Hong Kong

18 October 2013 Sector Report (Initiation)

Neutral (new) Hong Kong Potential Surprises in 2014

Potential earnings upgrade in 2014. This will be mainly from possible net interest margin (NIM) widening from QE tapering and a rapid rise in profit contributions from offshore RMB business. Besides, we see

Steven CHAN renewed speculations on M&A of small banks. Based on these [email protected] themes, our top picks are BOC (Hong Kong), Dah Sing Banking Group (852) 2268 0645 (DSB) and Wing Hang (WHB). However, as we have concerns over new regulatory costs for HSBC and weak performance of the Kieran LUK Indian and Korean business of Standard Chartered Bank (SCB), we [email protected] initiate the coverage of the Hong Kong banks with a NEUTRAL rating. (852) 2268 0631 QE tapering to benefit HK banks? We believe that QE tapering will

lead to a steepening US curve and moderate volatility.

We also believe the Fed funds target rate will remain stable in 2014. As

a contrarian view, we believe Hong Kong banks may lengthen the

duration of their HKD/USD assets slightly to improve NIM. We estimate a 2bps NIM expansion for large banks on marginal lengthening of the duration of 20% of their interbank lending and investment.

Offshore RMB business – gaining from the competition? We believe the opening of new offshore RMB centres will increase the acceptance of RMB as a settlement for international trade.

This will grow RMB deposits in Hong Kong to CNY1.3t by end-2014. We also estimate the utilisation rate of these deposits will rise to 73% in 2014, raising the operating profit contribution of offshore RMB business from 3.8% in 2013 to 6.4% in 2014 - another market contrarian view. M&A play – acquisition P/BV of >2x? Both Chong Hing Bank (CHB) and WHB have admitted they are being approached by potential bidders. Large China and Singapore banks do not need new equity funding to acquire for CHB and WHB even at P/BVs of 2.5x. Based on a funding cost of 3.15-4.25%, CHB and WHB could be acquired at maximum Jun 2013 P/BVs of 2.3x and 2.7x, respectively. Asset quality – no signs of overlending? In our view, there is no clear evidence to suggest that Hong Kong-listed banks have relaxed underwriting standards to boost loan growth in 1H13. The high debt leverage ratio in Hong Kong is well-cushioned by an even higher deposit-to-nominal-GDP ratio (i.e. accumulated wealth in Hong Kong).

Figure 1: Financial summary of Hong Kong-listed banks (Share price as of 16 Oct 2013) Bank BB SP TP Upside Net profit (HKDm) PER (x) P/B (x) ROE (%) Yield (%) name code Rating (HKD) (HKD) (%) 2012 2013F 2014F 2012 2013F 2014F 2012 2013F 2014F 2012 2013F 2014F 2012 2013F 2014F BEA 23 HK HOLD 32.95 32.30 -2.0% 5,725 5,731 5,960 12.1 12.8 12.3 1.3 1.2 1.1 10.9 9.7 9.4 3.1 2.3 2.4 BOCHK 2388 HK BUY 25.10 29.30 16.7% 20,930 22,446 25,274 12.7 11.8 10.5 1.8 1.7 1.6 14.9 14.5 15.5 4.9 5.3 6.0 CHB 1111 HK BUY 34.15 38.35 12.3% 543 490 526 27.3 30.3 28.2 2.0 1.9 1.9 7.6 6.5 6.7 1.3 1.3 1.4 DSB 2356 HK BUY 14.16 17.20 21.5% 1,411 1,651 1,910 12.3 10.5 9.1 1.2 1.1 1.0 9.3 10.3 11.1 2.2 2.9 3.3 DSF 440 HK HOLD 47.60 52.55 10.4% 1,236 1,301 1,449 11.3 10.7 9.6 0.9 0.9 0.8 8.1 8.2 8.6 2.5 2.8 3.1 HSB 11 HK SELL 128.30 107.25 -16.4% 19,327 25,622 16,426 12.7 9.6 14.9 2.7 2.3 2.1 22.5 25.6 14.8 4.1 4.1 4.1 HSBC* 5 HK HOLD 84.90 88.30 4.0% 13,454 16,935 18,869 14.7 11.9 10.7 1.2 1.1 1.1 8.1 9.4 10.1 4.1 5.0 5.6 SCB* 2888 HK HOLD 182.70 189.00 3.4% 4,786 4,646 5,702 11.8 12.2 9.9 1.2 1.2 1.1 11.1 10.0 11.5 3.6 3.8 4.1 WHB 302 HK BUY 113.10 156.60 38.5% 1,802 1,924 1,969 18.8 18.6 17.4 1.7 1.7 1.6 9.8 9.6 9.3 1.8 2.1 2.3 *Net profit has excluded dividends to preference shares and is denominated in USDm Source: Company data, Maybank Kim Eng

SEE APPENDIX I FOR IMPORTANT DISCLOSURES AND ANALYST CERTIFICATIONS

Banking Sector Report

Contents

The three most important charts/tables ...... 3

Investment summary ...... 4

US QE tapering – No need to panic ...... 9 Offshore RMB Business – Opportunities Amidst Challenges ...... 16

M&A speculations on small banks ...... 32

Asset quality – Light shower in a sunny day ...... 38

Valuation and Recommendations ...... 46

Bank of East Asia ...... 51

BOC (Hong Kong) ...... 55

Chong Hing Bank ...... 58

Dah Sing Banking ...... 61

Dah Sing Financial...... 64

Hang Seng Bank ...... 67

HSBC ...... 70

Standard Chartered PLC ...... 73

Wing Hang Bank ...... 76

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The three most important charts/tables

Figure 2: US PCE, unemployment rate, Fed fund rate and 10-year Treasury bond Chairman Bernanke stated ’ PCE YoY% (LHS) Unemployment rate (SA, LHS) that: (i) the Fed s portfolio of % % Fed fund target rate (RHS) 10-year Treasury bond (RHS) securities will not shrink 12 4.5 under QE tapering; (ii) even if Unemployment : 7.3% 4.0 the US inflation rate moves 10 close to 2.5% or the 8 3.5 unemployment rate to 6.5%, 3.0 6 this will not automatically 2.5 4 result in an increase in the 2.0 Fed funds rate. 2 1.5 0 1.0 QE tapering should lead to (2) PCE: 1.5% 0.5 steepening USD (4) 0.0 with moderate interest Jan 08 Sep 08 May 09 Jan 10 Sep 10 May 11 Jan 12 Sep 12 May 13 rate volatility Source: US Federal Reserve, Bloomberg

Figure 3: Market share of China’s RMB trade, RMB deposit and utilisation rate

With the increasing 2012 2013F 2014F acceptance of RMB as a Market share of China's trade settled in RMB N/A 8.4% 9.0% settlement currency for - Taiwan - Singapore N/A 11.3% 8.8% international trade, we expect that RMB deposits in - Hong Kong 89.5% 66.6% 50.8% Hong Kong will grow to Amount of RMB deposits (CNY b) 18 125 232 - Taiwan CNY1.3t by-end 2014. - Singapore 100 168 227

- Hong Kong 720 986 1,310

The utilisation rate of RMB Average utilization rate of RMB deposit in Hong Kong (%) 42 60 73 deposits in Hong Kong will Source: Source: Statistics & Census department, Bureau of Foreign Trade, Department of Statistics- rise to 73% in 2014 Singapore, MAS, HKMA, Ministry of Commerce, CBC, Maybank Kim Eng

Figure 4: Number of branches in Hong Kong 600 The acquisition of small 511 banks by large Chinese banks 500 and DBS will make their branch network in Hong Kong 400 comparable to those of BEA and SCB. 300 269 218 Potential sellers Potential buyers 200 We believe the acquisitions 88 83 will result in savings on 100 52 56 45 43 44 43 28 funding cost, cross-selling of 1 1 1 1 fee income products and 0 cross-border banking HSBC BOCHK HSB BEA SCB CHB DSB WHB ICBC BOCOM CCB DBS ABC MaybankOCBC UOB business Source: Company data, Maybank Kim Eng

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Investment summary

Room for earnings upgrades in 2014

The Hong Kong banking sector has performed largely in line with the MSCI Hong Share price performance of Kong Index since the beginning of 2013. However, share price performance of small banks has been small Hong Kong banks has been much better than that of large-to-medium-sized much better than that of banks YTD. This was mainly due to market expectations of a stronger earnings large banks YTD recovery for small banks in 2013 and renewed speculation of the potential acquisition of some small banks.

Looking ahead, with the exception of Hang Seng Bank (HSB), we forecast that We forecast core net profit the core net profit of most Hong Kong-listed banks will grow 7-14% YoY in 2014. growth of most banks at 7- Key earnings drivers will include: (i) healthy loan growth of 8-11% YoY (mainly in 28% YoY in 2014 residential mortgages, infrastructure loans and cross-border China loans); (ii) stable net interest margins (NIM) and asset quality; and (iii) a gradual increase in profit contribution from offshore RMB business in Hong Kong.

Figure 5: Forecast net profit of Hong Kong-listed banks 2013-14F Reported net profit (HKD m) YoY % change Core net profit* (HKD m) YoY % change 2012 2013F 2014F 2013F 2014F 2012 2013F 2014F 2013F 2014F BEA 5,725 5,731 5,960 0.1 4.0 4,965 5,480 5,961 10.4 8.8 BOCHK 20,930 22,446 25,274 7.2 12.6 19,264 22,279 25,107 15.7 12.7 CHB 543 490 526 (9.8) 7.4 534 487 523 (8.8) 7.4 DSB 1,411 1,651 1,910 17.0 15.7 1,346 1,718 1,910 27.6 11.2 DSF 1,236 1,301 1,449 5.3 11.3 1,127 1,338 1,449 18.8 8.3 HSB 19,327 25,622 16,426 32.6 (35.9) 18,387 17,584 16,426 (4.4) (6.6) HSBC# 13,454 16,935 18,869 25.9 11.4 9,702 16,635 18,869 71.5 13.4 SCB# 4,786 4,646 5,702 (2.9) 22.7 4,592 4,442 5,702 (3.3) 28.4 WHB 1,802 1,924 1,969 6.8 2.3 1,804 1,723 1,969 (4.5) 14.3 *Core net profit excludes the valuation change on own debt liabilities, currency effect, revaluation surplus on investment properties and disposal gain on assets #Figures denominated in USD m Source: Company data, Maybank Kim Eng

Our 2014 net profit forecast of Hong Kong-listed banks is quite close to We see room for earnings Bloomberg consensus forecasts. However, we see room for potential earnings upgrades at Hong Kong upgrades at these banks, mainly from two aspects. Firstly, Hong Kong banks banks in 2014 may ride on the steepening USD yield curve to lengthen the duration of their HKD and/or USD assets and improve their NIMs. Secondly, with the increasing acceptance of RMB as an international trade settlement currency and rising utilisation of RMB deposits in Hong Kong, profit contribution from offshore RMB

business of Hong Kong banks may increase rapidly in the coming years.

QE tapering could be POSITIVE for Hong Kong banks

In Jun 2013, Chairman Bernanke of the Federal Reserve (the Fed) indicated that Speculation on QE it would be appropriate for the FOMC to moderate the monthly pace of asset tapering has prompted purchases under QE4 later this year if the incoming economic data are broadly sharp rise in US 10-year consistent with the committee’s forecasts. Immediately after this hint on potential Treasury yields in QE tapering, US 10-year treasury yields surged from an average of 1.93% in May recent months 2013 to 2.5-2.9% over Jul-Sep 2013. However, Chairman Bernanke made it clear that even if there is a modest

reduction in the pace of asset purchases (i.e. the QE tapering), the Fed’s portfolio We believe US 10-year of securities would not shrink. As the Fed projects that the PCE inflation rate will Treasury yields are unlikely to rebound to stay low at 1.3-1.8% during 2014, we see little chance of the Fed disposing of its pre-QE levels long-term treasury and MBS holdings even if it starts off the QE tapering in 2H13- 2014. Hence, we believe the US 10-year Treasury yield is unlikely to rebound to the pre-QE level (i.e. 3.8% in Oct 2008). Rather, it is likely to fluctuate within a small range of 2.7-3.1% during 4Q13-2014, in our view.

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Chairman Bernanke also indicated in Jun 2013 that even if the US inflation rate Target Fed funds rate is likely to remain stable approaches 2.5% or the unemployment rate moves close to 6.5%, this will not during 2H13-2014 automatically result in an increase in the Fed funds rate target (0-0.25% currently). Both the Fed and the US congressional Budget Office (CBO) project that US unemployment will remain above 6.5% over 2013-14 and the PCE inflation rate will remain below 2% over 2013-15. Hence, we see little chance that the Fed will raise the target Fed funds rate during 2H13-2014. This would imply limited volatility in short-term HIBOR (and hence HKD deposit and prime rates) in the next 12-15 months.

Hong Kong banks may ride All told, we believe the QE tapering should lead to a steepening US yield curve on the steepening US yield with limited interest rate volatility. To lower , we see a chance curve to enhance their that Hong Kong banks will shift from short-term HKD interbank lending, HKD NIMs Exchange fund bills and/or USD Treasury bills (with maturities of 3-6 months) to

slightly longer-term HKD interbank lending, Exchange fund notes and/or US

Treasury bonds (with maturities of 1-2 years). We estimate that the lengthening in the duration of these assets will enhance their yields by an average of 30bps.

Figure 6: Sensitivity analysis on the increase in average yield of interbank lending and available-for-sale securities on NIM and pre-tax profit of Hong Kong-listed banks Impact of an increase in average yield of 10% interbank lending Impact of an increase in average yield of 30bp for interbank and AFS securities lending and AFS securities A 30bp increase in A 50bp increase in A 100bp increase in yield yield yield 10% of these assets 15% of these assets 20% of these assets 2014F 2014F 2014F 2014F 2014F 2014F 2014F 2014F 2014F 2014F 2014F 2014F NIM (bp) PBT (%) NIM (bp) PBT (%) NIM (bp) PBT (%) NIM (bp) PBT (%) NIM (bp) PBT (%) NIM (bp) PBT (%)

BEA 0.5 0.4 0.8 0.7 1.7 1.4 0.5 0.4 0.8 0.6 1.0 0.8 BOCHK 0.8 0.5 1.3 0.8 2.6 1.5 0.8 0.5 1.2 0.7 1.6 0.9 CHB 0.5 0.6 0.8 1.1 1.5 2.1 0.5 0.6 0.7 1.0 0.9 1.3 DSB 0.5 0.4 0.9 0.7 1.8 1.4 0.5 0.4 0.8 0.6 1.1 0.8 HSB 1.1 0.6 1.8 0.9 3.7 1.9 1.1 0.6 1.6 0.9 2.2 1.1 HSBC 1.0 0.6 1.6 1.0 3.3 1.9 1.0 0.6 1.5 0.9 2.0 1.2 SCB 0.9 0.6 1.4 0.9 2.8 1.9 0.9 0.6 1.3 0.9 1.7 1.1 WHB 0.5 0.5 0.9 0.8 1.7 1.5 0.5 0.5 0.8 0.7 1.0 0.9 Source: Company data, Maybank Kim Eng

Based on our sensitivity analysis, if the current average yield of 20% of the Large banks should benefit interbank lending and available-for-sale securities (AFS) of Hong Kong-listed more from the lengthening banks is increased by 30bps, the 2014 NIM and pre-tax profit of these banks will of their HKD/USD asset rise by 1-2bps and 0.8-1.3%, respectively. Large banks should benefit more than durations small banks from the lengthening of their HKD/USD asset durations, in our view.

Increasing profit contribution from offshore RMB business in Hong Kong

The PBOC opens three With the aim of promoting internationalisation of the RMB, the PBOC has recently new offshore RMB clearing appointed Bank of China (BOC) and Industrial & Commercial Bank of China centres (ICBC) to provide offshore RMB clearing and settlement services in Taiwan and Singapore, respectively. The State Council of China also unveiled the blueprint for the development of the Shanghai Free Trade Zone (FTZ) in late Sep 2013. The development of cross-border financial services is one of the primary focuses of the FTZ.

Hong Kong will maintain We believe Hong Kong will maintain some competitive advantages in the some competitive development of offshore RMB business against Singapore and Taiwan. These advantages in offshore include the relatively larger RQFII quota (CNY270b) and bilateral currency RMB business arrangement (CNY400b) as well as the implementation of real-time gross settlement (RTGS) for RMB clearing and settlement. Hong Kong’s corporate tax rate is also lower at 16.5% compared with the FTZ’s 25%. This may reduce the appetite of multi-national companies and merchandizing companies to relocate from Hong Kong to FTZ. Further, merchandising companies and manufacturers in Hong Kong have enjoyed zero tariff preferential treatment under CEPA, which should help sustain Hong Kong as the key re-export centre for products of China origin to overseas, especially those under the Outward Processing Arrangements.

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We expect RMB deposits Rather, the setup of new offshore RMB clearing centres will increase the in Hong Kong will reach acceptance of RMB as a settlement currency for international trade in coming CNY1.3t by end-2014 years. We expect the share of offshore RMB trade settlement to increase from 12.2% of China’s total trade value in 2012 to 17% in 2013 and further to 23% in 2014. This will result in an increase in RMB deposits in Hong Kong to CNY1t and CNY1.3t in 2013 and 2014, respectively.

The average utilisation rate Based on the assumptions that: (i) Hong Kong banks invest in 10% of the new of RMB deposits in Hong Dim Sum bonds issued; (ii) 30-35% of the net foreign currency external claims to Kong will rise to 73% in mainland banks are denominated in RMB; (iii) 3% and 10% of China’s RMB- 2014 denominated ODI and FDI respectively are funded by Hong Kong banks; and (iv) RMB loans in Hong Kong total CNY200b and CNY390b in 2013 and 2014, respectively, we estimate that the average utilisation rate of RMB deposits in Hong Kong will increase from 42% in 2012 to 60% in 2013 and 73% in 2014.

Figure 7: Estimation of the operating profit of offshore RMB business of HK banks 2012 2013F 2014F Net interest income (CNYb) (1) 3 8 Offshore RMB trade settlement fees (CNYb) 3 3 3 Total income (CNYb) 1 6 11 Expenses (CNYb) (1) (2) (5) Operating profit (CNYb) 1 4 7 Operating profit of retail banks (HKDb) 100 121 133 % contribution 1.0% 3.8% 6.4% Source: HKMA, Maybank Kim Eng With the increasing utilisation of RMB deposits in Hong Kong, we estimate that Operating profit the operating profit contribution of offshore RMB business will increase from 1.0% contribution of offshore in 2012 to 3.8% and 6.4% in 2013 and 2014, respectively. We have assumed RMB business will rise to conservatively that the net interest spread of this business narrows from 2.75% in 6.4% in 2014 2012 to 2.15% in 2013 and 1.75% and in 2014, in this analysis. BOC (Hong Kong)

(BOCHK) should be the key beneficiary of this business (25% market share).

Potential bidders in discussions with small Hong Kong banks

CHB and WHB have been CHB and WHB recently announced that their major shareholders have been approached by third approached by independent third parties in relation to the possible acquisition of parties in relation to stakes in their respective banks. We believe large Chinese, Singaporean and possible acquisitions Malaysian banks as well as non-bank Chinese conglomerates could be potential bidders. Through the acquisition of small Hong Kong banks, these banks can increase their branch network in Hong Kong. This could help lower their HKD funding cost, enhance cross-selling at their fee-income businesses, facilitate the expansion of cross-border banking business and enjoy stronger competitive

advantages in developing offshore RMB business.

We estimate that the core tier-1 CAR of large H-share and Singapore banks will Large H-share banks and remain at above 8.5% even if they acquire CHB or WHB based on Jun 2013 P/B Singapore banks do not of 2.5x. Hence, they do not need new equity funding to finance such acquisitions. need new equity funding to We therefore assume a funding cost of 3.15% (the average yield of government finance the acquisition of bonds in Hong Kong, China, US, Singapore and Malaysia, which is the opportunity WHB and CHB even if the cost of cash-rich buyers) and 4.25% (the average rate of subordinated acquisition P/BV is 2.5x debt of banks, for buyers who need to finance the acquisition through borrowings) to estimate the potential acquisition price of small Hong Kong banks.

Figure 8: Estimation of potential acquisition price for Hong Kong banks 1H13 Jun 2013E Potential acquisition P/B (x) Potential acquisition price (HKD)

ROE (%) BVPS (HKD) Maximum* Minimum* Maximum* Minimum BEA 9.9 26.71 3.13 2.32 83.60 61.96 CHB 7.4 17.12 2.34 1.74 40.12 29.74 DSB 11.3 12.68 3.57 2.65 45.31 33.58 WHB 8.5 66.39 2.71 2.01 179.88 133.32 Source: Company data, Maybank Kim Eng *Maximum and minimum potential acquisition P/B refers to the P/B generating a ROI of 3.15% and 4.25%, respectively

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Based on the core ROE of small Hong Kong banks in 1H13 and the assumed Maximum acquisition P/BV for CHB and WHB of 2.3x funding cost, we estimate the minimum and maximum acquisition P/BVs for these and 2.7x, respectively banks such that the return on investment (ROI) of an acquisition would equal the assuming acquisition ROI funding cost of the potential bidders. Based on this estimation, we see a equals funding cost possibility that CHB and WHB could be be sold at Jun 2013 P/BVs of 2.3x and 2.7x, respectively.

