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研究部 (Research Team)
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Bank of East Asia (00023.HK) Facing the Hard Time

Thursday, October 16, 2008

5189

Bank of East Asia(23)

Recommendation on 16 October 2008
Recommendation	Hold
Price on Recommendation Date	$22.100
Target Price	$25.600

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BEA continuously suffered from CDO/ SIV write-down in 1H08 and further MTM loss is anticipated in the coming year. Also, impact of financial crisis on global economy would leads to a slowdown in loan growth in spite of its strong China business. After downgraded by major rating agencies and the bank run, we expect the profit from HK business may drop while the profit contribution from Mainland business to its total profit would keep rising, making the bank’s profit from core business being stable but not fast growing.

Poor 1H08 Result due to MTM Loss

BEA posted a worse than expected 1H08 result which recorded a 58% drop in net profit. The decline was mainly attributable to the HK$1,309m and HK$232m MTM loss on its CDO and SIV portfolios respectively.

The accumulative write-down on the bank’s CDO investment is 40.5%, we expect the price of CDO will be continuously falling as the worldwide economy is deteriorating and 15% more write-down is needed for 2H08. The bank’s SIV investment was marked down 96% and we do not expect further write-down. As a result, HK$854m MTM loss for CDO and HK$473m impairment loss for exposure to Lehman and AIG are anticipated for 2H08 result and 2008 EPS is estimated to be HK$0.95 implying a 64% YoY fall.

Downgraded by Major Rating Agencies

BEA revealed at September 18, 2008 a trading loss of HK$93m, which was incurred by an equity derivatives trader who had manipulated valuation to hide loss. This discovery made the bank to revise down its 1H08 earning by HK$130m and raised rating agencies’ concern on the bank’s internal control and risk management. Standard & Poor’s, Moody’s and Fitch downgraded BEA’s outlook to negative accordingly, we believe such actions will negatively impact on the bank’s brand and business expansion. The bank’s interest expense will increase consequently in order to affect the profit.

Facing the financial turmoil, retail customers lost their confidence in BEA firstly after an unconfirmed rumour questioning the bank’s financial stability spread through mobile phones. Appeared to be bank run, thousands of customers queued up outside BEA branches for withdrawing money. The bank’s capital adequacy ratio was 14.6 percent as at Jun 2008, well above international standards, adding that its exposure to Lehman and AIG were HK$422.8m and HK$49.9m respectively out of total assets of HK$396.6b. We have no question on BEA’s stability but losing confidence from its customers would affect its business growth in both HK and Mainland China.

Solid Mainland Business Growth

Focus on BEA’s Mainland business, it has the most extensive branch networks among all foreign banks in Mainland, with service coverage extended to 19 cities where number of outlets reached 60. The bank’s China loans experienced a tremendous 68% YoY growth to HK$93.6b that was 40.3% of the group’s loan book while HK loans contributed 46.5%, or HK$108b. Net profit before tax from China business also rose sharply to HK$600m, up 71% YoY. Profit contribution from China business was 26.6% of the group’s total. We expect the bank’s China earnings will continue to experience solid growth and reach the group’s target contribution percentage of 35% in two years. Though the group’s Mainland business is remarkable, the bank’s core HK business only kept stable and we expect it will decline in 2009 offsetting growth contribution from its China business.

Sources: Company Data, Phillip Securities

Dividend

BEA largely slashed its dividend by 52% and declared a dividend of HK$0.23 for 1H08. Since we expect the bank has more MTM loss in 2H08 and 1H09, its net profit would keep at a low level and dividend would not catch up in the coming year. Full-year dividend is expected to be HK$0.46 which is only 28% of that for 2007, implying a yield of 0.9%. Such a low dividend yield makes BEA less attractive for investor in the coming year.

Key Risk

1. Impact of US financial crisis on global markets leads to a slowdown in BEA’s commercial and corporate loan

2. Extend of economic slowdown for China and NPLs may increase

3. More CDO write-down under worldwide economy downturn

4.More hidden trading loss unfold

Valuation

Our target price is based on target 2008E P/B ratio at 1.3x implying a 12- month TP at HK$25.6. The target P/B ratio is relatively low as we believe investors have lost their confidence in BEA and it would not be recovered easily during the economy downturn after the financial crisis. Low dividend yield would persist before BEA finished all CDO write-down, which justifies a low P/B ratio. After the drastic sell-off last month, BEA is trading at a relatively low price and we give a “Hold” rating.

Financial Data

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