Hong Kong Banks:Growth slowdown ahead

Liquidity is a double-edged sword. Hong Kong bankshave underperformed the index YTD (-6.0% versus -4.3%for the HSI) as tighter liquidity resulting in higher systemfunding costs begin to take a toll. Given continued investorconcerns over liquidity, a potential correction in propertyprices, China asset quality and continued regulatorymeasures being enacted, the upside for the group is likelyto be capped in the short-term. As such, investors cannotimplement a blanket strategy for the group as 2014 willdefinitely be a year where bottom-up stock picking will bewarranted given the defensive posture of the market.

FY13F results preview. Earnings season kicks off on18 February 2014 with BEA. For the group, we areforecasting earnings to be flat sequentially as continuedpositive credit experience will be offset by lower fee incomeand a small rise in funding costs. We expect margins to bebroadly flat in 2H13 as higher system funding costs (+7bp to0.34%) will be offset by upward loan re-pricing. Lookingahead, we see slowing loan growth (constrained by slowerdeposit growth), continued normalization of asset quality,and a drop-off in fee income as developing headwinds.

Questioning conventional wisdom. Given our view thatmaterially higher US rates are unlikely to materialize (seeQuestioning conventional wisdom, 27 January 2014), wemaintain our Neutral stance on both HSBC and Hang SengBank. We are of the view that in spite of tapering in 2014,the 10-year Treasury yield will end the year well short of the3.40% consensus as subdued inflation and globaluncertainty will keep a lid on rates. As US and Hong Kongrates are likely to surprise on the downside, HSBC/HSB willhave to wait a little while longer before they can capitalizeon their strong deposit franchises and excess liquidity.

Prefer BOCHK and DSBG/WHB. Given our conservativeview of slowing growth in 2014, we advise investors to stickwith stock-specific themes. We still like the family-ownedbanks as a deal for Wing Hang Bank is becomingincreasingly likely as they extended their exclusivityagreement with OCBC to 3 March 2014 (originally31 January 2014) whereby the two sides will try to reach anagreement for a takeover. If a deal does materialize,sentiment towards remaining independent banks (i.e.DSBG) would improve given increased scarcity. Among thelarge caps, our top pick remains BOCHK as the recenttightening of liquidity onshore and continued fundingdemand from Chinese corporates should continue to serveBOCHK well as the CNH deployment theme develops.