Asset quality should remain in good shape

Growth in domestic loans accelerated from 7.2% YoY in 2012 to 14.8% YoY in No clear evidence that 1H13, much faster than Hong Kong’s 1H13 nominal GDP growth of 4.1% YoY. Hong Kong banks have relaxed underwriting The market is concerned that banks may have relaxed their risk management standards to boost loan practices through price competition to boost loan growth. In our view, there is no growth clear evidence to suggest that Hong Kong-listed banks have relaxed their underwriting standards to boost their loan growth during 1H13.

The increase in leverage Hong Kong’s total leverage ratio (total loans as a percentage of nominal GDP) should be well cushioned increased to an annualised 305% in 1H13, even higher than the previous peak of by accumulated wealth in 302% in 1997. However, total deposits accounted for an annualised 363% of Hong Kong Hong Kong’s nominal GDP in 1H13. This implies that the increase in leverage in recent years should be well cushioned by accumulated wealth in Hong Kong over the past 15 years. Other key economic indicators such as a healthy current account surplus, low loan-to-value ratio of new mortgages and low short-term external liabilities also suggest that Hong Kong is unlikely to fall prey into a financial crisis similar to that of late 1997.

Neutral to positive outlook With the gradual recovery in the global economy, we have a neutral-to-positive for the asset quality of outlook for the asset quality of Hong Kong banks. However, we see no chance Hong Kong banks that the banks will lower their collective loan impairment allowance ratio given that there could be further consolidation in the Hong Kong property market. We forecast that credit costs of the Hong Kong-listed banks will remain stable or decline slightly in 2H13-2014.

NEUTRAL on Hong Kong banks; BOCHK, DSB and WHB our top picks

Adopting Gordon Growth We have adopted the Gordon Growth Model, which captures the long-term Model to estimate the fair growth potential of banks, to estimate the fair value of most Hong Kong-listed value of banks banks (with the exception of CHB and WHB). This is based on long-term sustainable ROE and dividend payout assumptions, which are consistent with our earnings forecasts for each bank. We have also compared the fair value derived from the model with each bank’s own historical ROE, P/E and P/B bands (over 2002-12) to check whether our target price is within a reasonable trading range of each bank’s P/E and P/B bands.

Initiating coverage of the We forecast that ROEs of Hong Kong-listed banks in 2014 will be close to or Hong Kong banking sector below their historical averages. In line with our forecast ROEs, the 2014 P/BVs of with a NEUTRAL rating most banks, at current share price levels, is also below their historical averages. We therefore initiate coverage of the Hong Kong banking sector with a NEUTRAL rating but with a slight upward bias as we have not fully factored in: (i) potential benefits from the lengthening asset duration of Hong Kong banks; and

(ii) the additional profit from the development of offshore RMB business.

Fundamentally, we prefer both BOCHK and DSB. We initiate on both with We prefer BOCHK and BUY ratings. BOCHK should be the key beneficiary of rapid development of DSB in terms of offshore RMB business in Hong Kong. Its strong capital position should allow it to fundamentals maintain a high dividend payout of 63%. DSB will benefit from management’s

efforts to improve asset and liability management and explore new fee income

opportunities. On M&A theme, As potential acquisition targets, we also initiate coverage of CHB and WHB with we prefer WHB BUY ratings. However, we prefer WHB for its greater upside, based on our estimated potential acquisition price for CHB (HKD38.35) and WHB (HKD156.60).

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Figure 9: Key financial data of Hong Kong-listed banks BEA BOCHK CHB DSB DSF HSB HSBC* SCB* WHB Pre-provisional profit (HKDm) 2012 6,384 24,358 534 1,127 1,282 15,873 25,403 8,061 2,039 2013E 7,005 27,965 599 1,616 1,704 17,730 27,643 9,239 2,114 2014E 7,554 31,344 636 1,737 1,836 19,676 29,593 9,562 2,361 YoY % change

2012 35.2 6.0 (1.3) 15.2 17.2 8.0 (17.3) 4.4 (0.6) 2013E 9.7 14.8 12.1 43.3 32.9 11.7 8.8 14.6 3.7 2014E 7.8 12.1 6.1 7.5 7.7 11.0 7.1 3.5 11.7 Net profit (HKDm)

2012 5,725 20,930 543 1,411 1,236 19,327 13,454 4,786 1,802 2013E 5,731 22,446 490 1,651 1,301 25,622 16,935 4,646 1,924 2014E 5,960 25,274 526 1,910 1,449 16,426 18,869 5,702 1,969 YoY % change

2012 42.1 2.4 (3.1) 29.0 21.1 14.5 (17.1) 0.8 (16.1) 2013E 0.1 7.2 (9.8) 17.0 5.3 32.6 25.9 (2.9) 6.8 2014E 4.0 12.6 7.4 15.7 11.3 (35.9) 11.4 22.7 2.3 EPS (HKD)

2012 2.72 1.98 1.25 1.15 4.22 10.11 0.74 2.00 6.00 2013E 2.57 2.12 1.13 1.35 4.44 13.40 0.92 1.93 6.07 2014E 2.68 2.39 1.21 1.56 4.95 8.59 1.02 2.36 6.52 YoY % change

2012 38.9 2.4 (3.1) 29.0 21.1 14.5 (19.0) (0.6) (17.0) 2013E (5.4) 7.2 (9.8) 17.0 5.3 32.6 23.5 (3.6) 1.1 2014E 4.0 12.6 7.4 15.7 11.3 (35.9) 11.4 22.7 7.3 DPS (HKD)

2012 1.04 1.24 0.46 0.32 1.20 5.30 0.45 0.84 2.08 2013E 0.77 1.33 0.45 0.40 1.33 5.30 0.55 0.90 2.43 2014E 0.80 1.49 0.48 0.47 1.48 5.30 0.61 0.97 2.61 YoY % change

2012 10.5 4.2 (8.0) 13.3 11.7 1.9 9.8 10.5 15.5 2013E (25.4) 7.2 (2.0) 27.7 11.6 - 22.2 8.0 16.9 2014E 4.0 12.6 7.4 15.7 11.3 - 11.4 8.0 7.3 Loan growth (%)

2012 11.2 11.3 (5.2) 6.6 6.6 11.5 5.8 4.7 3.1 2013E 11.5 10.9 11.1 9.7 9.7 9.5 (1.3) 6.0 10.0 2014E 11.0 11.0 11.0 9.8 9.8 9.2 2.3 7.5 10.1 Net interest margin (%)

2012 1.67 1.60 1.10 1.54 1.54 1.85 2.32 2.23 1.62 2013E 1.83 1.67 1.18 1.73 1.70 1.83 2.11 2.17 1.69 2014E 1.82 1.67 1.17 1.70 1.68 1.84 2.00 2.16 1.72 Cost-income ratio (%)

2012 57.7 31.9 59.6 61.9 61.6 34.9 62.8 57.1 47.6 2013E 57.5 30.3 55.9 53.9 55.4 33.7 58.1 54.1 48.8 2014E 57.5 29.3 55.6 53.8 55.2 32.8 56.0 54.9 47.7 Credit cost (%)

2012 0.06 0.12 (0.16) 0.10 0.10 0.08 0.83 0.43 0.21 2013E 0.10 0.10 0.09 0.28 0.28 0.07 0.62 0.51 0.07 2014E 0.10 0.08 0.07 0.22 0.22 0.07 0.57 0.47 0.06 Core tier-1 CAR (%)

2012 10.7 12.3 10.6 10.4 10.4 12.2 13.4 13.4 10.0 2013E 10.6 11.1 9.9 10.1 10.1 14.0 13.6 12.6 12.0 2014E 10.4 10.8 9.4 10.1 10.1 13.3 11.2 12.7 12.0 *Figures are denominated in USD and USDm Source: Company data, Maybank Kim Eng

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US QE tapering – No need to panic

Dual monetary policies in the US since 2008

The Fed cut the Fed funds Following the collapse of Lehman Brothers in Sep 2008 and the ensuing financial rate target to 0-0.25% crisis, the US Federal Reserve aggressively increased the excess reserve in Dec 2008 holdings (or the monetary base) in the banking system through open market operations during 4Q08. As a result, the federal funds rate plunged from 2% in Aug 2008 to below 0.25% in Dec 2008. Accordingly, the Federal Open Market Committee (FOMC) decided to announce a target range for the Fed funds rate of 0-0.25% in the Dec 2008 meeting. This was the first time the target Fed funds rate was set close to 0%. At that meeting, the FOMC also said that the appropriate future path for the Fed funds rate would hinge on their view of the likely path of economic activity.

The FOMC initiated the However, several committee members indicated that increases in excess QE1 programme to reserves might not have a significant stimulus on the US economy if banks were purchase GSE obligations unwilling to lend out their excess reserves. To help reduce the cost of and and MBS in Nov 2008 increase the availability of residential mortgages, the FOMC initiated a programme in Nov 2008 to purchase up to USD100b in direct obligations of housing-related government-sponsored enterprises (GSEs) and up to USD500b

in mortgage-backed securities (MBS) backed by Fannie Mae, Freddie Mac and

Ginnie Mae by the end of 2Q09.

The Fed ended up exceeding its target during Nov 2008-Jun 2010 (USD175m of The Fed also purchased GSEs and USD1.25t of MBS). It also purchased USD300b of long-term Treasury long-term Treasury notes notes (those with of 10-year or above) during this period. This marked under QE1 the beginning of the US quantitative easing programme, the so-called QE1.

Figure 10: Timetable of the US Federal Reserve’s quantitative easing programme Program Period Details QE1 Nov 2008 - Jun 2010 Purchase of USD175m of GSE obligations, USD1.25t of MBS and USD300b of long-term Treasury notes QE2 Nov 2010 - Jun 2011 Purchase of USD600b of long-term Treasury notes; Reinvestment of USD250-300b in Treasuries from proceeds of maturing MBS Operation Twist Sep 2011 - Dec 2012 Purchase of long-term Treasury notes from proceeds of maturing short-term Treasury bills; Reinvestment in MBS when due QE3 Sep 2012 - Dec 2012 Purchase of USD40b MBS and USD45b long-term Treasury notes through Operation Twist per month QE4 Jan 2013 - Present Termination of Operation Twist; purchase of USD40b MBS and USD45b long-term Treasury notes per month Source: US Federal Reserve

The Fed launched QE2, The Fed continued this programme through: (i) the launch of QE2 during Nov Operation Twist and QE3 2010-Jun 2011 (the purchase of USD600b in long-term Treasury notes, in during Nov 2010- addition to the reinvestment of USD250-300b in Treasuries from the proceeds of Dec 2012. maturing MBS); (ii) the launch of Operation Twist during Sep 2011-Dec 2012 (the purchase of long-term Treasury notes from the proceeds of maturing short-term It has launched QE4 to Treasury bills [those with maturity of three months or less] and the reinvestment maintain monthly in MBS as the old ones became due); (iii) the launch of QE3 during Sep 2012- purchase of USD40b new Dec 2012 (the purchase of USD40b new MBS and USD45b long-term Treasury MBS and USD45b long- term Treasury notes notes through Operation Twist per month); and (iv) the launch of QE4 since Jan since Jan 2013 2013 (the termination of Operation Twist and the purchase of USD40b new MBS and USD45b of long-term Treasury notes per month).

10-year US Treasury yield The reduction in Fed funds rate has helped lower the short-term US interest rates. fell to 1.5-2.3% during The three-month US Treasury bill rate fell from 1.75% in Aug 2008 to below Jul 2011-May 2013 0.20% during Nov 2008-Jun 2013. Meanwhile, the launch of successive QE programmes have helped suppress the long-term US interest rates. The 10-year US Treasury bond rate retreated from 3.8-4.0% during Jul-Oct 2008 to 3.2% on average during Nov 2008-Jun 2011 before sliding to 1.5-2.3% during Jul 2011- May 2013.

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Figure 11: 3-month US Treasury bill rate vs 10-year US Treasury bond rate

% 10-year Treasury bond (LHS) 3-month Treasury bill (RHS) % 4.5 3.0 4.0 2.5 3.5 3.0 2.0 2.5 1.5 2.0 1.5 1.0 1.0 0.5 0.5 0.0 0.0 Jan 08 Jul 08 Jan 09 Jul 09 Jan 10 Jul 10 Jan 11 Jul 11 Jan 12 Jul 12 Jan 13 Jul 13

Source: US Federal Reserve

QE tapering – time to defuse the time bomb?

Chairman Bernanke On 19 Jun 2013, Chairman Bernanke of the Fed indicated that it would be indicated in Jun 2013 that appropriate for the FOMC to moderate the monthly pace of asset purchase under it would be appropriate for the QE4 later this year if the incoming economic data are broadly consistent with the FOMC to moderate the the committee’s forecast. “The FOMC sees as most likely involve continuing monthly pace of asset gains in labour markets, supported by moderate economic growth that picks up purchase under the QE4 over the next several quarters. It also sees inflation moving back towards the 2% later this year objective over time,” according to Chairman Bernanke. The Fed expects that the

QE tapering will continue through 1H14 and the asset purchases will ultimately come to an end when the unemployment rate is in the vicinity of 7%.

However, Chairman Bernanke made it clear that Even if there is QE even if there is a modest tapering, the Fed’s reduction in the pace of asset purchase (i.e. the QE tapering), the Fed’s portfolio of securities will portfolio of securities will not be shrinking. Rather, this should result in a not be shrinking slower growth in the portfolio of securities as the Fed will continue to reinvest the principal payments of maturing securities.

Meanwhile, the QE tapering should not have any impact on the Fed funds Even if the US inflation rate. The FOMC said in its Dec 2012 meeting that it will keep the target range for rate is close to 2.5% or the the Fed funds rate at 0-0.25% for as long as the unemployment rate remains unemployment rate is above 6.5% and the inflation rate 1-2 years ahead is projected to be no more close to 6.5%, this will not than 0.5ppt above the 2% long-run goal. Moreover, Chairman Bernanke stated in automatically result in an Jun 2013 that these economic conditions set out as preceding any future interest increase in the Fed funds rate hikes are thresholds, not triggers. In other words, even if the US inflation rate target rate is close to 2.5% or the unemployment rate is close to 6.5%, it will not

automatically result in an increase in the Fed funds rate target.

According to Chairman Bernanke, the QE programmes are an unconventional monetary policy used to achieve some near-term momentum to get the economy

moving forward into a sustainable recovery. Hence, we believe it is reasonable We believe it is reasonable for the Fed to for the Fed to engage in QE tapering when the US unemployment rate is on a engage in QE tapering gradual recovery trend and falls to about 7% as: (i) the unemployment rate was when unemployment rate 6.8% in Nov 2008 when the QE programme was first launched; and (ii) if the is on a gradual recovery unemployment rate were to fall to about 7%, the US real GDP growth will also trend and falls to rebound to above 2.3% (close to the sustainable GDP growth before the Lehman about 7% crisis), according to the Sep 2013 economic projection of the Federal Reserve.

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Figure 12: US Fed funds rate vs inflation and jobless rates Figure 13: US real GDP growth vs unemployment rate

PCE YoY% (LHS) % Real GDP growth Unemployment rate (SA) Unemployment rate (SA, LHS) % 15 % Fed fund target rate (RHS) 12 3.5 10 3.0 10 8 2.5 6 2.0 5 4 1.5 2 0 1.0 0 (2) 0.5 (4) 0.0 (5) Jan 08 Sep 08 May 09 Jan 10 Sep 10 May 11 Jan 12 Sep 12 May 13 1Q08 3Q08 1Q09 3Q09 1Q10 3Q10 1Q11 3Q11 1Q12 3Q12 1Q13 Source: US Federal Reserve, Bloomberg Source: Bloomberg

US short-term rate hike seems unlikely in 2H13-2014 As aforesaid, the QE tapering will be gradual, depending on the pace of recovery The Fed will not shrink its in the US labour market. Besides, the Fed has not set out any criteria or timetable balance sheet until there is on when it is to reduce the balance of its portfolio of long-term treasury bonds a sustainable downtrend in and MBS. Hence, we believe it will not shrink the size of its balance sheet until unemployment rate and a there is a sustainable downtrend in unemployment rate and a substantial substantial increase in US increase in inflationary pressure in the US. inflationary pressure Immediately after the hint from Chairman Bernanke on potential QE tapering, the US 10-year Treasury yield surged from an average of 1.93% in May 2013 to 2.3% in Jun 2013 and further to 2.5-2.9% during Jul-Sep 2013. However, the Fed The US 10-year Treasury projects that the PCE inflation rate will stay low at 1.3-1.8% during 2014 (1.23% yield is unlikely to rebound in Aug 2013). Hence, we see a low chance of the Fed disposing of its holdings on to the pre-QE level (3.8% in Oct 2008) long-term treasury bonds and MBS even it were to begin to taper QE in 2H13- 2014. In other words, we believe the US 10-year Treasury yield is unlikely to rebound to the pre-QE level (i.e. 3.8% in Oct 2008). Instead, it may fluctuate within a small range of 2.7% to 3.1% during 4Q13-2014.

Figure 14: Projections of Federal Reserve and CBO on key US economic indicators 2013F 2014F 2015F 2016F Federal Reserve 2.0-2.3 2.9-3.1 3.0-3.5 2.5-3.3 Real GDP growth (%) CBO 1.4 2.6 4.1 4.4 Federal Reserve 7.1-7.3 6.4-6.8 5.9-6.2 5.4-5.9 Unemployment rate (%) CBO 7.9 7.8 7.1 6.3 Federal Reserve 1.1-1.2 1.3-1.8 1.6-2.0 1.7-2.0 PCE inflation (%) CBO 1.3 1.8 1.9 1.9

Source: US Federal Reserve, CBO

Meanwhile, both the Fed and the US Congressional Budget Office (CBO) project that the US unemployment rate will remain above 6.5% during 2013-2014 and the PCE inflation rate will remain below 2% during 2013-2015. Hence, we see a low chance for the Fed to raise the target Fed funds rate during 2H13-2014. The Fed will not raise the Indeed, the three-month US Treasury bill rate was flat at below 0.05% during target Fed funds rate during 2H3-2014 Jun-Sep 2013 despite widespread expectations of an imminent QE tapering. This implies that the market expects the Fed to maintain its short-term interest rate policy in the near term.

All told, we believe the QE tapering should lead to a steepening US yield curve

as the short rate is unlikely to rise during 2H13-2014. The Fed has also said that The QE tapering should it may not reduce its holdings of long-term Treasury bonds and MBS even after lead to a steepening USD the termination of the QE programme. This should result in limited volatility in the yield curve with moderate medium-term US interest rates (2-3 year US Treasury yields). Hence, Hong Kong interest rate volatility banks may take advantage of the steepening yield curve to lengthen their duration of US bond holdings and improve their NIMs.

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Figure 15: US Treasury yield curve before and after speculation on QE tapering

% Jun 08 Dec 12 Sep 13 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 1M 3M 6M 1Y 2Y 3Y 5Y 7Y 10Y 20Y 30Y

Source: US Federal Reserve

Liquidity should remain flooded elsewhere

The ECB has no intention Notwithstanding the potential QE tapering in the US, central banks in other to withdraw the LTRO developed markets have maintained their relaxed monetary policies. For instance, before end-2014 the European (ECB) has implemented a three-year loan facility (known as the Long-term Refinancing Operation or LTRO) since late 2011. The

ECB has no intention to withdraw the LTRO before end-2014.

Meanwhile, although the area economy has recovered gradually, the pace of recovery remained subdued. As a result, the ECB lowered the interest rate on Interest rates in Europe will the main refinancing operations of the Eurosystem by 25bps to 0.50% in May remain at the current or 2013 and the ECB committee members have agreed that the interest rates in lower levels for an extended period of time Europe will remain at the current or lower levels for “an extended period of time”. According to ECB President Mario Draghi, the length of time for the continued low interest rates will depend on the medium-term outlook for inflation, the economy and monetary dynamics (i.e. monetary aggregates and credit flows).

Mr Draghi also stated clearly that the ECB will not react to other central banks’ monetary policy decisions. In addition, the ECB announced the Outright Monetary The ECB will not react to Transactions (OMT) bond-buying programme in Sep 2012. Under the OMT, the other central banks’ ECB would offer to purchase Eurozone countries’ short-term bonds in the monetary policy decisions secondary market. The size of the bond purchase is unlimited but the liquidity created through OMT will be fully sterilised.

