Banks:Mixed picture

The latest available data points for the HK banking sector paint a mixedpicture. System loan growth for 2016 may be 5-6% and 9M16 sector PBTis up 4.5% YoY. But Rmb outflows have reaccelerated, and offshore CNHrates have spiked to levels near record highs. HK$ rates are rising, butcompetition suggests that banks might not fully benefit from Hibor uptick.

Asset quality continues to slightly weaken. We move from UW to Neutral.

System loans on track to expand 5-6% in 2016q HK system loans grew 1.0% MoM in Nov (Oct: 0.6%, YTD 4.8%).

This was driven by HK loans (in both HK$ and FCY) and ex-HK loans in HK$,partially offset by declines in ex-HK FCY loans and trade.

Market rates climbing higherq System deposits grew 0.6% MoM (October: 0.6%, YTD 9.5%).

Growth was driven by FCY CASA/HK$ time inflows, partially offset by HK$CASA/FCY time outflows; 2016 system deposit growth of 9-10% looks achievable.

Rmb deposits outflows reaccelerated, -5.3% in Rmb terms (-7.1% in HK$ terms).

Liquidity in offshore RMB tightened noticeably in the last 2 weeks of Dec. 1M CNH Hiborspiked up to 11.9%, approaching the levels last seen during the Jan’16 squeeze.

Three-month HKD HIBOR has risen sharply in recent weeks and sits at 102bp althoughunlike RMB, liquidity is ample. HKD HIBOR now slightly exceeds US Libor.

HK banks’ PBT up 4.5% YoY in 9M16, driven by contained costsq According to HKMA’s banking sector supplement in its Dec quarterly bulletin, the PBTof HK retail banks grew 4.5% YoY in 9M16. This was driven by a 4.9% decrease inexpenses; NII was up 0.9% and fee income down 14%.

9M16 NIM was 1.32% (1H16: 1.30%); bad debts were stable at 7bp of averageassets; 9M16 cost-to-income ratio was 41.9% (1H16: 42.7%).

Moving to Neutralq Overall, the outlook remains challenging in our view. Key pressures are:competition, RMB outflows, muted loan demand, asset-quality deterioration.

However, our negative view of BOCHK was largely driven by our concern over thebank’s regional (first stop ASEAN) pivot. Given i) the resilience of the HK business,ii) that the bank has sold another non-core asset, iii) that the expansion of thebank’s footprint is unfolding at a slow pace, we feel comfortable removing most ofthe transformation-related discount we applied to the bank’s valuation. We valueBOCHK at 1.3x fwd PB versus 0.9x previously and move from SELL to O-PF.

We slightly adjust our earnings (~2%) to reflect higher revenues at HSB. Thistriggers a revised target price of HK$141. We reiterate our U-PF recommendation.

There is no change to our HK$24.50 target price or SELL recommendation for BEA.