a unique concept among the industry, we expect the bank's corporate finance and RMB-related business remained strong growth in 2010. Therefore, the expected dividend and earnings per share of HK $ 1.05 HK $ 1.75 respectively. Target price 28.75 and give a "buy" rating, which forecast price to earning ratio is16.42 times.

Risk

1. China's economic hard landing

2. Demand for RMB offshore loans continued to decline

Peers Comparison

The expected price to earnings ratio of BOC Hong Kong is 13 times which is below the average of industry. Although the loan to deposit ratio and interest margin was lower in the industry, as the RMB clearing bank in Hong Kong, , we expect spreads and loan to deposit ratio will be improved because of the economy situation and the valuation will be catch up with peers .

Financial Data

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