On the other hand, the Bank of England (BOE) has had a new leader in Governor Mark Carney since 1 Jul 2013. Nevertheless, it has maintained the official bank The BOE’s asset purchase rate paid on commercial bank reserves at a historic low of 0.5% in view of the programme will be continued slow recovery in the UK economy. The BOE also said it will maintain maintained during its asset purchase programme (i.e. the purchase of high-quality private sector FY2013/14 assets on behalf of the Treasury, financed by the issue of Treasury bills) at £375b

during FY2013/14. In Asia, the Bank of Japan (BOJ) finally decided to change the main operating

target for operations from interest rates (i.e. the uncollateralised The BOJ will conduct money market operations overnight call rate) to the monetary base in Jan 2013. The BOJ will conduct to expand its monetary money market operations so that the monetary base in Japan will increase from base during 2013-2014 JPY138t as at end-2012 to JPY200t by end-2013 and further to JPY270t by end- 2014. To achieve this, it will purchase JCBs, ETFs and Japan real estate investment trusts (J-REITs) so that its outstanding balance will increase at an annual pace of JPY50t, JPY1t and JPY30b, respectively, during 2013-2014. Through this asset purchase programme, the BOJ hopes to raise the CPI inflation rate in Japan from 0% in 2012 to 2% over the next two years.

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Figure 16: ECB main refinancing rate, BOE bank rate and BOJ overnight call rate

% ECB main refinancing rate BOE rate BOJ overnight call rate 6.0

5.0

4.0

3.0

2.0

1.0

0.0 Jan 08 Jul 08 Jan 09 Jul 09 Jan 10 Jul 10 Jan 11 Jul 11 Jan 12 Jul 12 Jan 13 Jul 13

Source: Bloomberg

We see low chance of a Overall, we believe that the negative effect on global liquidity from potential QE massive capital outflow tapering in the US could be offset by continued liquidity injection from Europe, the from the Hong Kong UK and Japan. Hence, we see low chance of a massive capital outflow from banking system during the Hong Kong banking system during 2H13-2014. Excluding the certificates 2H13-2014 of indebtedness and money in circulation, the adjusted monetary base in Hong Kong has increased substantially from HKD152b in Aug 2008 to HKD917b in Dec

2012, due to global liquidity influx. In spite of the speculation on potential QE

tapering in the US, the adjusted monetary base has remained rather stable at HKD915b during Jun-Aug 2013.

Figure 17: The Aggregate Balance and adjusted monetary base* in Hong Kong

HKDb Aggregate balance (LHS) Adjusted monetary base (RHS) HKDb 350 1,000 900 300 800 250 700 200 600 500 150 400 100 300 200 50 100 0 0 Jan 08 Sep 08 May 09 Jan 10 Sep 10 May 11 Jan 12 Sep 12 May 13

*Adjusted monetary base has excluded the certificates of indebtedness and money in circulation Source: HKMA

Hong Kong banks – Potential benefit from lengthening asset duration

As aforesaid, we see low chance for the Federal Reserve to raise the target Fed funds rate during 2H13-2014 as there has been an improvement in employment Short-term USD and HKD conditions and the inflationary pressure in the US should remain moderate. interest rates should Moreover, we believe the ECB, BOE and BOJ will continue to inject additional remain low and stable before 2015 liquidity in the banking system of Eurozone, the UK and Japan, respectively in the coming quarters. Therefore, we see low chance of massive capital outflow from Hong Kong during 2H13-2014. In other words, short-term USD and HKD interest rates should remain low and stable before 2015. This should help stabilise the HKD funding cost (both savings and time deposit rates) and lending rate (i.e. HKD prime rate) of Hong Kong-listed banks in the next few quarters.

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Figure 18: The adjusted monetary base* in HK and HKD savings rate and prime rate Adjusted monetary base (LHS) Prime rate (RHS) % HKDb HKD savings rate (RHS) 1,000 7 900 6 800 700 5

600 4 500 400 3

300 2 200 1 100 0 0

Jan 08 Sep 08 May 09 Jan 10 Sep 10 May 11 Jan 12 Sep 12 May 13

*Adjusted monetary base has excluded the certificates of indebtedness and money in circulation Source: HKMA

Meanwhile, despite the potential QE tapering in the US, the Federal Reserve has

The 2-year and 3-year US indicated that it may not reduce its holdings on long-term treasury bonds and Treasury-bond yield also MBS. This is under the same rationale of moderate recovery in US increased to 0.36% and unemployment rate and sustainable low inflation rate. Thus, we believe that the 0.68% during Jun-Sep 2013 10 year US Treasury-bond yield is unlikely to rebound to the pre-QE level (i.e. after the speculation on 3.5% in Nov 2008). Rather, we expect it to sway within a small range of 2.7%- QE tapering 3.1% in the next few quarters. Still, the recent rise in long-term US Treasury-bond yield has resulted in some rippling effect to medium-term US interest rates. For instance, the two year and three year US Treasury-bond yield has increased from an average of 0.26% and 0.38% during Jan-May 2013 to 0.36% and 0.68%

during Jun-Sep 2013, respectively.

Figure 19: The 2-year and 3-year US Treasury-bond yield

% 2-year 3-year 0.8 0.7

0.6 0.5

0.4 0.3

0.2 0.1 Jan 12 Apr 12 Jul 12 Oct 12 Jan 13 Apr 13 Jul 13

Source: The Federal Reserve Hence, we believe that Hong Kong banks may ride on the steepening US yield

curve to improve their NIM. To lower the interest rate risk, we see a chance for

We estimate that a mild Hong Kong-listed banks to shift from short-term HKD interbank lending, HKD lengthening in duration of Exchange fund bills and/or US Treasury-bill (with maturity of 3-6 month) to HKD/USD assets will help slightly longer term HKD interbank lending, Exchange fund notes and/or US enhance average yield of Treasury-bonds (with maturity of 1-2 years). We estimate that the lengthening in these assets by 30bps duration of these assets will help enhance their average yield by about 30bps. Meanwhile, there is no imminent intention for the Federal Reserve to reduce its holdings on long-term Treasury bonds and MBS. Hence, we see the lengthening in duration of these assets should not result in significant mark-to-market loss to Hong Kong banks in 2014.

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Figure 20: HIBOR and HKD Exchange fund yield curve in Figure 21: US Treasury yield curve in Sep 2013 Sep 2013

% HK Exchange Fund Note (Sep13) HIBOR (Aug13) % 1.0 0.8 0.7 0.8 0.6 0.6 0.49% 0.5 0.4 0.4 0.3 0.2 0.28% 0.2 0.07% 0.1 0.0 0.0 1W 1M 3M 6M 9M 1Y 2Y 1M 3M 6M 1Y 2Y 3Y Source: US Federal Reserve, HKMA (2012-13M) Source: US Federal Reserve, HKMA (2012-13M) We conducted a sensitivity analysis to estimate the impact of an increase in the The 2014 NIM of Hong Kong-listed banks will average yield of the interbank lending and available-for-sale (AFS) securities of widen 1-2bps through mild Hong Kong-listed banks on the NIM and pre-tax profit of Hong Kong-listed banks. lengthening in duration of Based on the analysis, we estimate that if the average yield of 20% of the their HKD/USD assets interbank lending and AFS securities of Hong Kong-listed banks is increased by 30bps, the 2014 NIM and pre-tax profit of these banks will be increased by 1-2bp and 0.8%-1.3%, respectively.

Figure 22: Sensitivity analysis on the increase in average yield of interbank lending and available-for-sale securities on NIM and pre-tax profit of Hong Kong -listed banks Impact of an increase in average yield of 10% interbank lending Impact of an increase in average yield of 30bp for interbank and AFS securities lending and AFS securities A 30bp increase in A 50bp increase in A 100bp increase in yield yield yield 10% of these assets 15% of these assets 20% of these assets 2014F 2014F 2014F 2014F 2014F 2014F 2014F 2014F 2014F 2014F 2014F 2014F NIM (bp) PBT (%) NIM (bp) PBT (%) NIM (bp) PBT (%) NIM (bp) PBT (%) NIM (bp) PBT (%) NIM (bp) PBT (%) BEA 0.5 0.4 0.8 0.7 1.7 1.4 0.5 0.4 0.8 0.6 1.0 0.8 BOCHK 0.8 0.5 1.3 0.8 2.6 1.5 0.8 0.5 1.2 0.7 1.6 0.9 CHB 0.5 0.6 0.8 1.1 1.5 2.1 0.5 0.6 0.7 1.0 0.9 1.3 DSB 0.5 0.4 0.9 0.7 1.8 1.4 0.5 0.4 0.8 0.6 1.1 0.8 HSB 1.1 0.6 1.8 0.9 3.7 1.9 1.1 0.6 1.6 0.9 2.2 1.1 HSBC 1.0 0.6 1.6 1.0 3.3 1.9 1.0 0.6 1.5 0.9 2.0 1.2 SCB 0.9 0.6 1.4 0.9 2.8 1.9 0.9 0.6 1.3 0.9 1.7 1.1 WHB 0.5 0.5 0.9 0.8 1.7 1.5 0.5 0.5 0.8 0.7 1.0 0.9

Source: Company data, Maybank Kim Eng

All told, due to the recent price competition on HKD time deposits, the HKD We forecast NIM of most composite interest rate of Hong Kong banks crawled upward from an average of Hong Kong-listed banks to 0.26% during Jan-May 2013 to 0.32% during Jun-Aug 2013. Besides, some stay flat in 2014 compared banks offered higher offshore RMB time deposit rates to enhance market share in with 2H13 Jun-Jul 2013. As such, we forecast NIM of most banks to narrow 1-10bps in

2H13 compared to 1H13. As we expect the US short-term interest rates to remain We have not factored in stable and there should be limited capital outflow of Hong Kong in 2014, we potential benefit from forecast NIM of Hong Kong-listed banks to stay flat in 2014 compared to 2H13. lengthening asset duration Meanwhile, we have not factored in the potential benefit from lengthening the in our NIM forecast asset duration in our NIM forecasts of Hong Kong-listed banks. We thus see potential upside in their NIM in 2014.

Figure 23: NIM forecasts of Hong Kong-listed banks 2012 1H13 2H13F 2013F 2014F 2015F BEA 1.67 1.83 1.77 1.80 1.77 1.77 BOCHK 1.60 1.67 1.67 1.67 1.67 1.67 CHB 1.10 1.19 1.17 1.18 1.17 1.17 DSB 1.54 1.77 1.70 1.73 1.70 1.70 HSB 1.85 1.84 1.83 1.83 1.84 1.84 HSBC 2.32 2.17 2.07 2.11 2.07 2.04 SCB 2.23 2.19 2.16 2.17 2.16 2.16 WHB 1.62 1.69 1.69 1.69 1.72 1.72 Source: Company data, Maybank Kim Eng

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Offshore RMB Business – Opportunities Amidst Challenges

RMB deposits in Hong Kong – On the recovery track in 2013

Total RMB deposits in Including the certificates of deposit (CDs) issued, total RMB deposits in Hong Hong Kong grew 21.2% Kong grew 21.2% YTD to CNY873b in Aug 2013. This was faster than a growth YTD to CNY873b in Aug of 8.9% YoY in 2012. We believe the recovery in growth momentum of RMB 2013 deposits was due to: (i) the anticipation of an appreciation of RMB against the USD; (ii) slight pick-up in market share of offshore trade settlement business; and (iii) increasing acceptance of RMB as key international trade settlement currency.

Reversing the trend during the first nine months of 2012, the 12-month USD/RMB Expectation in RMB non-delivery forward (NDF) rate declined gradually from 6.408 in Sep 2012 to appreciation and price 6.201 in Aug 2013. This implied the market expectation for potential RMB competition for RMB appreciation against USD (and hence HKD due to the linked deposits helped revive system). Indeed, the RMB/HKD spot exchange rate has appreciated steadily from growth in RMB deposits 1.235 in Sep 2012 to 1.27 in Aug 2013. This, coupled with some price in Hong Kong competition for RMB deposits among Hong Kong banks (especially during May- Jul 2013), has helped revive the growth momentum in RMB deposits in Hong Kong.

Figure 24: 12-month USD/RMB NDF rate and RMB deposits in Hong Kong

HKDb RMB deposits in HK (LHS) 12-month USD/RMB NDF (RHS) % 900 6.50 6.45 850 6.40 800 6.35 6.30 750 6.25 700 6.20 6.15 650 6.10 600 6.05 Jan 12 Mar 12 May 12 Jul 12 Sep 12 Nov 12 Jan 13 Mar 13 May 13 Jul 13 Sep 13

Source: HKMA (Jan12-Aug13)

Extension of operating On the other hand, the operating hours for RMB real time gross settlement hours of RMB RTGS (RTGS) system in Hong Kong were extended from 10 hours to 15 hours in Jun system helped increase 2012 (from 08:30-23:30). This enabled customers in Europe and part of the US to Hong Kong’s market carry out same day settlement of RMB-related trading activities. As a result, the share in offshore RMB market share of Hong Kong in RMB offshore trade settlement rebounded slightly trade settlement from 78.9% in 4Q12 to 83% during Jan-Aug 2013.

Figure 25: Market share of Hong Kong in RMB offshore trade settlement

120%

100%

80%

60%

40%

20%

0% 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 Jul-Aug13

Source: HKMA, PBOC (1Q12-2Q13 and Jul-Aug13)

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The acceptance of RMB as key international trade settlement currency has also RMB was ranked 12th as been on a steady rise. The share of offshore RMB trade settlement in China has global payments currency increased from 8.9% of total trade value in 2011 to 12.2% in 2012 and further to in Sep 2013 16.4% in 1H13 (16.3% during Jul-Aug 2013). Similarly, according to SWIFT, RMB was ranked 12th as global payments currency in Sep 2013, with a rising market share of 0.84%, overtaking the market share of Norwegian Krone. The market

share of RMB was 0.25% in Dec 2011 and 0.57% in Dec 2012.

Figure 26: Share of offshore RMB trade settlement in China Figure 27: Market share and ranking of RMB as global payments currency in Sep 2013

% 1. EUR 37.93% 18 2. USD 36.48% 3. GBP 8.19% 16 4. JPY 2.34% 14 5. AUD 1.95% 6. CAD 1.84% 12 7. CHF 1.60% 8. HKD 1.01% 10 9. SGD 0.95% 8 10. SEK 0.88% 11. THB 0.85% 6 12. RMB 0.84% Jan 12 Mar 12 May 12 Jul 12 Sep 12 Nov 12 Jan 13 Mar 13 May 13 Jul 13 13. NOK 0.74%

Source: PBOC, Ministry of Commerce (1Q11-Jul13) Source: SWIFT Net outflow of RMB trade Finally, the gradual appreciation of RMB against USD since 4Q12 has increased settlement in China the appetite of overseas exporters to accept RMB as trade settlement currency. As rebounded to CNY104.3b such, the net outflow of RMB trade settlement in China rebounded sharply from in 2Q13 CNY80.2b in 4Q12 (CNY0.6b in 3Q12) to CNY170.5b in 1Q13 and CNY104.3b in 2Q13, respectively. This has helped accumulate the offshore RMB deposits,

especially in Hong Kong during 1H13.

Figure 28: Net outflow of RMB trade settlement in China RMB inflow RMB outflow Net outflow RMB outflow/RMB inflow (%) Increase in RMB deposits in HK 1Q11 39.3 219.2 180 557.8 158.9 2Q11 103.8 305.3 201.5 294.1 124.6 3Q11 156.9 262.7 105.8 167.4 91.1 1Q12 232.1 317.9 85.9 137.0 10.9 2Q12 279.4 382.8 103.4 137.0 11.4 3Q12 417.6 418.2 0.6 100.2 -22.7 4Q12 370.9 451.1 80.2 121.6 59.2 1Q13 416.71 587.21 170.5 140.9 91.9 2Q13 468.49 572.79 104.3 122.3 48.4 Source: PBOC (1Q11-2Q13)

Taiwan and Singapore as new offshore RMB centres

The PBOC opened new With the aim to promote internationalization of RMB, the PBOC has recently offshore RMB clearing appointed Bank of China’s (BOC’s) Taipei branch and Industrial & Commercial centres in Singapore Bank of China’s (ICBC’s) Singapore branch to provide offshore RMB clearing and and Taiwan settlement services in Taiwan and Singapore, respectively. Before that, BOC (Hong Kong) (BOCHK) was one of the two designated offshore RMB clearing

banks (the other being Bank of China Macau), allowing Hong Kong to enjoy first-

mover advantage to develop itself as offshore RMB centre.

Meanwhile, the PBOC and the Central Bank of the Republic of China (CBC)

signed a Memorandum of Understanding (MoU) on Cross Strait Currency RMB deposits in Taiwan Settlement in Aug 2012. Following the regulatory approval of BOC’s Taipei surged to CNY85.1b in Aug 2013 branch as the RMB clearing bank in Taiwan, the CBC allowed Taiwan banks to conduct RMB-denominated business under the Domestic Banking Units (DBUs), in addition to OBUs in Feb 2013. Since then, RMB deposits in Taiwan have increased steadily to CNY85.1b in Aug 2013 (DBUs: CNY54.5b; OBUs: CNY30.7b).

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Figure 29: RMB deposits in Taiwan (including OBUs and DBUs)

CNYb OBUs DBUs 90 80

70

60 50 40 30 20 10

0 Aug-11 Nov-11 Feb-12 May-12 Aug-12 Nov-12 Feb-13 May-13 Aug-13

Source: China Economic News Services, CBC (1Q11-2Q13)

Despite being a latecomer, we see some competitive advantages of Taiwan to Strong trading value and develop RMB business. Firstly, China is one of the key trading partners of Taiwan. large trade surplus against Total trade value between China and Taiwan surged by more than ten-fold (or a China as well as lower CAGR of 24.6%) during 2001-12. The share of China in Taiwan’s total trade transaction costs should value increased steadily from 4.6% in 2001 to 21.3% in 2012 (21.5% during Jan- help Taiwan to develop Jul 2013). Besides, Taiwan has maintained a trade surplus against China since RMB business 2002. It again reported a strong trade surplus of USD39.8b in 2012 (USD17.8b

during Jan-Jul 2013). This should help Taiwan banks to accumulate RMB

deposits if Taiwan exporters accept RMB as trade settlement . According to SWIFT, since RMB has become available to invoice trade, about 44% of Taiwan’s trade with both China and Hong Kong was cleared in RMB in Dec 2012 (2.6% in Jan 2012). The transaction costs for merchandise trading companies will be reduced by 2%-3% through the use of RMB or NTD to settle cross-Strait trade (instead of USD), according to the estimation of the Commissioner of Discipline Inspection of the CBC.

Figure 30: Share of China in Taiwan’s total trade and trade balance of Taiwan against China

% Share of total trade (LHS) Trade balance (RHS) USDb 25 50

20 40

30 15

20 10 10

5 0

0 (10) 2001 2003 2005 2007 2009 2011 Jan-Aug13

Source: Bureau of foreign trade (2001-2012; Jan-Jul 2013)

As a result of the Economic Cooperation Framework Agreement (ECFA) in Jun Sharp rise in mainland 2010, Taiwanese companies have been encouraged to invest in various local investment by Taiwanese government projects in China. According to Ministry of Economic Affairs of companies should help Taiwan, the approved amount of mainland investment by Taiwan government has boost demand for nearly doubled from USD6.1b in 2009 to USD10.9-12.2b p.a. during 2010-12 RMB funding (USD5.3b during Jan-Jul2013). If this trend continues, demand for RMB funding to invest in China by Taiwanese companies should increase, which will help enhance the utilization of RMB deposit pool in Taiwan.

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Total RMB deposits in Similarly, the PBOC and Monetary Authority of Singapore (MAS) signed a MOU Singapore also increased on RMB business co-operation in Apr 2013. Under the MOU, both PBOC and to CNY140b in Jul 2013 MAS will cooperate closely to review the conduct of RMB businesses and RMB clearing and settlement arrangements, liquidity conditions and stability of the RMB market in Singapore. Through ICBC (Singapore branch), the RMB

participating banks have been able to access the in

China to conduct RMB trade-related clearing and settlement business since May

2013. According to the MAS, the RMB deposit pool (including interbank deposits) in Singapore has increased from CNY60b in May 2012 to over CNY100b in Dec 2012 and further to CNY140b in Jul 2013.

We see three grounds to support a rapid development of offshore RMB business Strong trade value and in Singapore in the near term. Firstly, similar to Taiwan, China is one of the key healthy trade surplus trading partners of Singapore. Total trade value between China and Singapore against China helped surged by more than three-fold (or a CAGR of 15%) during 2001-12. The share of accumulated RMB China in Singapore’s total trade value increased steadily from 5.3% in 2001 to deposits in Singapore 10.5% in 2012 (11.3% during Jan-Aug 2013). Singapore also maintained an external trade surplus against China of S$5.9b and S$2.0b during 2012 and Jan- Aug 2013, respectively, implying room for Singapore to accumulate RMB

deposits.

