Hong Kong banks:Squeeze

Contraction in loans and deposits plus CNH squeeze.

July is typically a robust month for lending in HK, but balances declined.

The outlook for lending is muted for the remainder of 2H15. Depositscontracted, but to a lesser degree, causing the system LDR to improve.

However, there was a liquidity squeeze in CNH in August and the CNHdeposit pool is likely to see further outflows. We remain Neutral on theHong Kong banking sector.

Loan contraction.

System loan balances declined 1.5% MoM in Jul (Jun: +2.7%). Loan balances werelower across all three lending categories: i) for use in HK, ii) for use outside of HK,and iii) trade, in both HK$ and FCY. The sole exception was a slight uptick in FCYloans for use in HK, but this was insufficient to offset overall weakness.

Trade has been the main drag on a YTD basis, limiting overall system loan growthto 3.9%. YoY loan growth in 2015 is likely to be the slowest since 2009 at ~6%.

Deposit outflows.

System deposits declined 0.2% MoM in Jul (Jun: -0.1%), as HK$ outflows (bothCASA and fixed) were only partially offset by inflows in FCY CASA. YTD depositgrowth stands at 4.7%, vs 11% and 10% in 2013 and 2014, respectively.

The system, HK$, RMB and FCY (ex RMB) CASA ratios stand at 55%, 64%, 18%and 56%, respectively.

US$ and RMB deposits rose 0.3% and 0.1% in Jul, respectively (Jun: -1.6%/+2.0%). On a YTD basis, US$ and RMB deposits are down -0.2% and 1.0%.

With loans declining more than deposits, the HK$ and FCY LDR have declined from80.1%/65.6% to 79.3%/64.5%. The system LDR stands at 71.9% (Jun: 72.9%).

Offshore RMB interbank liquidity squeeze.

Following the devaluation of the RMB on 11 Aug, CNH HIBOR rose by anuncomfortable 528bps to 8.59% on 25 Aug or a record high since the launch of theindex in mid-2013. The situation has materially improved in the last few days.

The spread between the onshore and offshore rates has inverted, with the 1M CNHHIBOR now at a higher rate than the equivalent SHIBOR benchmark.

The 3M HKD HIBOR has seen an 8% step-up since the end of June, but the increaseremains small in absolute terms (3bps increase).

We remain Neutral on the HK banks.

We already anticipate a deceleration in loan growth between 1H15 and 2H15 drivenby trade and a lack of corporate demand. We also anticipate margin pressure,particularly on RMB-denominated portfolios.

As such, there is no change to our view. We remain Neutral on the sector. Order ofpreference is BOCHK (O-PF), BEA (U-PF) and HSB (SELL).