Figure 31: Share of China in Singapore’s total trade and trade balance of Singapore against China

% Share of total trade (LHS) Trade balance (RHS) SGD b 12 8 10 6

4 8 2 6 0

4 (2) 2 (4)

0 (6) 2001 2003 2005 2007 2009 2011 Jan-Aug13

Source: Department of Statistics, Singapore (2001-2012; Jan-Aug 2013) In addition, Singapore is a key financial and trading hub for ASEAN countries. Hence, it may provide RMB clearing and settlement for external trade activities Expansion of China- between ASEAN and China. The share of China in ASEAN countries’ total trade ASEAN external trade value also surged from 4% in 2000 to over 16% in 2012. Singapore is also the activities should help expand RMB trade-related second largest corridor for the issuance of RMB letter of credits (LCs), accounting business in Singapore for more than 20% of all RMB-denominated LCs globally, according to the MAS. The ongoing expansion of China-ASEAN external trade activities should provide huge room for expansion of RMB-denominated LCs business in Singapore.

Secondly, Singapore is one of the key regional headquarters and treasury With a solid trading centres for multinational companies (including more than 4,000 mainland platform for FOREX and companies) and a major wealth management and private banking centre for high derivatives, Singapore net worth individuals in Asia (there are more than 30m Chinese residing in South banks should have strong East Asia). In order to attract foreign direct investment, the Singapore capability to innovate RMB government has signed up tariff exemption agreements with various regions and corporate cash offered incentive programmes for foreign companies. Besides, Singapore is management and retail amongst the top four most active foreign exchange and derivatives trading management products centres in the world, with average daily turnover of USD338b in 2012 (USD356b during Jan-Aug 2013). It is also the largest OTC interest rate derivatives trading centre in Asia ex Japan. This should provide a solid platform for the innovation of

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RMB corporate cash management and retail wealth management products by Singapore banks once they obtain RQFII quota from the Chinese government.

Finally, Singapore is one of the key regional funding centres in Asia. For example, The well-established bond the establishment of a USD1t Asian dollar market has played a critical role in market and the new supporting the liquidity and funding need of the Asian markets. Moreover, development of Singapore Singapore has a well-established , with total amount of bonds issued Exchange could help outstanding at SGD82.6b at end-Dec 2012. Total gross bond issuance amounted Singapore become a to SGD16.4b and S$10.6b during 2012 and Jan-Aug 2013, respectively. We major RMB funding centre believe the rapid development of bond market in Singapore was partly due to the for mainland companies tax concession for bond issuers and investors under the “Qualifying Debt

Securities” scheme (including offshore RMB bonds). Similarly, Singapore Exchange is able to provide dual currency (including RMB) listing, quoting, trading, clearing and settlement services for companies. China recorded a foreign direct investment net inflow of USD6b to ASEAN countries in 2011. This represented a CAGR of 180.5% during 2009-11. If China maintains a strong growth in direct investment in ASEAN countries in the coming years, Singapore could become a major financial centre of RMB fund raising (through the bond and equity market) and RMB loans for mainland companies.

Figure 32: Total gross bond issuance and bonds issued outstanding in Singapore

SGDb Bonds issued outstanding (LHS) Total gross bond issuance (RHS) SGDb 100 18 90 16 80 70 14 60 50 12 40 10 30 20 8 10 0 6 2003 2005 2007 2009 2011 Jan-Aug13

Source: Monetary Authority of Singapore (2003-2012; Jan-Aug 2013)

Hong Kong still enjoys some competitive advantages

Despite that both Taiwan and Singapore could be potential competitors of Hong The restriction on issue of Kong on offshore RMB business, we see some competitive disadvantages of Formosa bonds and the these two countries against Hong Kong. In the case of Taiwan, the development 15% tax charges on of Formosa bonds remains very restrictive. Bond issuers have to meet a purchases of debt minimum credit level of BBB to raise funds. Besides, non-Taiwan resident products will restrain investors need to pay a 15% tax on purchases of debt products (including development of RMB Formosa bonds) listed in Taiwan. It is also unclear when the Taiwan regulators bond market in Taiwan will allow free transferability of offshore RMB between Taiwan and other offshore

markets. This will further restrain the development of RMB bond market and lending business in Taiwan.

Meanwhile, according to media reports, the China Securities Regulatory

Potential RQFII quota of Commissions (CSRC) will provide a RQFII quota of CNY100b to Taiwan. CNY100b to Taiwan However, final approval has not been granted by the CSRC. Even if it is granted, the RQFII quota for Taiwan remains much lower than that of CNY270b for Hong Kong. This may restrict the development of RMB-denominated wealth management and life insurance products in Taiwan. Finally, the PBOC has not signed up any bilateral currency swap arrangement with CBC. This will restrain the development of RMB lending business in Taiwan given the lack of back-up RMB liquidity from CBC.

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In the case of Singapore, the PBOC and MAS has expanded the bilateral The MAS has not launched currency swap arrangement from CNY150b to CNY300b in Mar 2013. However, the RMB liquidity facility the MAS has not launched the RMB liquidity facility which provides emergency and RTGS system for RMB RMB liquidity in the banking system. Besides, the RTGS system for RMB clearing clearing and settlement and settlement will not be available in Singapore till 2014. We believe this will

restrain the growth in RMB lending, clearing and settlement business in

Singapore in the near term.

Moreover, the trade surplus of Singapore against China has reduced significantly Reducing trade surplus of from S$5.9b in 2012 to an annualised S$3b in 2013 (S$2b during Jan-Aug 2013). Singapore against China This will raise concerns over the capability of Singapore to accumulate RMB will raise concerns over the growth in RMB deposits deposits. Finally, the CSRC has not granted any RQFII quota to Singapore. This in Singapore will restrain the development of RMB-denominated wealth management and life insurance products in Singapore.

London- A partner, not competitor

According to the survey conducted by Bourse Consult on the development of RMB business in London, the overall conclusion is: “London’s role in the global Total RMB customer RMB market has continued to grow rapidly both in terms of the range of products deposits in London fell to and in the volume of business…the key indicators of the development of offshore CNY5.12b in Dec 2012 RMB market activity are not the level of deposits but the volume of transactional flows …”. Indeed, total RMB customer deposits (including both retail and corporate deposits) in London fell from CNY6.85b in Dec 2011 to CNY5.12b in Dec 2012.

In our view, the financial institutions in Europe, especially in London, will primarily We see it difficult for be strategically-important players to enhance RMB interbank lending market London to develop itself as liquidity, increase the acceptance as trade settlement currency, develop RMB key offshore RMB centre to FOREX and trade-related products, and offer RMB bond issuance service. We retain RMB deposits see it difficult for London to develop itself as key offshore RMB centre to retain RMB deposits. This is because: (i) the PBOC has not yet prepared to establish a clearing and settlement platform for RMB in Euro zone; and (ii) unlike Singapore, Taiwan and Hong Kong, both EU and UK reported a trade deficit against China

(USD109.6b and USD29.5b in 2012, respectively).

The interbank and institutional business remained as the most significant segment of UK’s current RMB business. As at end-Dec 2012, interbank RMB The interbank and RMB deposits amounted to about CNY7b, higher than the amount of RMB customer FOREX business remained as the most significant deposits. Besides, a full range of RMB FOREX products is actively traded in segment of UK’s London. Spot RMB FOREX trading in London surged from USD0.68b per day in RMB business 2011 to CNY2.5b in 2012, accounting for 59% of the global offshore RMB . Including non-deliverable and deliverable RMB-related FOREX products, overall daily trading value of all RMB FOREX products was more than doubled to USD16.8b in 2012.

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Figure 33: Average daily trading value of deliverable RMB Figure 34: Average daily trading value of non-deliverable products in London RMB products in London

Source: Bourse Consult Source: Bourse Consult

On the other hand, the volume of RMB LCs and other RMB loan guarantees’ A surge in RMB-trade business increased by more than 13-folds to CNY4.7b in 2012. Similarly, the related financing and RMB volume of RMB import and export financing was CNY27b and CNY6.6b in 2012, bond origination in London respectively. In aggregate, the volume of RMB import and export financing grew in 2012 100% YoY in 2012. The RMB bond origination activity in London also increased by 76% YoY to CNY12b in 2012.

Figure 35: RMB-related corporate banking and bond origination business in London CNY m 2011 2012 30,000

25,000

20,000

15,000 10,000

5,000

0 Commercial loan Letters of credit Import financing Export financing Bond issuance

Source: Bourse Consult The PBOC signed a bilateral RMB swap agreement of CNY200b with the Bank of England in Jun 2013. This should provide extra liquidity for London to develop UK banks will not compete RMB-denominated FOREX and trade-related business. However, as the PBOC with Hong Kong banks for has not assigned a RMB clearing bank in London, “the city of London should offshore RMB deposits but will refer RMB trade-related continue to use the clearing arrangement in Hong Kong, on the basis of business clearing and settlement needs”, according to the Bourse Consult survey. All said, UK banks are unlikely business to Hong Kong to compete aggressively with Hong Kong for offshore RMB deposits. In fact, they will continue to refer the RMB trade-related clearing and settlement business to the offshore clearing centres, especially to Hong Kong (given its large RMB deposit pool) in the near term. Besides, they may also borrow from Hong Kong banks to expand its RMB FOREX and trade financing business.

Shanghai Free Trade Zone – Too early to affect Hong Kong

State Council set up The State Council of China unveiled the blueprint of Shanghai Free Trade Zone Shanghai FTZ in Sep 2013 (FTZ) on 29 Sep 2013. The FTZ covers four regions, namely, Waigaoqiao, Pudong airport, Yangshan deepwater port (Land) and Yangshan deepwater port (Harbour). According to the State Council, the Shanghai FTZ will become a vehicle to expedite the globalization of China within the next two to three years

and it will meet the international standards for the facilitation of trade and

investment, financial reform, effective and simple regulatory framework as well as

a standardised legal environment.

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Figure 36: Location of Shanghai Free Trade Zone

Source: Wall Street Journal Within the framework of financial reform, the primary focus will be on interest rate liberalization, currency convertibility under capital account and the development of cross-border financial services. On the aspect of trade and investment, the FTZ will streamline the approval process of foreign direct investment (FDI) (except for those investments in the negative list) and overseas direct investment (ODI). The State Council also aims to develop the FTZ into a key international clearing, settlement and financial centre for cross-border trade business in China.

The State Council identified six focus areas for the FTZ, including financial services, shipping and logistics, commercial trade, professional services, culture and entertainment and social services. The blueprint provides guidelines for the liberalization of 18 industries, including banks, health and medical insurance and financial leasing in financial services sector. Under the guidelines for banks, foreign banks will be allowed to set up a subsidiary bank or a joint-venture bank (with private enterprises) in the FTZ. Besides, qualified mainland banks will be allowed to operate cross-border banking business after the release of relevant regulations.

A first batch of 36 companies were approved to set up business in the FTZ, including the opening of branches by eight mainland banks and the opening of sub-branches by Citibank and DBS on 1st Oct 2013.

Apparently, the establishment of Shanghai FTZ may result in direct competition with Hong Kong on offshore RMB business as overseas importers and exporters may settle in RMB with their counterparts in China on external trade activities through banks in the FTZ. These banks may even provide cross-border trade finance and bill-discounting service (including the issue of LC) to the overseas importers and exporters. In addition, the liberalization of financial leasing and shipping and logistics sectors and the establishment of commodities trading platform may attract multi-national companies and large merchandising companies to relocate to the FTZ. Finally, the simplification of the approval process for FDI and ODI, together with full interest rate liberalization, in the FTZ may re-channel some of the funding needs of these investments from Hong Kong to the FTZ.

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Details of cross-border However, we do not see the Shanghai FTZ will create immediate threat to the businesses that are offshore RMB business in Hong Kong. Firstly, details of cross-border businesses permitted to banks in that are permitted to banks in the FTZ have not been announced. It is also the FTZ have not unsure whether loans and deposits booked in the FTZ will be excluded from the been disclosed calculation of loan-to-deposit ratio and loan quota of mainland banks.

Hong Kong has lower Secondly, the FTZ does not offer any corporate income tax concessions. Hence, corporate tax than the FTZ the corporate tax rate in the FTZ would remain as the existing minimum 25%, at 16.5% which is much higher than the corporate tax rate of 16.5% in Hong Kong. This may reduce the appetite of multi-national companies and large merchandizing

companies to relocate from Hong Kong to FTZ.

Thirdly, Hong Kong is a key merchandising centre to source raw materials or semi-manufactured goods for outward processing operations in China and to re- Hong Kong merchandising export the finished goods to overseas buyers. Products processed by these companies and manufacturers have outward processing arrangements (OPA) primarily include textiles and clothing, enjoyed zero tariff electronic products, toys, clocks and watches. Indeed, the proportion of outward preferential treatment processing trade was maintained at more than 30% of Hong Kong’s exports to under CEPA China during 2010-1H13. Similarly, more than 70% of Hong Kong’s re-exports of China origin to overseas were products under the OPA over the same period. In the meantime, we believe it will be difficult for the FTZ to replace Hong Kong as key merchandising centre given that Hong Kong merchandising companies and manufacturers have enjoyed zero tariff preferential treatment under CEPA (even for raw materials and partial-manufactured products with OPA).

Figure 37: Proportion of trade involving outward processing arrangement in China % OPA in China: % of total export OPA in China: % of re-exports to other places 80 70 60 50 40 30 20 10 0 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13

Source: Statistics & Census department Hong Kong has Finally, we believe the FDI to China through Hong Kong may not be significantly competitive advantages affected by the simplification of approval process in the FTZ. Indeed, the Chinese over FTZ on sound legal government has also streamlined the approval process for FDI from Hong Kong system, good protection of to China in late 2012. Moreover, in our opinion, with sound legal system, good intellectual property, solid protection of intellectual property, solid financial system and low corporate tax financial system and low rate, Hong Kong should remain as a major intermediary platform for overseas corporate tax rate companies which intend to invest in China,.

Still room to enlarge the offshore RMB deposit pool in Hong Kong

We expect the share of According to the forecast of EIU, total trade value in China will grow 7.3% YoY offshore RMB trade and 8.7% YoY in 2013 and 2014, respectively (+8.3% YoY during Jan-Aug 2013). settlement will increase to We believe the establishment of the new offshore RMB business centres in 23% of China’s total trade Singapore and Taiwan and the Shanghai FTZ should help increase the value in 2014 acceptance of RMB as settlement currency for international trade in the coming

years. As such, we expect the share of offshore RMB trade settlement will increase further from 12.2% of China’s total trade value in 2012 (8.9% in 2011) to

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about 17% for 2013 and may reach 23% for 2014. This will imply that the total amount of offshore RMB trade settlement will increase from CNY2.94t in 2012 to CNY4.3t in 2013 (CNY2.8b during Jan-Aug 2013) and CNY6.3t in 2014.

The trade value of The trade value of Taiwan, Singapore and Hong Kong with China accounted for Taiwan, Singapore and 3.1%, 2.2% and 12.3% of China’s total trade value in 2012, respectively. This Hong Kong with China market share has been quite stable for the three regions over the past five years. accounted for 3.1%, Meanwhile, we estimate that about 46% and 88% of Hong Kong’s total trade 2.2% and 12.3% of value with China was settled and cleared in RMB during 2011 and 2012, China’s total trade value respectively. Also, an average of 34.4% of the offshore RMB trade settlement has in 2012 been retained as RMB deposits in Hong Kong during 2011-1H13 (27.4% in 2012,

41.2% in 1H13) . Overall, based on the assumption of: (i) similar market share of the three regions We estimate the RMB on total trade with China during 2013-14; (ii) about 46-92% of Taiwan’s and deposits in Hong Kong will rise to CNY1.3t Singapore’s total trade with China will be settled in RMB during 2013-14; (iii) in 2014 about 92%-95% of Hong Kong’s total trade with China will be settled in RMB during 2013-14; and (iv) an average of 34.4% and 41.2% of the offshore RMB trade settlement will become RMB deposits of the three regions in 2013 and 2014, respectively, we estimate that the RMB deposits in Taiwan, Singapore and Hong Kong will be CNY125b, CNY168b and CNY986b in 2013 and CNY232b, CNY227b and CNY1.3t in 2014, respectively.

Figure 38: Estimation of offshore RMB deposits in Hong Kong, Taiwan and Singapore 2012 2013F 2014F Total trade in China (USDb) 3,867 4,149 4,512 Total trade in China (CNYb) 24,090 25,352 27,208 % share of RMB trade settlement 12.2 17.0 23.0 Amount of offshore RMB trade settlement (CNYb) 2,940 4,310 6,258 Total trade with China - Taiwan (CNYb) 758 786 843 % of trade settled in RMB NA 46.1 66.9 Amount of trade settled in RMB - Taiwan (CNYb) NA 362 564 Market share NA 8.4% 9.0% Total trade of Singapore with China (CNYb) 524 558 599 % of trade settled in RMB NA 87.6 92.0 Amount of trade settled in RMB - Singapore (CNYb) NA 489 551 Market share NA 11.3% 8.8% Total trade of Hong Kong with China (CNYb) 3,006 3,118 3,347 % of trade settled in RMB 87.6 92.0 95.0 Amount of trade settled in RMB - Hong Kong (CNYb) 2,633 2,869 3,179 Market share 89.5% 66.6% 50.8% RMB deposits as % of total trade settled in RMB 27.4 34.4 41.2 Amount of RMB deposits - Taiwan (CNYb) 18 125 232 - Singapore 100 168 227 - Hong Kong 720 986 1,310 Source: Statistics & Census department, Bureau of Foreign Trade, Department of Statistics- Singapore, MAS, HKMA, CBC, Maybank Kim Eng

Market share of Hong Separately, we also estimate that the market share of Hong Kong in total offshore Kong in total offshore RMB trade settlement of China will decline from 89.5% in 2012 to 66.6% in 2013 RMB trade settlement of and 50.8% in 2014, reflecting the loss of some market share to Taiwan, China may decline Singapore and Shanghai FTZ. However, the proposed opening of the capital in 2014 account in Shanghai FTZ could imply that Hong Kong banks may borrow RMB from the banks in the FTZ in the near future. This could help enlarge the offshore RMB interbank deposit pool in Hong Kong.

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Increasing utilization of RMB deposits…

The tightening onshore We expect the utilization of the RMB deposits in Hong Kong to increase gradually liquidity, the lower in the coming years. This is mainly due to: (i) the tightening onshore liquidity in offshore RMB lending rate, China banking system, the expectation of moderate appreciation of RMB against strong growth in China’s USD and the more favourable offshore RMB lending rate should prompt demand FDI and ODI and the for offshore RMB loans; (ii) the rise in offshore RMB trade settlement, the recovery increase in investment in in foreign direct investment (FDI) and the continued strong growth in overseas Dim Sum and mainland direct investment (ODI) in China could be key drivers for offshore RMB loans; and interbank bonds will help (iii) the PBOC may continue to increase the interbank bond and RQFII quota and enhance the utilization of RMB deposits the approval of Dim Sum bonds issued in Hong Kong to facilitate the development in Hong Kong of RMB-denominated wealth management products offshore.

In the wake of robust M2 growth and potential credit inflation, the PBOC has

We believe the PBOC will actively withdrawn excess liquidity from the China banking system through reverse not relax the liquidity in repo during Mar-Jun 2013. Consequently, total RMB deposits in China grew slower China aggressively in from CNY6.1t QoQ in 1Q13 to CNY3.0t QoQ in 2Q13. Total RMB loan growth also 2H13 and 2014 moderated from CNY2.8t QoQ in 1Q13 to CNY2.3t QoQ in 2Q13. The tightening liquidity in the banking system has also led to a surge in SHIBOR (with maturity of 1-month or below) to 7.6%-13.4% in mid-Jun 2013. We believe the PBOC will not relax the liquidity in the China banking system aggressively in 2H13 and 2014 given the moderate downward adjustment in property price and the concern over

expansion in shadow banking business.

On the other hand, the appreciation of RMB against USD remained moderate at Bloomberg consensus 1.8% during the first three quarters of 2013, compared with 1.29% in 2012 and expects RMB will 4.43% in 2011. The 12-month USD/RMB NDF is 6.20 at end-Sep 2013, implying appreciate against USD by limited upside in RMB against USD in the next 12 months. This is reasonable 1.0% in 2014 given market expectation of potential US QE tapering. According to Bloomberg consensus forecasts, RMB will appreciate against USD by 2.1% and 1.0% in 2013 and 2014, respectively. This should reduce the exchange rate risk of foreign companies on borrowing offshore RMB loans.

Figure 39: USD/RMB cross rate and 12-month USD/RMB NDF rate

USD/CNY cross rate 12-mth USD/CNY NDF rate 6.35

6.30

6.25

6.20

6.15

6.10 Dec 12 Jan 13 Feb 13 Mar 13 Apr 13 May 13 Jun 13 Jul 13 Aug 13 Sep 13 Oct 13

Source: Bloomberg (Dec 2012-Sep 2013, D)

Most Hong Kong-listed Similarly, the PBOC cut the one year RMB benchmark lending rate by a total of banks lowered the 56bps during Jun-Jul 2012 to 6%. It also lowered the floor of RMB lending rate to offshore RMB lending rate 0.7x of the benchmark rate in Jul 2012. As such, the proportion of loans quoted at to 5% in 1H13 below benchmark rate increased substantially from 5.35% in May 2012 to 12.55% in Jun 2013. Accordingly, most Hong Kong-listed banks lowered the offshore RMB lending rate from 5.25%-5.50% to 5% in 1H13, based on our channel checks. This remained well below the weighted average onshore RMB corporate lending rate of 6.78% during 1H13.

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Figure 40: Weighted average onshore RMB corporate lending rate and mortgage rate and the proportion of new loans quoted at below benchmark rate Proportion of new loans below benchmark rate (RHS) % Weighted average onshore RMB corporate lending rate (LHS) % Weighted average mortgage rate (LHS) 8.5 16 8.0 14 7.5 12 10 7.0 8 6.5 6 6.0 4 5.5 2 5.0 0 Mar 11 Jun 11 Sep 11 Dec 11 Mar 12 Jun 12 Sep 12 Dec 12 Mar 13 Jun 13

Source: PBOC (Mar2011-Jun 2013, M)

We forecast the offshore As aforesaid, with increasing acceptance of RMB as settlement currency for RMB trade settlement in international trade, we expect the share of offshore RMB trade settlement will Hong Kong to grow 10% increase from 12.1% in 2012 to 17% and 23% of China’s total value by 2013 and p.a. during 2013-14 2014, respectively. Accordingly, we forecast the offshore RMB trade settlement in Hong Kong to grow about 10% p.a. during 2013-14. This should instigate demand for offshore RMB trade-related business, such as trade financing loans,

discounted bills and the issue of RMB letter of credit.

Meanwhile, the smoothening of the approval process for FDI from Hong Kong to Initial basic infrastructure China could help expand offshore lending business in Hong Kong. The FDI in investment in Qianhai will China amounted to USD71.4b for 1H13, up 7.1% YoY (as compared to -3.7% amount to CNY389.8b YoY in 2012). Of which, about USD39.7b (or 64.4%) was channeled through during 2013-15 Hong Kong, up 9.8% YoY (as compared to -7.4% YoY in 2012). With gradual recovery in global economy, the Ministry of Commerce expects the growth of China’s FDI to remain stable or improve slightly in 2H13. In addition, the Qianhai Development Authority in Shenzhen has an initial basic infrastructure investment plan of CNY389.8b during 2013-15. Companies in Qianhai will be allowed to borrow RMB from Hong Kong or other offshore centres to take advantage of the lower rate for investment. According to the HKMA, about 15%-20% of total FDI to China was conducted in RMB during Jan-Aug 2013.

The Chinese Academy of On the other hand, Hong Kong banks may also ride on the rising overseas direct International Trade and investment (ODI) of mainland companies to expand their offshore RMB loans and Economic Cooperation interbank lending businesses. The ODI from China maintained a strong figure of forecast that China’s ODI 18.5% YoY to USD56.5b during Jan-Aug 2013 (+28.6% YoY in 2012). According will reach USD550b during to the HKMA, about 4% of ODI from China was conducted in RMB in 2012. As 2011-15 the Chinese government continues to encourage domestic companies to expand overseas, the Chinese Academy of International Trade and Economic Cooperation forecast that China's ODI will reach around USD550b during 2011- 15 (or an average of USD138b p.a. during 2013-15). This implies that China’s ODI may grow at a CAGR of over 21% during 2012-15. However, the opening of Shanghai FTZ is likely to seize some of the ODI-related RMB lending business in the medium-term.

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Figure 41: Key factors affecting RMB business in Hong Kong YoY % YoY % Jan-Aug YoY % 2010 2011 change 2012 change 2013 change Offshore RMB trade settlement handled by Hong Kong banks (CNYb) 369.2 1,914.9 418.7 2,632.5 37.5 2,284.9 35.1 Total Offshore RMB trade settlement in China (CNYb) 506.3 2,085.0 311.8 2,940.0 41.0 2,759.1 56.1 % share 72.9 91.8 89.5 82.8 RMB customer deposits in Hong Kong (CNYb)* 314.9 588.5 86.9 603.0 2.5 709.5 17.7 RMB certificates of deposits issued in Hong Kong (CNYb)* 5.7 73.0 1,181.4 117.3 60.6 163.5 39.4 Total RMB deposits in Hong Kong (CNYb)* 320.6 661.6 106.4 720.3 8.9 873.0 21.2 RMB bond outstanding in Hong Kong (CNYb)# NA 146.7 NA 237.2 61.7 258.4 8.9 Outstanding RMB loans (CNYb)# 1.8 30.8 1,611.1 79.0 156.5 88.7 12.3 Foreign direct investment in China (USDb) 105.7 116.0 9.7 111.7 (3.7) 79.8 6.4 Overseas direct investment from China (USDb) 59.0 60.1 1.9 77.2 28.6 56.5 18.5 *Figures refer to YTD % change #Refer to end-Mar 2013 figures and YTD % change Source: HKMA, Ministry of Commerce

The CSRC announced in Meanwhile, some Hong Kong banks indicated that the PBOC has increased their Mar 2013 to allow foreign quota to invest in mainland’s interbank bond market in 2012 given the robust funds based in Hong growth in RMB deposits in Hong Kong. We believe this quota could have Kong and offshore increased from CNY50b in 2011 to CNY70-100b during 2012-1H13, based on our branches of Chinese channel checks. This remains immaterial compared with the amount of interbank banks to apply for a bonds issuance in China (CNY4.1t during 1H13, +19.8% YoY). Similarly, the RQFII quota China Securities Regulatory Commission (CSRC) announced in Mar 2013 to

allow foreign funds based in Hong Kong and offshore branches of Chinese banks to apply for a RQFII quota (CNY270b currently). Before that, the RQFII scheme was limited to offshore subsidiaries of mainland asset management companies and securities brokers. Both HSBC and BEA have been granted the RQFII license recently. That said, we see room for the PBOC and CSRC to increase the interbank bond quota and RQFII quota in the coming years. Former CSRC governor Guo Shuqing indicated in Jan 2013 that there is room to increase the RQFII quotas up to 10 times of the current level.

We expect the RMB bond Finally, some Hong Kong banks enhanced the yield on RMB-business by issuance in Hong Kong to increasing investment in Dim Sum bonds issued in Hong Kong by non-financial stabilize at CNY100-120b institutions. The RMB bond issuance in Hong Kong stood at CNY49.2b during p.a. during 2013-14 1H13, up 22% YoY. Most of the issuance was from Chinese property companies

as their borrowing cost from the dim sum market was lower than the USD market.

However, the market speculation on potential QE tapering in the US has dampened new issuance of Dim Sum bonds in 3Q13. Still the Ministry of Finance in China is set to offer CNY23b in Dim Sum bonds in 2013. That said, we expect the RMB bond issuance in Hong Kong to stabilise at about CNY100-120b p.a. during 2013-14. This should provide investment opportunities for the surplus RMB liquidity of Hong Kong banks.

With Qianhai investment, All told, the RMB loans extended in Hong Kong, maintained a solid growth of we project RMB loans in 12.3% YTD to CNY89b during 1Q13. With the initial investment in Qianhai, we Hong Kong will rise to project the RMB loans in Hong Kong will increase to CNY200b and CNY390b by CNY390b in 2014 the end of 2013 and 2014, respectively. Besides, total amount of net foreign currency external claims to mainland banks by Hong Kong banks was increased substantially by HKD1.45t (or 35.7% HoH) during 1H13, implying strong demand

for cross-border interbank lending.

Based on the assumptions that: (i) Hong Kong banks invest in 10% of the new We estimate the utilization Dim Sum bonds issued; (ii) 30%-35% of the net foreign currency external claims rate of RMB deposits in to mainland banks are denominated in RMB; (iii) 3% and 10% of China’s RMB- Hong Kong will rise to denominated ODI and FDI are funded by Hong Kong banks, respectively; and (iv) 73% in 2014 RMB loans in Hong Kong of CNY200b and CNY390b in 2013 and 2014, respectively, we estimate that the average utilization rate of RMB deposits in Hong Kong will increase from 42% in 2012 to 60% in 2013 and further to 73% in 2014.

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Figure 42: Estimation of the average utilization rate of RMB deposits in Hong Kong (CNYb) 2012 2013F 2014F Net interbank lending to mainland banks 195 348 508 ODI from China 14 18 26 FDI in China 8 13 20 Investment in Dim Sum Bonds 9 10 12 Offshore RMB loans in Hong Kong 79 200 390 Total 305 589 955 As a % of total RMB deposits in Hong Kong 42 60 73 Source: HKMA, Ministry of Commerce, Maybank Kim Eng

….and rising profit contribution from offshore RMB business

As aforesaid, due to the RMB interest rate cuts in China during Jun-Jul 2012 and The full deregulation of the lowering RMB lending floor, most Hong Kong-listed banks have lowered their RMB lending rate in Jul offshore RMB lending rate from 5.25%-5.50% to 5% in 1H13. This is to maintain 2013 may not result in the price competitiveness of offshore RMB lending. While the PBOC has lifted the severe price competition floor on RMB lending rate on 20 Jul 2013, we believe this is unlikely to result in for lending business severe price competition for lending business among mainland banks in the near among mainland banks term. This is mainly due to: (i) tightening liquidity in the banking system; (ii) loan

quota set by the PBOC to the banks; and (iii) high loan-to-deposit ratio of small banks. However, with increasing competition from Singapore and Taiwan, we expect some downward pressure on offshore RMB lending rate in 2014.

With increasing utilization of offshore RMB deposits, most Hong Kong banks, in

Net interest spread of particular for China-related banks and small banks, have competed aggressively offshore RMB business in for 3-12 month RMB time deposits during Jun-Jul 2013. Large banks have issued Hong Kong was 2.1% certificates of deposit (CDs) to absorb wholesale RMB funding. The offshore RMB in 1H13 time deposit rates have increased from an average of 2.65% in 2012 to 2.75%-3% during 1H13 for most Hong Kong banks. Still, the net interest spread of these loans remained high at 2.1% in 1H13 (net interest margin of all retail banks in Hong Kong was 1.41% in 1H13).

On the other hand, the interest rate cuts in China during Jun-Jul 2012 has resulted A rebound in China in a fall in two year China yield and SHIBOR (one to three month) government bond yield from 3.33% and 5.19% in 2011 to 2.80% and 4.22% in 2012, respectively. and SHIBOR during Jan- However, the impact of interest rate cuts was crowded out by liquidity tightening in Sep 2013 on liquidity the banking system in 2013. As such, the two year China government bond yield tightening and SHIBOR (1-3 month) rebounded to 3.23% and 4.41% during Jan-Sep 2013.

Figure 43: SHIBOR and China government bond yield

% SHIBOR (1-3 month) 2-year government bond 5.5

5.0

4.5

4.0

3.5

3.0

2.5

2.0 Jan 11 May 11 Sep 11 Jan 12 May 12 Sep 12 Jan 13 May 13 Sep 13

Source: Bloomberg To estimate the profit contribution of offshore RMB business of Hong Kong banks, we made the following assumptions: (i) the average offshore RMB lending rate is reduced from 5.38% in 2012 to 5% and 4.75% in 2013 and 2014, respectively; (ii) the average yield on other interest earnings assets is 3.5% in 2012 and 3.75% in

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2013-14; (iii) the surplus funds are cleared with the PBOC at 0.72%; (iv) the We estimate the operating average offshore RMB time deposit rate is 2.625%, 2.85% and 3% in 2012, 2013 profit contribution of and 2014, respectively; (v) fee income charge of 0.1% for RMB trade settlement offshore RMB business in and clearing; (vi) cost-income ratio of 40%; (vii) operating profit of all retail banks in Hong Kong will rise to Hong Kong will grow 20% for 2013 and 10% for 2014. We estimate that the 6.4% in 2014 operating profit contribution of offshore RMB business will increase from 1.0% in

2012 to 3.8% and 6.4% in 2013 and 2014, respectively.

Figure 44: Estimation of the operating profit of offshore RMB business of Hong Kong banks 2012 2013F 2014F Interest income - Loans (CNYb) 4 10 19 Interest income - Other interest earning assets (CNYb) 8 15 21 Interest income - Clearing with PBOC (CNYb) 3 3 2 Interest expenses - Deposits (CNYb) (16) (24) (34) Net interest income (CNY b) (1) 3 8 Offshore CNY trade settlement fees (CNYb) 3 3 3 Total income (CNYb) 1 6 11 Expenses (CNYb) (1) (2) (5) Operating profit (CNYb) 1 4 7 Operating profit (HKDb) 1 5 8 Operating profit of retail banks (HKDb) 100 121 133 % contribution 1.0% 3.8% 6.4% Source: HKMA, Maybank Kim Eng

BOCHK and HSBC have We estimate that BEA, BOCHK, HSB, HSBC and SCB have a combined market the largest market share in share in Hong Kong’s RMB deposits of about 65% in Jun 2013. Of which, BOCHK RMB deposits in Hong and HSBC have the largest market share of 25% and 19%, respectively. It is Kong of 25% and 19% in reasonable for BOCHK to have the largest market share given it is the sole Jun 2013, respectively offshore RMB clearing bank in Hong Kong. Meanwhile, HSBC should have benefited from its extensive branch network and strong multinational customer

base in Hong Kong.

Figure 45: Market share in RMB deposits in Hong Kong (Jun 2013)

30 25 25 19 20

15

10 9 7 5 5 2 1 1 0 BEA BOCHK CHB DSB HSB HSBC SCB WHB

Source: Company data, Maybank Kim Eng Based on our estimated market share in Hong Kong’s RMB deposits, we conduct a We estimate that the scenario analysis to estimate the impact of a change in offshore RMB deposit increase in offshore RMB deposit utilization by spread and deposit utilization on the NIM and pre-tax profit of Hong Kong-listed 10ppts will enhance banks’ banks. We estimate that a decline in average deposit spread of the utilised offshore NIM by 1-6bps RMB deposits by 50bps will lower banks’ NIM by 1-8bps (or their 2014 pre-tax profit of 0.5-5.4%). Meanwhile, the increase in offshore RMB deposit utilization by 10ppts (with an assumed deposit spread of 2.5%) will enhance banks’ NIM by 1- 6bps (or their 2014 pre-tax profit of 0.5%-3.7%).

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Figure 46: Scenario analysis of a change in offshore RMB deposit spread and deposit utilization on NIM and pre-tax profit Impact on 2014F NIM (bps) if deposit Impact on 2014F NIM (bps) if deposit utilization rate is Estimated average RMB spread is reduced by: increased by:

deposits in HK in 2014F (assuming the utilization rate is 73%) (assuming the deposit spread is 250bps) (HKDb) 50bps 100bps 150bps 10ppts 20ppts 30ppts BEA 77 (4) (8) (13) 3 6 9 BOCHK 419 (8) (17) (25) 6 12 17 CHB 9 (4) (8) (12) 3 5 8 DSB 14 (3) (6) (9) 2 4 6 HSB 114 (4) (8) (12) 3 5 8 HSBC 323 (1) (2) (3) 1 1 2 SCB 148 (1) (2) (4) 1 2 2 WHB 32 (6) (11) (17) 4 8 11

Impact on 2014F pre-tax profit (%) if deposit Impact on 2014F pre-tax profit (%) if deposit utilization Estimated average RMB spread is reduced by: rate is increased by:

deposits in HK in 2014F (assuming the utilization rate is 73%) (assuming the deposit spread is 250bps) (HKDb) 50bps 100bps 150bps 10ppts 20ppts 30ppts BEA 77 (3.6) (7.1) (10.7) 2.4 4.9 7.3 BOCHK 419 (5.0) (9.9) (14.9) 3.4 6.8 10.2 CHB 9 (5.3) (10.7) (16.0) 3.7 7.3 11.0 DSB 14 (2.3) (4.6) (6.9) 1.6 3.2 4.8 HSB 114 (2.1) (4.2) (6.4) 1.5 2.9 4.4 HSBC 323 (0.6) (1.1) (1.7) 0.4 0.8 1.2 SCB 148 (0.8) (1.7) (2.5) 0.6 1.1 1.7 WHB 32 (5.0) (10.0) (15.0) 3.4 6.9 10.3 Source: Company data, Maybank Kim Eng

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M&A speculations on small banks

CHB and WHB – Get ready for sale

CHB did not promote the Chong Hing Bank (CHB) announced that Mr. Liu Lit Chi stepped down as CEO of third generation of the Liu the bank in late Nov 2012. The position of CEO was taken up by Mr. Lau Wai family to be CEO Man. This is the first time that a non-family member of Liu’s has become the CEO of the bank. Mr. Lau became the deputy CEO of CHB only in 2007. We are perplexed as to why the board did not promote Mr. Liu Tit Shing, Don as CEO, even though he has been the deputy CEO of CHB since 2002. Besides, two other

non-family members were promoted as deputy CEOs. This implies that the

managerial role of Don Liu in CHB will be reduced. Fundamentals of CHB have remained weak in recent years. The bank has the CHB suffered from low NIM lowest NIM among all Hong Kong-listed banks (1.19% in 1H13) given its focus on and ROE and tightening capital constraint low-yield large corporate loans and aggressive pricing on time deposits. Besides, CHB has heavy reliance on securities brokerage business. brokerage fees accounted for 45.9% of CHB’s 1H13 total gross fees. Meanwhile, its ROE remained lower than peers at 7.4% in 1H13 despite that its core tier-1 CAR has dropped to 10.8% in Jun 2013. We therefore believe it is reasonable for the Liu family to pave way for possible sale of CHB.

The shareholding structure Moreover, we believe the shareholding structure of CHB also helped facilitate the of CHB helped facilitate the sale of the bank. The major shareholder of CHB is Liu Chong Hing Investment sale of the bank (LCHI), which holds 50.2% stake in the bank. LCHI is another Hong Kong-listed vehicle (194 HK) and is 58% owned by the Liu family. Hence, the proceeds from the potential disposal of CHB will be channeled to LCHI for future investment purpose of the Liu family.

The third generation of the In the case of WHB, the chairman and CEO, Mr. Patrick Fung, has already Fung family is not reached the age of 66 and the third generation of the Fung family is not interested in running interested in running banking business. The Fung family holds 24.2% stake in banking business WHB in Jun 2013. Besides, the second major shareholder of WHB, the Bank of

New York Mellon (BNY; with 20.8% stake) may also be willing to dispose of its

holding in WHB if price is reasonable. We estimate that this will help improve BNY’s core tier-1 CAR by 10-20bps. BNY reported a core tier-1 CAR of 9.3% under the Basel III capital rules in Jun 2013. Indeed, BNY intended to sell 10% of its stake in WHB to China Life (though the deal was unsuccessful) in Aug 2008.

WHB suffered from NIM In terms of fundamentals, being small Hong Kong banks, we believe WHB also pressure and declining fee suffered from NIM pressure and declining fee income contribution. Its NIM income contribution narrowed from 1.9%-2% during 2001-11 to 1.67% in 2012 and 1.69% in 1H13. Its net fees contribution accounted for 15%-16% of total income during 2011-1H13, down signficantly from over 18% before the Lehman mini-bond crisis. As such, there has been limited recovery in its ROE in recent years (ROE has stayed at about 10-11% for WHB in recent years).

Major shareholders of CHB CHB and WHB announced that their major shareholders have been approached and WHB have been by independent third parties in relation to possible acquisition of interests in the approached by third bank in Aug 2013 and Sep 2013, respectively. In a later announcement of CHB parties in relation to made on 16 Sep 2013, it stated that the independent third parties that are in talk possible acquisition of for possible acquisiton of interests in the bank have included Yue Xiu Group. interests in the bank Meanwhile, in the announcement of WHB, it stated that the potential purchaser of the major shareholders’ shares could lead to a mandatory general offer to minority shareholders of the bank. At the same time, WHB announced the cancellation of the interim scrip dividend scheme for 1H13.

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China, Singapore and Malaysian banks could be potential buyers

We see chance for China Construction Bank (CCB), Bank of Communications We see chance for CCB, (BOCOM), Agricultural Bank of China (ABC) and Industrial & Commercial Bank of BOCOM, ABC and ICBC as China (ICBC) to be potential buyers of CHB and WHB as they have solid core potential buyers of stronger capital positions (i.e. high core tier-1 CAR) than peers. We believe they CHB and WHB have abundant excess capital to take advantage of opportunities in overseas M&A activities. Besides, through acquisition of small Hong Kong banks, these banks

can increase the number of outlets in Hong Kong. This could help lower their HKD

funding cost, enhance their cross-selling of fee-income business (in particular for

RMB-related bancassurance and wealth management products) and facilitate the expansion of cross-border banking businesses.

According to media reports, large Singaporean and Malaysian banks could also

Large Singapore and be potential bidders of CHB and WHB. In terms of strategic benefits, we believe Malaysia banks could also CHB should be more attractive to DBS as the latter has already had a good be potential bidders platform in both Hong Kong and China. Similar to the China banks, the acquisition of CHB should help strengthen the branch network of DBS in Hong Kong and allow DBS to enjoy greater economies of scale for their Hong Kong and China banking business.

Figure 47: Hong Kong branch network of listed banks

Source: Company data

On the other hand, we believe WHB should fit more to the appetite of other Singaporean and Malaysian banks, such as OCBC, UOB and Maybank, which WHB should fit more to the have strong capital positions and limited distribution outlets in Hong Kong and appetite of OCBC, UOB China. WHB has a balanced network distribution within Hong Kong (43 branches), and Maybank Macau (12 branches) and China (14 branches and sub-branches). This should help facilitate these banks to develop cross-border banking business within these

regions.

All said, we believe the large Singaporean and Malaysian banks could enjoy strong competitive advantages on developing offshore RMB business if they

acquire CHB or WHB. All of these banks have solid platform in ASEAN countries. Large Singapore and Malaysia banks could As aforesaid, the external trade and investment activities between China and enjoy strong competitive ASEAN countries have increased gradually in recent years. The acquisition of advantages on developing CHB or WHB could thus allow these banks to expose to four out of the five offshore RMB business offshore RMB clearing centres, namely, Singapore, Hong Kong, Macau and Shanghai.

Based on our scenario analysis, we estimate that the core tier-1 CAR of large H- share banks and Singapore banks will remain at above 8.5% even if they acquire Core tier-1 CAR of potential CHB or WHB based on Jun 2013 P/B of 2.5x. Similarly, core tier-1 CAR of bidder will remain high Maybank will remain solid at 8.5% if it acquires CHB based on Jun 2013 P/B of even acquiring CHB and 2.5x. We have not factored in any potential equity capital fund raising for or any WHB at a P/B of 2.5x potential cost and/or revenue synergies from the acquisition.

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Figure 48: Scenario analysis of the acquisition of CHB and WHB on the core tier-1 CAR of banks As at end-Jun 2013 CHB WHB Core tier-1 capital (HKDb) 6.2 13.7 Risk-weighted assets (HKDb) 57.3 126.9 Risk-weighted assets (CNYb) 45.3 100.3 Shareholders' equity (HKDb) 7.5 20.4 Shareholders' equity (CNYb) 5.9 16.1 No of branches in Hong Kong 52 43 No of branches in Macau 1 12 No of branches in China 1 5 No of sub-branches in China - 9

As at end-Jun 2013 ABC BOCOM CCB ICBC Core tier-1 capital (CNYb) 785 398 989 1,165 Risk-weighted assets (CNYb) 8,613 3,930 9,282 11,109 Core tier-1 CAR (%) 9.11 10.14 10.66 10.48 No of branches in Hong Kong 1 44 43 56

Acquisition of CHB Core tier-1 CAR (acquisition at a Jun13 P/B of 1.5x) 9.05 10.00 10.60 10.44 Core tier-1 CAR (acquisition at a Jun13 P/B of 2x) 9.02 9.93 10.57 10.41 Core tier-1 CAR (acquisition at a Jun13 P/B of 2.5x) 8.99 9.85 10.53 10.38

Acquisition of WHB Core tier-1 CAR (acquisition at a Jun13 P/B of 1.5x) 8.97 9.81 10.51 10.37 Core tier-1 CAR (acquisition at a Jun13 P/B of 2x) 8.87 9.60 10.43 10.29 Core tier-1 CAR (acquisition at a Jun13 P/B of 2.5x) 8.78 9.40 10.34 10.22

As at end-Jun 2013 Maybank DBS OCBC UOB Core tier-1 capital (HKDb)* 77 194 138 128 Risk-weighted assets (HKDb)* 749 1,508 920 944 Core tier-1 CAR (%) 10.31 12.88 14.95 13.59 No of branches in Hong Kong 1 28 1 1 No of branches in China 2 26 16 13 No of branches in Macau - 1 - -

Acquisition of CHB Core tier-1 CAR (acquisition at a Jun13 P/B of 1.5x) 9.46 12.40 14.11 12.80 Core tier-1 CAR (acquisition at a Jun13 P/B of 2x) 8.98 12.16 13.72 12.42 Core tier-1 CAR (acquisition at a Jun13 P/B of 2.5x) 8.50 11.91 13.32 12.04

Acquisition of WHB Core tier-1 CAR (acquisition at a Jun13 P/B of 1.5x) 8.25 11.71 12.95 11.72 Core tier-1 CAR (acquisition at a Jun13 P/B of 2x) 7.00 11.06 11.91 10.70 Core tier-1 CAR (acquisition at a Jun13 P/B of 2.5x) 5.74 10.41 10.87 9.69 Source: Company data, Maybank Kim Eng

Non-bank China conglomerates as new potential bidders

As aforesaid, CHB admitted that China’s Yue Xiu Group is one of the parties that Media reports that Yue Xiu has interest in acquiring the controlling shareholders’ stake in the bank. According Group is considering to to media reports, Yue Xiu Group is considering to acquire 60% stake in CHB. We acquire 60% stake in CHB believe it is possible for Yue Xiu Group, as a non-bank China conglomerate, to purchase CHB as: (i) Yue Xiu’s subsidiaries and other companies (the suppliers and customers of its subsidiaries) in Guangdong province could help enlarge CHB’s deposit pool and lower its funding costs; (ii) CHB could develop cross- border banking business (such as loans, trade finance, discounted bills and other fee income business) for the suppliers and customers of Yue Xiu’s subsidiaries;

and (iii) CHB could co-operate with the financial arms of Yue Xiu (including

securities brokerage, futures, asset management, financing leasing, financial guarantee and small-enterprise finance) to develop cross-border RMB business.

Concerning whether the HKMA will approve Yue Xiu Group, as a non-bank China

We see chance for the conglomerate, to acquire stake in CHB, there are two relevant sections in the HKMA to approve a non- latest “Guideline on Minimum Criteria for Authorization” issued in Sep 2013. Firstly, bank China conglomerate under Section 31 of the guideline, the HKMA may not require a controller of a to acquire stake in bank to have relevant quality and experience of running a bank if the controller Hong Kong banks does not influence the directors and management in the day to day activities of the business. As Yue Xiu Group has various financial subsidiaries, we believe the

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management has, to a certain extent, some knowledge and experience required for running a bank.

Besides, under the newly amended Section 36 of the guideline, in considering The new guideline on Minimum Criteria for applications from persons who intend to hold more than 50% stake in an Authorization may authorised institution incorporated in Hong Kong but without appropriate relevant increase the chance of experience of running the authorised institution, the HKMA may impose conditions non-bank China on the applicant. One key condition is to request the applicant to establish a conglomerate to acquire locally-incorporated holding company to hold the shares of the authorised small Hong Kong banks institution to be acquired. This holding company, however, will be subject to certain conditions imposed by the HKMA, including capital adequacy, liquidity, large exposures, intra-group exposures, charges over assets and the like. We see

this new guideline may increase the chance of non-bank China conglomerates to

acquire small Hong Kong banks provided that they form a clean and/or well-

capitalised holding company to hold the acquired.

DSB – The next acquisition target

If both CHB and WHB are successfully sold later this year, we believe that the Shareholding structure of next possible acquisition target could be DSB, as it will then be the remaining DSB is similar to CHB small family-owned bank in Hong Kong. Indeed, the shareholding structure of DSB

is similar to that of CHB. The major shareholder of DSB is DSF (with a 74.6%

stake in DSB), which is 40.7%-owned by the Wong family. Hence, the potential disposal of DSB is unlikely to affect other businesses of the Wong family (e.g. the life business in DSF).

The potential disposal of We believe the potential disposal of DSB by DSF could be similar to the sale of DSB by DSF could be Asia Commercial Bank (ACB) by Asia Financial Holdings (AFH, 662 HK) to Public similar to the sale of ACB Financial Holdings (PFH, 626 HK) in May 2006. The proceeds from the sale of by AFH in May 2006 ACB were retained in AFH, which is 55.3%-owned by the Chan family. AFH has used these proceeds to expand its life insurance and medical healthcare businesses for the past few years.

DSB also faced the Similar to CHB and WHB, we believe DSB also faced the challenges of increasing challenges of NIM pressure price competition for deposits and lending business (its NIM narrowed from over and tightening capital 1.9% before 2009 to below 1.7% during 2010-1H13) and tightening capital requirement requirement (core tier-1 CAR was 10.0% under Basel III capital rules in Jun 2013). As such, its ROE remained weak at 6%-9% over the past few years.

The second generation of However, unlike WHB, the second generation of Wong family, Mr. Harold Wong is Wong family is keen to run running DSB. Under his management, DSB has successfully explored new fee DSB at present income opportunities, such as securities brokerage and corporate cash management fees. As such, its net fees contribution increased steadily from

16.6% of total income in 2011 to 17.9% in 2012 and further to 19.1% in 1H13. We

also forecast its ROE will recover gradually to 10%-12% during 2013-15. Hence, we see it to be less urgent for the Wong family to dispose of DSB compared with CHB and WHB.

BEA – Not an easy acquisition target BEA is less attractive to In the case of BEA, about 28.1% of its pre-tax profit was contributed by its China Chinese financial banking business in 1H13. We believe this may reduce the appetite of Chinese institutions on M&A play financial institutions towards BEA as there could be overlapping business between these institutions and BEA in China.

Still, we believe BEA may fit the appetite of non-bank China conglomerate and Singapore banks may need to raise new equity funding Singapore banks. In both cases, the extensive distribution network of BEA in Hong to finance acquisition Kong and China will allow the bidder to penetrate into the market rapidly. However, of BEA total assets of BEA (HKD697b in Jun 2013) were more than three times the size of WHB (HKD201b in Jun 2013). We estimate that the acquisition of BEA at a Jun 2013 P/B of 2.5x will lower the core tier-1 CAR of DBS, OCBC and UOB to be

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below 6%. Hence, these banks may need to raise new equity capital in order to acquire BEA. The three Singapore banks are trading at a 2013 P/E of 11-12x, based on the Bloomberg consensus forecast. Hence, we believe there will be EPS dilution to these banks if they raise new equity capital to acquire BEA at a Jun 2013 P/B of 2.5x (our forecast 2013 P/E for BEA is 12.8x at current share price).

Meanwhile, market believes that the Guoco group could be potential buyer of BEA We see it difficult for as it has gradually increased its stake in BEA from 5.02% in Jan 2009 to 15.02% Guoco group to engage in in Jun 2013. However, we see it difficult to engage in a hostile takeover bid on a hostile takeover bid on BEA. Firstly, BEA has allotted and issued 111.57m new shares to Sumitomo BEA as (i) BEA has no Mitsui Banking Corporation in Dec 2012. As a result, the core tier-1 CAR of BEA urgent need of equity capital replenishment; (ii) under the Basel III capital rules remained solid at 10.5% in Jun 2013. We the Li family and other therefore see no urgent need of equity capital replenishment for BEA in the near major shareholders of BEA term. hold about 40% stake in the bank; (iii) Caixabank has no After the share placement in Dec 2012, we estimate that the Li family, their friends urgent need to dispose of in the board (mainly local tycoons), Caixabank, SMBC and BOCHK together will its investment in BEA; and hold about 40% stake in BEA. Besides, Caixabank has signed a strategic (iv) the third generation of agreement of BEA in Jun 2009 that it will not dispose of a significant number of the Li family is keen to shares to a single place unless it is recommended by the Board of BEA. This run the bank should increase the difficulty of the Guoco group to acquire large stake in BEA without the agreement of the Li family and their friends.

Thirdly, the largest shareholder of BEA, Caixabank, has no urgent need to dispose of its investment in BEA as it reported a sharp rebound in net profit of 146% YoY to Euro 408m in 1H13 and solid core tier-1 CAR of 11.6% (under Basel 2.5 capital rules) in Jun 2013.

Finally, the third generation of the Li family (Mr. Adrian Li and Brian Li) has become deputy CEO of BEA. Based on recent media reports, both Adrian and Brian are keen to run the bank and aim at maximizing the shareholders’ value of BEA. Meanwhile, we believe the Guoco group, as second largest shareholder of

BEA, has indicated to the HKMA that it will remain as a passive investor of the

bank when it increased its shareholding of BEA to above 10% in Feb 2011. As such, none of the senior management of the Guoco group is in the board of BEA.

Acquisition price could be more than 2x of the book value

To set the potential acquisition price for Hong Kong small banks, we believe the potential bidders will take reference from the recent M&A deals of Hong Kong There were historic case banks. These include: (i) ICBC announced to privatise ICBC (Asia) at a Dec 2009 that China, Singapore and Malaysia banks were P/B of 2.14x in Aug 2010; and (ii) Fubon Financial announced to privatise Fubon willing to pay a P/B of more Bank (Hong Kong) at a Jun 2010 P/B of 1.42x in Jan 2011. This implies that China than 2x to acquire or banks are still able to and willing to pay a P/B of more than 2x on potential privatize Hong Kong acquisitions. Meanwhile, in May 2006, Public Bank announced to acquire 100% small banks stake in Asia Commercial Bank with a Jun 2005 P/B of 2.5x. Similarly, DBS acquired Dao Heng Bank at a Jun 2001 P/B of 3.07-3.17x in Apr 2011. These reflect that both Malaysia and Singapore banks may also be willing to pay a good premium in acquiring Hong Kong banks.

Figure 49: Historical acquisition price of Hong Kong banks Announcement Offer price date Acquirer Acquiree BVPS as of per BVPS Apr 01 DBS Dao Heng Bank Jun 01 3.07-3.17x Aug 03 Wing Hang Bank CKFB Dec 02 1.22x Feb 04 Fubon Financial IBA Jun 03 1.16x May 06 Public Bank Asia Commercial Bank Jun 05 2.5x Jan 08 CMB Wing Lung Bank Dec 07 2.91x Sep 08 Citic Group CIFH Jun 08 1.42x Aug 10 ICBC ICBC Asia Dec 09 2.14x Jan 11 Fubon Financial Fubon Bank HK Jun 10 1.42x Source: Company data, HKEx

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Banking Sector Report

Based on our channel checks, it is unlikely that the Liu family and the Fung family The Liu family and Fung will sell CHB and WHB, respectively, at a P/B of lower than 2x. Hence, we see it family will not sell their improbable to use the privatization price of Fubon deal as a reference to estimate banks at a P/B of below 2x the minimum acquisition price for small Hong Kong banks.

As aforesaid, the acquisition of CHB and WHB will not significantly undermine the We believe the potential capital strength of large Chinese, Singaporean and Malaysian banks. In other bidders may use long-term words, we see no need for these banks to raise new equity capital to facilitate the government bond yield as acquisition. Rather, they may use their cash on hand and/or dispose of some bond a reference to set the investment to pay for the acquisition. We therefore believe that the potential acquisition price bidders may use long-term government bond yield as a reference to set the

acquisition price of small Hong Kong banks. The current long-term (10-30 year) China, US, Singapore and Malaysia treasury-bond yield range from 2.3%-4.0%.

On the other hand, according to media reports, Yue Xiu Group may borrow Potential bidders may also issue long-term bonds to USD1b in loans (with funding cost of USD LIBOR + 300bps), equivalent to 3.4% to finance the acquisition finance the acquisition of 60% stake in CHB. We believe other potential bidders may also issue long-term bonds to finance the acquisition. The latest coupon rate of the issued by China, Singapore and Malaysia banks range from 3.5%-5%.

That said, we assume a funding cost of 3.15% (the average yield of government We assume a funding cost bonds in different regions) and 4.25% (the average coupon rate of subordinated of 3.15-4.25% to estimate debt of banks) for the potential bidders to finance their acquisition of small Hong the minimum and Kong banks. Based on the core ROE (excluding the revaluation surplus on maximum acquisition P/B investment properties and disposal gain on assets) of these banks in 1H13, we for banks estimate the minimum and maximum acquisition P/B for these banks such that the return on investment (ROI) of such acquisition equals the funding cost of the

potential bidders.

Figure 50: Estimation of potential acquisition price for small-to-medium sized Hong Kong banks CHB WHB DSB BEA Core ROE# in 1H13 (%) 7.4 8.5 11.3 9.9 BVPS in Jun 2013 (HKD) 17.12 66.39 12.68 26.71

ROI of buyer if acquisition P/B is (%): 1.5x 4.92 5.69 7.50 6.57 2.0x 3.69 4.27 5.63 4.93 2.5x 2.95 3.41 4.50 3.94 3.0x 2.46 2.84 3.75 3.29

Minimum acquisition P/B (x)* 1.74 2.01 2.65 2.32 Equivalent acquisition price (HKD) 29.74 133.32 33.58 61.96 Maximum acquisition P/B (x)^ 2.34 2.71 3.57 3.13 Equivalent acquisition price (HKD) 40.12 179.88 45.31 83.60 #Core ROE excludes revaluation surplus on investment properties and gain on disposal of assets *Minimum acquisition P/B refer to the P/B when ROI = 4.25% (maximum funding cost of bidders) ^Maximum acquisition P/B refer to the P/B when ROI=3.15% (minimum funding cost of bidders) Source: Company data, Maybank Kim Eng

We estimate the maximum Based on the core ROE of 7.4% of CHB for 1H13, we estimate that the potential acquisition P/B for CHB acquisition P/B should be 1.74-2.34x. This is equivalent to an acquisition price of and WHB could be HKD29.74-40.12 based on its BVPS at end-Jun 2013. Similarly, the core ROE of 2.3x and 2.7x WHB was 8.5% for 1H13. We estimate that the potential acquisition P/B for WHB should be 2.01-2.71x. This is equivalent to an acquisition price of HKD133.32- 179.88.

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Asset quality – Light shower on a sunny day

No clear evidence of over-lending

Growth in domestic loans In the wake of moderate economic recovery in the US and Europe and the was much faster than Hong liquidity tightening in China, Hong Kong banks saw a pick-up in loan growth in Kong nominal GDP growth 1H13. Growth in domestic loans accelerated from 7.2% YoY in 2012 to 14.8% in 1H13 YoY in 1H13 (or 10.2% HoH). This was much faster than Hong Kong’s nominal GDP growth of 4.1% YoY during 1H13. Offshore loans also grew robustly by

14.5% YoY (or 9.5% HoH) in 1H13. Key domestic loan growth drivers during

1H13 include manufacturing loans, wholesale and retail trade lending, syndicated

loans and trade finance. Key offshore loans were mainly cross-border China- related lending.

Figure 51: Loan growth by industry sectors

2008 2009 2010 2011 2012 1H13 Manufacturing 20.8 (13.7) 28.2 17.5 (5.4) 12.0 Transportation 7.5 (2.5) 11.1 14.6 12.3 3.7 Property-related 18.8 (0.0) 20.5 10.3 1.8 3.3 Wholesale & retail trade 30.9 (1.1) 52.5 36.7 12.7 10.4 Financial concerns 12.8 (34.3) 26.0 16.2 1.6 5.2 Other corporate loans 1.8 12.0 25.8 8.4 15.1 17.0 Residential mortgages 4.4 7.4 14.1 6.7 7.6 3.1 Other personal loans 2.5 (1.8) 15.2 14.3 14.5 5.3 Trade finance 1.7 (6.1) 56.7 26.9 10.1 48.1 Total domestic loans 10.3 (2.4) 23.3 13.8 7.2 14.8 Total offshore loans 14.1 11.6 50.3 41.6 16.2 14.5 Total loans 10.9 0.1 28.6 20.2 9.6 14.7 Loan-to-deposit ratio 54.2 51.5 61.6 66.9 67.1 71.9 Nominal GDP growth 3.4 (2.8) 7.1 9.0 5.5 4.1 Source: HKMA, Census and Statistics department We believe that there are market concerns over the latent systemic risk to the Market has concerns Hong Kong banking sector arising from rapid loan growth during 1H13. To assess whether banks have relaxed their risk whether banks have relaxed their risk management through price competition to management through price boost loan growth, we compare loan growth and gross loan yield of Hong Kong- competition to boot listed banks with market average during 1H13. Our analysis shows that both loan growth Chong Hing Bank (CHB) and BOC (Hong Kong) (BOCHK) reported lower than market average gross loan yield during 1H13. However, both banks also reported slower-than-market-average loan growth of 8.8% HoH and 6.7% HoH during 1H13. We believe both banks have relatively higher exposures to less risky loans (e.g. syndicated loans and residential mortgages) and hence, should have lower weighted average lending yield than peers.

Figure 52: Credit growth and average gross loan yield of Hong Kong-listed banks against market average Total credit growth in 1H13 minus industry average (X-axis) 0.80 DSB 0.60 WHB HSBC 0.40

HSB SCB 0.20 BEA -

BOCHK (0.20) CHB (0.40) (4.5) (4.0) (3.5) (3.0) (2.5) (2.0) (1.5) (1.0) (0.5) - Average gross lending yield in 1H13 minus industry average (Y-axis)

No evidence that Hong Source: Company data, Maybank Kim Eng Kong banks have relaxed their underwriting Overall, there is no clear evidence to suggest that Hong Kong-listed banks standards to boost relaxed their underwriting standards to boost their loan growth during 1H13. The loan growth situation was similar to that during 2010-11 when Hong Kong banks reported

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robust loan growth of over 20% p.a. In spite of the strong loan growth, the Hong Kong-listed banks did not report a drastic increase in NPLs and credit cost during 2011-12. Meanwhile, most Hong Kong-listed banks indicate that they will maintain a cautious attitude towards loan growth, in particular for manufacturing loans and property lending in Eastern China, in 2H13. That said, we believe the chance of rapid loan growth leading to a surge in latent should be lower in this business cycle compared with that during 1996-97.

Figure 53: NPL amount, NPL ratio and credit cost of Hong Kong-listed banks during 2011-1H13 NPL amount - Total loans (HKDm) NPL ratio - Total loans (%) Credit cost (%)

Dec-11 Jun-12 Dec-12 Jun-13 Dec-11 Jun-12 Dec-12 Jun-13 1H12 2H12 2012 1H13 BEA 1,475 1,398 1,138 1,445 0.46 0.37 0.32 0.38 0.08 0.05 0.06 0.10 BOCHK 710 749 2,054 2,120 0.10 0.10 0.26 0.26 0.02 0.20 0.12 0.09 CHB 78 28 24 32 0.19 0.07 0.06 0.08 (0.17) (0.15) (0.16) 0.09 DSB 386 385 283 359 0.48 0.47 0.33 0.38 0.07 0.12 0.10 0.31 HSB 1,584 1,568 1,190 1,131 0.33 0.31 0.22 0.19 0.10 0.05 0.08 0.07 HSBC* 41,739 40,744 38,671 38,120 4.36 4.11 3.81 3.87 0.93 0.68 0.83 0.64 SCB* 4,183 5,154 5,538 5,753 1.61 1.85 1.94 1.97 0.42 0.45 0.43 0.51 WHB 336 237 512 444 0.30 0.22 0.45 0.36 0.08 0.34 0.21 0.07 Figures are denominated in USDm. Source: Company data

On the other hand, we believe market may also have concern over the increase Total debt leverage ratio in household and corporate debt leverage ratio over the past few years. Total rose to 305% in 1H13 debt leverage ratio in Hong Kong (total loans as a percent of nominal GDP) has increased steadily from 234% in 2010 to 273% in 2012 and further to an annualised of 305% in 1H13. The current debt leverage ratio is even higher than the historical peak of 302% in 1997.

However, as a key international financial centre, it is reasonable for Hong Kong to record a higher debt leverage ratio than other regions. Indeed, offshore loans in This is a normal case for Hong Kong accounted for 28% of the total loans in Jun 2013 (28.6% in Aug 2013). international financial The situation in Hong Kong is very similar to that in Singapore, which has a well- centre established Asian currency financial centre (especially for Asian dollar). Including

both, the domestic banking unit and Asian currency unit, the debt leverage ratio of Singapore has also reached 254% in 2012.

Meanwhile, total savings of households and companies in Hong Kong have also Total deposits also accounted for 363% of increased substantially over the past 15 years. Even excluding the monetary Hong Kong’s nominal base (i.e. the printing of new money and foreign capital inflow to Hong Kong), GDP in 1H13 total deposits accounted for an annualised 363% of Hong Kong’s nominal GDP in 1H13. This is significantly higher than the level of 184% in 1997. As such, the loan-to-deposit ratio remained healthy at 72% in Jun 2013 (72.3% in Aug 2013) compared with 152% in Dec 1997.

Figure 54: Total loans, total adjusted deposits* as a % of nominal GDP and loan-to- deposit ratio of Hong Kong banks (1993-2013) Total loan as % of nominal GDP % Total adjusted deposits as % of nominal GDP Loan-to-deposit ratio 400 350 300 250 200 150 100 50 0 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 1H13

*Total adjusted deposits have excluded the monetary base Source: HKMA, Census and Statistics Department

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All told, we believe the ongoing low interest rate environment has prompted The high debt coverage households and companies in Hong Kong to increase their leverage in recent ratio should be well- years. Still, this should be well-cushioned by their accumulated wealth over the cushioned by accumulated past 15 years. In other words, we believe that Hong Kong households and wealth in Hong Kong companies should have a stronger financial position to absorb economic shocks currently compared with that in 1997-98.

Other key economic indicators remained healthy

Apart from the strong accumulation of personal and corporate savings over the past decade, other key economic indicators also show that Hong Kong is unlikely to fall into a financial crisis similar to that which happened in late 1997.

Firstly, immediately after the Asian financial crisis in 1997, Hong Kong has Hong Kong will report consistently returned to current account surplus. This could be related to current account surplus increasing integration between Hong Kong and China economy. Hong Kong during 2013-14 reported current account deficit, ranging from 0.8%-6.2% of its real GDP during 1994-97. According to the estimation of IMF, Hong Kong will report current account surplus equivalent to 2.0%-2.5% of its real GDP during 2013-14.

Figure 55: Current account balance as % of real GDP (1993-2014F) % of GDP 15

10

5

0

(5)

(10) 1993 1996 1999 2002 2005 2008 2011 2014F

Source: IMF

Secondly, despite that Hong Kong banks reported strong loan growth over the past few years, the rise in property price was far higher than the credit growth. The loan-to-value ratio of According to IMF, the growth in real household debt in Hong Kong was 31.3% new mortgages remained during 2007-12. The change in real property prices was higher at 60.6% over the low at below 56% during same period. This was in line with the gradual reduction in loan-to-value ratio in Jan-Aug 2013 new mortgages over the past few years, implying that Hong Kong banks have been cautious to avoid the creation of credit bubble in the property market. The loan-to-value ratio of new mortgages remained low at below 56% during Jan-Aug 2013. We believe the rise in property prices in Hong Kong in recent years was partly driven by the increase in personal wealth of Hong Kong and mainland households.

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Figure 56: Average loan-to-value ratio of new mortgages (2Q98-2Q13) % 70 68 66 64 62 60 58 56 54 52 50 2Q98 4Q99 2Q01 4Q02 2Q04 4Q05 2Q07 4Q08 2Q10 4Q11 2Q13

Source: HKMA

External liabilities of Hong Thirdly, the external liabilities of Hong Kong in recent years remained lower than Kong has reduced to 148- the level during the 1990’s. Total external liabilities of Hong Kong toward BIS 189% during 2009-12 banks amounted to 148-189% of its nominal GDP during 2009-12, compared with the level of over 290% during 1993-96. It is reasonable for Hong Kong to have its external liabilities to nominal GDP ratio of over 100% as it is one of the key international financial centres in Hong Kong. Indeed, the ratio of external liabilities

to external assets towards BIS banks in Hong Kong was only 0.61-0.95 during

2009-12, implying that the external liabilities in Hong Kong was more than offset

by its external assets. The ratio was also much lower than the level of 1.43-1.65 during 1993-97.

Finally, among the external liabilities, short-term liabilities towards BIS banks only Short-term external liabilities of Hong Kong accounted for 33%-38% of total external liabilities during 2010-12. This was much was well-covered by its lower than the level of 82% in 1996, implying limited maturity mismatch for the foreign reserve external liabilities in Hong Kong. Furthermore, the short-term external liabilities was well-covered by the foreign reserves in Hong Kong. These liabilities accounted for 52.2%-61.5% of Hong Kong’s foreign reserves during 2010-12

Figure 57: Short-term liabilities towards BIS banks as % of foreign reserve (HK) 90 80

70 60 50

40 30 20

10

0 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Source: BIS, Bloomberg (1996-2012)

Strong loan growth has not Overall, the recent economic indicators demonstrate that the strong loan growth resulted in the creation of of Hong Kong banks in recent years has not resulted in the creation of credit credit bubble in Hong Kong bubble in Hong Kong. The massive accumulation of household and corporate wealth over the past decade should help prevent the emergence of substantial credit default in Hong Kong. Moreover, the strong foreign reserves in Hong Kong should help Hong Kong banks weather from any potential default in external liabilities.

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Moderate rise in total NPLs in 1H13 With the exception of HSB, HSBC and WHB, all the Hong Kong-listed banks Most Hong Kong-listed reported a slight rise in total NPLs in Jun 2013 compared with Dec 2012. Among banks saw a slight rise in them, BEA, BOCHK and DSB saw a rise in China-related NPLs during 1H13. This total NPLs in 1H13 was mainly related to a few export-oriented manufacturers located in Eastern and Southern China who faced short-term financial difficulties. We believe the tightening liquidity and economic slowdown (especially for external trade activities) in China has led to a weakening in asset quality of China loans during 1H13.

Figure 58: Total and China NPL amount and NPL ratio of Hong Kong-listed banks NPL amount - China loans (HKDm) HoH % change NPL ratio - China loans (%)

Dec-11 Jun-12 Dec-12 Jun-13 1H12 2H12 1H13 Dec-11 Jun-12 Dec-12 Jun-13 BEA 216 315 453 706 45.8 43.8 55.8 0.16 0.22 0.30 0.40 BOCHK 79 174 385 441 120.3 121.3 14.5 0.07 0.12 0.28 0.32 CHB 3 2 2 2 (11.7) (2.9) 0.0 0.43 0.56 0.28 0.69 DSB 152 150 153 187 (1.6) 1.9 22.3 2.20 1.64 1.24 1.29 HSB# NA NA 196 193 NA NA (1.7) NA NA 0.38 0.32 HSBC* 58 NA 127 NA NA NA NA 0.05 NA 0.10 NA SCB@ 333 NA 452 NA NA NA NA 0.38 NA 0.48 NA WHB 26 100 209 138 289.0 109.3 (33.9) 0.19 0.82 1.71 1.14 China 4,000 5,800 5,400 6,300 45.0 (6.9) 16.7 0.40 0.58 0.52 0.60 *Figures refer to HSBC (China) and denominated in CNYm #Figures refer to Hang Seng Bank (China) @Figures refer to Standard Chartered Bank (China) and denominated in CNYm Source: Company data BEA, CHB, DSB and WHB Similarly, BEA, CHB, DSB and WHB reported a slight rise in NPLs of domestic reported a slight rise in loans. This was associated with export-oriented manufacturing loans, property NPLs in domestic loans investment lending and slight rise in delinquency ratio of credit card advances. The slowdown in real GDP growth, slight rise in unemployment rate and the moderation in external trade activities have prompted the rise in NPLs of domestic loans of these banks.

Figure 59: Domestic NPL amount and NPL ratio of Hong Kong-listed banks NPL amount - HK loans (HKDm) % Change NPL ratio - HK loans (%)

Dec-11 Jun-12 Dec-12 Jun-13 1H12 2H12 1H13 Dec-11 Jun-12 Dec-12 Jun-13 BEA 558 457 338 379 (18.1) (26.0) 12.1 0.37 0.30 0.21 0.23 BOCHK 574 539 1,631 1,546 (6.1) 202.6 (5.2) 0.10 0.09 0.27 0.24 CHB 75 26 22 30 (65.6) (15.7) 36.6 0.19 0.07 0.06 0.07 DSB 195 188 101 142 (3.3) (46.4) 40.9 0.24 0.29 0.16 0.21 HSB 1,315 1,292 948 886 (1.7) (26.6) (6.5) 0.32 0.30 0.21 0.19 HSBC* 604 555 477 446 (8.1) (14.1) (6.5) 0.38 0.33 0.27 0.23 SCB* 131 132 188 186 0.8 42.4 (1.1) 0.26 0.25 0.36 0.33 WHB 282 110 273 274 (61.0) 147.6 0.5 0.34 0.13 0.32 0.30 *Figures are denominated in USDm Source: Company data Meanwhile, the rise in total NPLs of SCB during 1H13 mainly reflected the shift in Both SCB and HSBC saw mix towards unsecured lending and the impact of the Personal Debt slight rise in NPLs in Rehabilitation Scheme regulation in Korea. Besides, there were new NPLs different regions associated with a small number of wholesale banking exposures in India and

Africa. On the contrary, HSBC continued to benefit from the improvement in asset

quality in North America in 1H13. However, this was offset by new NPLs for a

small number of commercial banking customers in the UK and Spain, top up provisions for some restructured loans in Brazil and the exposures to homebuilders in Mexico.

The NPLs level in Jun 2013 Despite that, some Hong Kong–listed banks reported a rise in total NPLs during remained lower than that 1H13. The amount of NPLs of most banks in Jun 2013 remained similar or lower in Dec 2011 or Jun 2012 than the level in Dec 2011 or Jun 2012. Among them, only BOCHK reported a sharp rise in NPLs from below HKD750m during Dec 2011-Jun 2012 to over HKD2b during Dec 2012-Jun 2013. This was mainly related to the default in loan repayment of one shipping company in Hong Kong and a photovoltaic company in

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China. As a result, with the exception of BOCHK, we saw a stable-to-declining collective loan impairment allowance ratio for the Hong Kong-listed banks during 1H13. The collective loan impairment allowance ratio of BOCHK increased slightly from 0.36% in Jun 2012 to 0.38% and 0.42% in Dec 2012 and Jun 2013, respectively.

Stable-to-declining credit cost in 2H13-2014

According to Bloomberg consensus forecasts, the real GDP growth in Hong Kong Economic conditions in will pick up gradually from 1.5% in 2012 to 3.0%-3.5% during 2013-14. Market also both Hong Kong and expects limited moderation in the real GDP growth of China (from 7.7% in 2012 to China should remain 7.45%-7.5% during 2013-14). Similarly, the unemployment rate and short-term stable in 2014 interest rates for both Hong Kong and China are expected to remain rather stable during 2013-14, based on Bloomberg consensus forecasts. However, with various

tightening measures on property market, we expect stable-to-slight-declining

property price in both Hong Kong and China during 2013-14.

In view of the rise in HKD loan-to-deposit ratio in recent months (79.6% in Aug 2013), we expect Hong Kong banks to moderate their loan growth in 2H13. We forecast loan growth Besides, the increase in China-related NPLs may prompt Hong Kong banks to of Hong Kong-listed banks to be 7-11% YoY become more selective in granting new China loans. Some banks may shift from in 2014 manufacturing loans and property lending towards less risky cross-border trade finance and bill discounting business. Besides, they will continue to request high collateral coverage for these loans. Overall, we forecast loan growth of Hong Kong-listed banks to be 6%-12% YoY in 2013 (+3%-10% HoH in 1H13). We expect loan growth of these banks will remain rather stable in 2014. Key loan growth drivers include residential mortgages, property development lending and syndicated loans (both infrastructure loans and corporte working capital loans) and cross-border trade finance.

With the gradual recovery in global economy, we expect asset quality of Hong We forecast credit cost of Kong-listed banks to remain stable or improve slightly in 2H13-2014. Nonetheless, banks will remain stable we believe banks will maintain their collective loan impairment allowance ratio or reduce slightly given that there could be further consolidation in the Hong Kong property market. in 2H13-2014 Still, with limited new NPL formation, we forecast credit cost of the Hong Kong- listed banks will remain stable or reduce slightly in 2H13-2014 compared with the level in 1H13.

Figure 60: Forecast credit cost of Hong Kong-listed banks Credit cost (%)

1H12 2H12 2012 1H13 2013E 2014E BEA 0.08 0.05 0.06 0.10 0.10 0.10 BOCHK 0.02 0.20 0.12 0.09 0.10 0.08 CHB (0.17) (0.15) (0.16) 0.09 0.09 0.07 DSB 0.07 0.12 0.10 0.31 0.28 0.22 HSB 0.10 0.05 0.08 0.07 0.07 0.07 HSBC 0.93 0.68 0.83 0.64 0.62 0.57 SCB 0.42 0.45 0.43 0.51 0.51 0.47 WHB 0.08 0.34 0.21 0.07 0.07 0.06 Source: Company data, Maybank Kim Eng

Scenario analysis

HKMA concluded that The Hong Kong Monetary Authority (HKMA) has conducted macro stress testing of Hong Kong banks should the credit risk of Hong Kong retail banks. The macro stress testing simulated future be able to withstand credit loss rate of retail banks in 2Q15 under four specific macroeconomic shocks, macroeconomic shocks namely, Hong Kong GDP, property price, interest rate and China GDP. Based on similar to those in 1997 the macro stress testing conducted in Sep 2013, the HKMA concluded that the

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Hong Kong banking sector should be able to withstand rather severe macroeconomic shocks, similar to those experienced during the Asian financial crisis in 1997.

Figure 61: The macro stress testing on credit cost of Hong Kong retail banks

Mean to 99.9th percentile 1.8 1.6 1.55 1.4 1.29 1.2 1.0 0.92 0.8 0.61 0.65 0.6 0.4 0.51 0.40 0.2 0.17 0.18 0.25

portfolio the % asa loan of loss Credit 0.0 Baseline scenario Stressed scenarios: 2) Property price 3) Interest rate 4) Mainland GDP 1) HK GDP shock shock shock shock

* HK GDP shock: Reductions in HK real GDP by 2.3%, 2.8%, 1.6% and 1.5% respectively in each of the four consecutive quarters starting from 3Q13 Property price shock: Reductions in HK real property price by 4.4%, 14.5%, 10.8% and 16.9% respectively in each of the four consecutive quarters starting 3Q13 Interest rate shock: A rise in real interest rates (HIBORs) by 200bps in 3Q13, followed by no change in 4Q13-1Q14 and another rise of 300bps in 2Q14 China GDP shock: Slowdown in YoY real GDP growth to 4% during 3Q13-2Q14 Source: HKMA

Asset quality of Hong Kong According to the macro stress testing, the expected average credit cost for Hong banks will likely to suffer Kong retail banks under different macroeconomic shocks (during 2H13-1H14) are the most from a decline in estimated to be moderate, ranging from 0.18% (interest rate shock) to 0.51% Hong Kong GDP and (Hong Kong GDP shock) in 2Q15. Asset quality of Hong Kong banks is likely to significant fall in suffer the most from a decline in Hong Kong GDP and significant fall in property property price price but will be least affected by sharp rise in HIBOR. The banks’ maximum credit cost (at the confidence level of 99.9%) under the stress scenarios will range from 0.65% (interest rate shock) to 1.55% (Hong Kong GDP shock) in 2Q15. This will remain lower than the credit cost of 4.39% for Hong Kong banks after the Asian financial crisis in 1998.

Figure 62: Forecast credit cost of Hong Kong-listed banks under the macro stress testing Credit cost under base 2014F credit cost Impact on 2014F pre-tax profit case (%) under the scenario of: under the scenario of: HKGDP Property Interest China GDP HK GDP Property Interest China

2012 2013F 2014F shock* price shock* rate shock* shock* shock* price shock* rate shock* GDP shock* BEA 0.06 0.10 0.10 0.30 0.23 0.10 0.15 (10.3) (7.0) (0.3) (2.4) BOCHK 0.12 0.10 0.08 0.25 0.19 0.09 0.12 (4.9) (3.3) (0.1) (1.2) CHB (0.16) 0.09 0.07 0.21 0.17 0.07 0.10 (10.3) (7.0) (0.3) (2.4) DSB 0.10 0.28 0.22 0.66 0.51 0.23 0.32 (20.3) (13.8) (0.6) (4.8) HSB 0.08 0.07 0.07 0.22 0.17 0.08 0.11 (4.6) (3.1) (0.1) (1.1) HSBC# 0.83 0.62 0.57 0.59 0.59 0.58 0.58 (1.0) (0.8) (0.3) (0.5) SCB# 0.43 0.51 0.47 0.62 0.59 0.52 0.54 (5.8) (4.6) (2.1) (2.9) WHB 0.21 0.07 0.06 0.18 0.14 0.06 0.09 (6.6) (4.5) (0.2) (1.6) #Scenario analysis on Hong Kong operation only * HK GDP shock: Reductions in HK real GDP by 2.3%, 2.8%, 1.6% and 1.5% respectively in each of the four consecutive quarters starting from 3Q13 Property price shock: Reductions in HK real property price by 4.4%, 14.5%, 10.8% and 16.9% respectively in each of the four consecutive quarters starting 3Q13 Interest rate shock: A rise in real interest rates (HIBORs) by 200bps in 3Q13, followed by no change in 4Q13-1Q14 and another rise of 300bps in 2Q14 China GDP shock: Slowdown in YoY real GDP growth to 4% during 3Q13-2Q14 Source: HKMA, Company data, Maybank Kim Eng Based on this stress testing results, we estimate the FY14 credit cost of Hong Kong-listed banks under different macroeconomic shocks. Both CHB and DSB will suffer more than peers under these shocks, according to our estimation. In the case of DSB, we believe this was due to its higher credit cost than peers in FY14.

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Meanwhile, CHB has lower NIM and net fees contribution than peers. Hence, it should suffer more than peers if there is a sharp rise in its credit cost.

The risk of contagion in the The HKMA also estimated “the banking distress index” in Hong Kong in Sep 2013. Hong Kong banking This is a market-based systemic risk indicator for the local banking sector. The system remains latest index suggests that the risk of contagion in the Hong Kong banking system insignificant remains insignificant and the probability of an occurrence of multiple bank defaults is small.

We estimate that for every Finally, we conducted a sensitivity analysis to estimate the impact of an increase in 10% increase in the collective loan impairment allowances (i.e. a weakening in macro-economic and collective loan impairment operating environment of banks) on the credit cost and pre-tax profit of Hong Kong- allowances, Hong Kong- listed banks. Based on our analysis, we estimate that for every 10% increase in the listed banks’ credit cost collective loan impairment allowances of Hong Kong-listed banks, their credit cost will be increased by 1-9bps will increase by 1-9bps. This will lower our forecast FY14 pre-tax profit of these banks by 1%-3%. Among these banks, we expect both CHB and HSBC will be most affected given that they have a higher collective loan impairment allowance ratio than peers.

Figure 63: Sensitivity analysis of the impact of an increase in collective loan impairment allowances on the credit cost and pre-tax profit of Hong Kong-listed banks For every 10% increase in Collective loan impairment allowance ratio collective impairment allowances Impact on credit Impact on 2014E (%) 2008 2009 2010 2011 Jun-12 Dec-12 Jun-13 cost (bps) pre-tax profit (%) BEA 0.23 0.33 0.28 0.24 0.21 0.19 0.18 2 (0.9) BOCHK 0.33 0.31 0.32 0.37 0.36 0.38 0.40 4 (1.1) CHB 0.34 0.33 0.33 0.42 0.42 0.42 0.42 4 (2.9) DSB 0.49 0.63 0.42 0.23 0.22 0.20 0.20 2 (0.9) HSB 0.24 0.23 0.15 0.16 0.14 0.13 0.12 1 (0.4) HSBC 2.16 2.07 1.39 1.15 1.06 0.82 0.89 9 (3.3) SCB 0.36 0.43 0.31 0.28 0.25 0.25 0.25 2 (0.9) WHB 0.24 0.20 0.16 0.12 0.11 0.22 0.18 2 (0.9) Source: Company data, Maybank Kim Eng

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Valuation and Recommendations

Market preferred small banks in recent months

Share price of Hong Kong banking sector have performed largely in line with the Share price of small Hong MSCI Hong Kong index since the beginning of 2013. However, share price of Kong banks outperformed large-to-medium sized banks have underperformed the market since Sep 2013 large-to-medium sized whilst the small banks have outperformed the market most of the time YTD. The banks YTD recent poor share price performance of HSBC and SCB was partly due to market concern over negative impact of potential QE tapering on global economic

recovery and the weakening in financial position of some Asian economies, such

as India and Indonesia. In addition, both HSBC and SCB posted weaker-than- expected 1H13 results, with NIM pressure and weakening in asset quality.

On the other hand, due to management guidance of a gradual recovery in Share price performance of BOCHK was negatively earnings in 1H13 and the release of better-than-expected 1Q13 operating data, affected by the news of share price of BOCHK outperformed the market in 1H13. However, the lower- opening Shanghai FTZ than-expected core tie-1 CAR in Jun 2013 and the concern over negative impact on offshore RMB business after the opening of Shanghai FTZ have prompted an underperformance of its share price in recent weeks.

Share price performance Finally, the strong share price performance of small Hong Kong banks was partly of small banks was driven by market belief of strong earnings recovery of these banks for 2013. boosted by announcement Besides, the announcement that major shareholders of CHB and WHB have of possible acquisition of been approached by independent third parties in relation to possible acquisition CHB and WHB of interests in the bank in Aug 2013 and Sep 2013 has triggered a sharp rise in their share price. This has some ripple effects to the share price performance of DSB (and hence, its parent DSF) and to a smaller extent to BEA.

Figure 64: Relative performance of HSBC and SCB against Figure 65: Relative performance of HSB, BOCHK and BEA MSCI HK index against MSCI HK index

MSCI HK Index HSBC + Stanchart MSCI HK Index Hang Seng + BEA + BOCHK 110 115

110 105 105 100 100 95 95

90 90 Jan 13 Feb 13 Mar 13 Apr 13 May 13 Jun 13 Jul 13 Aug 13 Sep 13 Oct 13 Jan 13 Feb 13 Mar 13 Apr 13 May 13 Jun 13 Jul 13 Aug 13 Sep 13 Oct 13 Source: Bloomberg Source: Bloomberg

Figure 66: Relative performance of CHB, DSB, DSF and Figure 67: Relative performance of all Hong Kong banks WHB against MSCI HK index against MSCI HK index

MSCI HK Index MSCI HK Index HK banks Wing Hang + Chong Hing + Dahsing + Dah Sing Financial 115 165 110 155 145 105 135

125 100 115 105 95 95 85 90 Jan 13 Feb 13 Mar 13 Apr 13 May 13 Jun 13 Jul 13 Aug 13 Sep 13 Oct 13 Jan 13 Feb 13 Mar 13 Apr 13 May 13 Jun 13 Jul 13 Aug 13 Sep 13 Oct 13 Source: Bloomberg Source: Bloomberg

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Our 2014 earnings forecast is quite in line with consensus

With the exception of SCB and WHB, the Hong Kong-listed banks reported a Core net profit of most healthy growth in core net profit of over 7% YoY in 1H13. This was mainly driven Hong Kong-listed banks by strong loan growth, NIM widening for small banks and a recovery in net fees grew over 7% YoY in 1H13 growth. SCB suffered from NIM narrowing (due to decline in deposit spread and trade margin) across most regions and the goodwill write-offs of its Korean business (USD1b). WHB’s poor 1H13 result was mainly driven by lower trading

profit of its Treasury business.

For the year 2013 as a whole, we forecast core net profit of most Hong Kong- We forecast core net listed banks will grow more than 10% YoY. However, we expect CHB, HSB, SCB profit of most banks will and WHB to report a decline in core net profit for 2013. With limited recovery of grow more than 10% YoY for 2013 NPLs, we expect CHB will reverse from a net write-back in loan impairment allowances (HKD65m) to a small loan impairment charge of HKD37m in 2013. In the case of HSB, due to the change in account booking of its investment in Industrial Bank (with HSB’s shareholding being diluted from 12.8% in Dec 2012 to 10.9% in Jan 2013) from associated company to available-for-securities, we expect this will lower its 2013 net profit by about HKD5b (equivalent to 28.4% of our forecast core net profit of HSB for 2013).

Figure 68: Forecast core net profit growth of Hong Kong-listed banks in 2013-14F Reported Net profit (HKD m) YoY % change Core net profit* (HKD m) YoY % change Core net profit (HKD m) 2012 2013F 2014F 2013F 2014F 2012 2013F 2014F 2013F 2014F 1H12 1H13 % change BEA 5,725 5,731 5,960 0.1 4.0 4,965 5,480 5,961 10.4 8.8 2,452 2,897 18.1 BOCHK 20,930 22,446 25,274 7.2 12.6 19,264 22,279 25,107 15.7 12.7 10,286 11,079 7.7 CHB 543 490 526 (9.8) 7.4 534 487 523 (8.8) 7.4 254 274 7.8 DSB 1,411 1,651 1,910 17.0 15.7 1,346 1,718 1,910 27.6 11.2 616 864 40.2 DSF 1,236 1,301 1,449 5.3 11.3 1,127 1,338 1,449 18.8 8.3 624 717 14.9 HSB# 19,327 25,622 16,426 32.6 (35.9) 18,387 17,584 16,426 (4.4) (6.6) 9,054 10,430 15.2 HSBC# 13,454 16,935 18,869 25.9 11.4 9,702 16,635 18,869 71.5 13.4 6,672 9,809 47.0 SCB 4,786 4,646 5,702 (2.9) 22.7 4,592 4,442 5,702 (3.3) 28.4 2,730 1,919 (29.7) WHB 1,802 1,924 1,969 6.8 2.3 1,804 1,723 1,969 (4.5) 14.3 936 807 (13.8) *Core net profit excludes the valuation change on own debt liabilities, currency effect, revaluation surplus on investment properties and disposal gain on assets #Figures denominated in USD m Source: Company data, Maybank Kim Eng

We forecast core net With the exception of HSB, we forecast core net profit of most Hong Kong-listed profit of most Hong Kong- banks to grow 7%-14% YoY in 2014. Key earnings drivers will include: (i) healthy listed banks to grow 7- loan growth of 8%-11% YoY (mainly residential mortgages, infrastructure loans, 28% YoY in 2014 property development lending and cross-border China loans); (ii) stable NIM and asset quality; and (iii) potential increase in profit contribution from offshore RMB business.

Core earnings growth of We forecast strong core earnings growth of 13.4% YoY and 28.4% YoY for HSBC and SCB will be HSBC and SCB for 2014, respectively. We believe HSBC will benefit from stronger than peers due additional cost savings from its group restructuring program and lower credit cost to low base for and regulatory cost. Meanwhile, the non-recurrence of the goodwill write-off for comparison the Korean business (USD1b; equivalent to 17.5% of our forecast 2014 core net profit) should help boost SCB’s earnings in 2014.

On the other hand, our net profit forecasts for BOCHK and DSB for 2014 are well Our net profit forecast of above than the Bloomberg consensus. We believe the market is too bearish to BOCHK and DSB for 2014 are well above the the impact of the opening of Shanghai FTZ on the offshore RMB business in Bloomberg consensus Hong Kong. Hence, it has turned more conservative to the earnings forecast of BOCHK given it has the highest market share of RMB deposits in Hong Kong (25% in Jun 2013). However, we believe market has concern over potential increase in short-term USD (and hence HKD) interest rates after the termination of QE3. This will hit the NIM of DSB given that three quarter of its deposits are HIBOR-based. Market may also have concern over weakening in asset quality of DSB given its strong China loan growth of 18% HoH during 1H13.

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Figure 69: Kim Eng forecasts vs. Bloomberg consensus forecasts on Hong Kong-listed banks Kim Eng net Bloomberg Kim Eng EPS Bloomberg profit forecasts consensus net profit forecasts consensus EPS Bloomberg stock-rating Kim (HKD b) forecasts (HKD b) (HKD ) forecasts (HKD) (Number of) Eng Target price (HKD) Bloomberg 2013F 2014F 2013F 2014F 2013F 2014F 2013F 2014F BUY NEUTRAL SELL rating average Kim Eng BEA 5.73 5.96 5.60 5.82 2.57 2.68 2.49 2.56 2 16 7 H 31.04 32.30 BOCHK 22.45 25.27 21.75 23.43 2.12 2.39 2.07 2.22 19 8 1 B 29.16 29.30 CHB 0.49 0.53 0.51 0.52 1.13 1.21 1.17 1.20 1 1 1 B 25.70 38.35 DSB 1.65 1.91 1.63 1.68 1.35 1.56 1.32 1.36 11 5 - B 13.74 17.20 DSF 1.30 1.45 1.29 1.36 4.44 4.95 4.42 4.65 12 4 1 H 45.66 52.55 HSB 25.62 16.43 21.45 16.86 13.40 8.59 11.70 8.80 4 15 6 S 120.45 107.25 HSBC* 23.80 26.67 25.50 27.55 0.92 1.02 0.96 1.04 26 16 5 H 94.21 88.30 SCB* 6.93 8.34 7.53 8.49 1.93 2.36 2.24 2.45 18 17 6 H 206.55 189.00 WHB 1.92 1.97 1.88 1.97 6.07 6.52 6.28 6.47 7 11 3 B 105.77 156.60 *EPS are denominated in USD; pre-tax profit forecasts are used to replace net profit forecasts and are denominated in USD b Source: Bloomberg, Maybank Kim Eng

Meanwhile, our net profit forecast for HSB and pre-tax profit forecast for HSBC Our net profit of HSB and for 2014 are slightly lower than the Bloomberg consensus. We believe HSB may pre-tax profit forecast of need to spend more on organic China expansion given the sharp decline in profit HSBC for 2014 are slightly contribution from Industrial Bank under the new account booking. In the case of below Bloomberg HSBC, we have conservatively assumed that it may still need to pay US$0.5b for consensus the settlement of some of its outstanding legal proceedings, investigations and other regulatory matters in the US and Europe in 2014.

Initiate Hong Kong banking sector with NEUTRAL rating

We have adopted the Gordon growth model, which captures the long-term growth potential of banks, to estimate the fair value of most Hong Kong-listed (with the We have adopted the exception of CHB and WHB). This is based on the long-term sustainable ROE Gordon Growth Model to and dividend payout assumptions, which are consistent with our earnings estimate the fair value of forecasts for each bank. We have also compared the fair-value derived from the most Hong Kong-listed model with each bank’s own historic ROE, P/E and P/B bands (during 2002-12) banks to check whether the target price is at reasonable trading range of each bank. As

both CHB and WHB have been approached by independent third parties on potential acquisition of interests in the bank, we estimate the potential acquisition as their fair value.

We forecast the ROE of With the exception of BOCHK and DSB, we forecast the ROE of Hong Kong- most Hong Kong-listed listed banks in 2014 will be close to or below their historic average ROE. We banks in 2014 will be expect the 2014 ROE of HSB and WHB will even be below the historic trough close to or below their ROE. As aforesaid, we believe HSB will suffer from the reduction in profit historic average ROE contribution from Industrial Bank after the change in account booking. WHB, on the other hand, have seen heavy NIM pressure and slower net fees income under rising market competition, in recent years.

Figure 70: Current valuation vs. historic valuation of Hong Kong-listed banks Share 2002-2012 Projected price P/E (x) P/B (x) ROE (%) 2013E 2014E long-term 16-Oct-13 Max Avg Min Max Avg Min Max Avg Min PER (x) P/B (x) ROE (%) PER (x) P/B (x) ROE (%) ROE (%) BEA 32.95 1,222.6 22.1 10.8 3.06 1.56 0.63 14.4 9.6 0.1 12.8 1.20 9.7 12.3 1.12 9.4 10.0 BOCHK 25.10 28.0 14.4 7.9 2.75 1.96 0.77 18.6 14.8 3.8 11.8 1.67 14.5 10.5 1.59 15.5 16.3 CHB 34.15 68.3 18.2 8.9 1.69 0.97 0.49 8.5 6.3 1.0 30.3 1.94 6.5 28.2 1.86 6.7 7.5 DSB 14.16 31.1 14.9 6.5 2.02 1.21 0.39 13.3 8.5 2.2 10.5 1.07 10.3 9.1 0.99 11.1 11.5 DSF 47.60 51.5 13.9 5.5 2.27 1.28 0.34 27.0 11.2 1.0 10.7 0.86 8.2 9.6 0.80 8.6 9.0 HSB 128.30 21.5 15.8 9.2 5.83 3.93 2.09 35.3 25.4 22.4 9.6 2.28 25.6 14.9 2.15 14.8 16.0 HSBC 84.90 36.1 16.1 8.0 2.45 1.66 0.51 19.3 12.0 5.0 11.9 1.10 9.4 10.7 1.06 10.1 11.5 SCB 182.70 20.2 14.2 4.6 3.41 2.22 0.78 19.0 14.4 11.1 12.2 1.18 10.0 9.9 1.11 11.5 11.8 WHB 113.10 21.2 13.6 7.7 3.37 1.86 0.90 20.5 14.0 9.8 18.6 1.66 9.6 17.4 1.57 9.3 9.5 Source: Bloomberg, Maybank Kim Eng On the other hand, we forecast the 2014 ROE of BOCHK and DSB will rebound to well above their historic average level during 2002-12. We believe both banks will benefit from stable NIM and asset quality, strong net fees growth and tight

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cost control in 2014. We also expect BOCHK to see increasing profit contribution from offshore RMB business in Hong Kong.

We initiate the coverage of In line with our forecast ROE, the 2014 P/B of most banks, at current share price, Hong Kong banking sector is also below their historic average value. We therefore initiate the coverage of with a NEUTRAL rating but Hong Kong banking sector with a NEUTRAL rating with a slight upward bias. We a slight upward bias see potential earnings upgrade of Hong Kong-listed banks in 2014 from a slight lengthening in their HKD and USD and the continued expansion of offshore RMB business in Hong Kong. Besides, we see the current M&A premium of small banks has not fully reflected the potential maximum acquisition price. Overall, we prefer small Hong Kong-listed banks in the next 6 months.

DSB, WHB and BOCHK as our top picks

We prefer BOCHK among Among the large-to-medium-sized Hong Kong-listed banks, we prefer BOCHK the large-to-medium-sized and initiate the coverage of the stock with a BUY rating. With the highest market Hong Kong banks share in RMB deposits in Hong Kong (25% in Jun 2013), we believe BOCHK should benefit from increasing utilization of these deposits in the coming years. Besides, it has proven track record of disciplined cost control and low credit cost in recent years. We also forecast BOCHK’s core tier-1 CAR will remain close to

11% during 2013-15 even with loan growth of 10%-11% p.a. and high dividend

payout ratio of 63%. We forecast BOCHK’s core ROE to rise to 14.4%-15.4% during 2013-14. Based on a long-term ROE assumption of 16.25% in our Gordon Growth Model (GGM), we derive our target price at HK$29.30, equivalent to a projected Dec 2014 P/B of 1.85x.

Figure 71: Fair value and stock recommendation of Hong Kong-listed banks Share Target P/E EPS P/B Yield ROE

Stock Price* Price 2012 2013F 2014F 2015F CAGR (%) 2012 2013F 2014F 2015F 2013F 2012 2013F 2014F 2015F

Code (HKD) (HKD) Rating (x) (x) (x) (x) 2012-15F (x) (x) (x) (x) (%) (%) (%) (%) (%)

BEA 23 HK 32.95 32.30 H 12.1 12.8 12.3 11.1 3.0 1.28 1.20 1.12 1.05 2.3 10.9 9.7 9.4 9.8

BOCHK 2388 HK 25.10 29.30 B 12.7 11.8 10.5 9.3 10.7 1.76 1.67 1.59 1.50 5.3 14.9 14.5 15.5 16.5

CHB 1111 HK 34.15 38.35 B 27.3 30.3 28.2 25.7 2.1 2.01 1.94 1.86 1.78 1.3 7.6 6.5 6.7 7.1 DSB 2356 HK 14.16 17.20 B 12.3 10.5 9.1 8.0 15.5 1.15 1.07 0.99 0.91 2.9 9.3 10.3 11.1 11.6 DSF 440 HK 47.60 52.55 H 11.3 10.7 9.6 8.5 9.7 0.91 0.86 0.80 0.76 2.8 8.1 8.2 8.6 9.1 HSB 11 HK 128.30 107.25 S 12.7 9.6 14.9 13.6 (2.3) 2.66 2.28 2.15 2.03 4.1 22.5 25.6 14.8 15.3 HSBC 5 HK 84.90 88.30 H 14.7 11.9 10.7 9.2 17.0 1.15 1.10 1.06 1.01 5.0 8.1 9.4 10.1 11.3 SCB 2888 HK 182.70 189.00 H 11.8 12.2 9.9 9.0 9.1 1.25 1.18 1.11 1.03 3.8 11.1 10.0 11.5 11.8 WHB 302 HK 113.10 156.60 B 18.8 18.6 17.4 15.7 6.2 1.75 1.66 1.57 1.48 2.1 9.8 9.6 9.3 9.7 *Share price as of 16 Oct 2013 Source: Bloomberg, Company data, Maybank Kim Eng Excluding the M&A theme, we like DSB the most among small Hong Kong-listed We also rate DSB a BUY banks. We therefore initiate the coverage of the stock with a BUY rating. With an due to management’s improvement in asset and liability management, we forecast DSB’s NIM to widen efforts to improve NIM and to 1.70-1.73% during 2013-14 (1.58% in 2012). Besides, management has made explore new fee income opportunities efforts to explore new fee income opportunities (such as securities brokerage and corporate treasury management business) and lower its cost-income ratio. We forecast DSB’s core ROE to rebound to 11% during 2013-14. Based on a long- term ROE assumption of 11.5% in our GGM, we derive our target price at HKD17.20, equivalent to a projected Dec 2014 P/B of 1.2x.

We estimate the potential As aforesaid, both CHB and WHB have announced that their major shareholders acquisition P/B for CHB have been approached by independent third parties in relation to possible will be 2.24x acquisition of interests in the bank. However, share price of CHB has risen faster than WHB since the announcement. According to media reports, Yue Xiu Group may borrow USD1b to finance the acquisition of 60% stake in CHB. Using a funding cost of 3.3% and CHB’s 1H13 ROE of 7.4%, we estimate the potential acquisition P/B for CHB will be 2.24x (or potential acquisition price of HKD38.35). This represents 12.3% upside compared with current share price of CHB.

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On the other hand, we believe China, Singapore and Malaysia banks could be We estimate the potential potential bidders of WHB. We therefore assume a funding cost of 3.15% (the acquisition P/B for WHB average yield of government bonds in Hong Kong, China, US, Singapore and will be 2.01-2.71x Malaysia; which is the opportunity cost of cash-rich buyers) and 4.25% (the average coupon rate of subordinated debt of banks; for buyers who needs to finance the acquisition through borrowings) for the acquisition. Based on WHB’s 1H13 ROE of 8.5%, we estimate the potential acquisition P/B for WHB will be 2.01-2.71x. We use the middle of this range to derive our target price of

HK$156.60 for WHB, equivalent to a Jun 2013 P/B of 2.36x. This represents more

than 35% upside compared with current share price of WHB.

We initiate the coverage of both CHB and WHB with a BUY rating. However, in We prefer WHB to CHB view of fundamentals (WHB has better NIM and cost-income ratio than CHB) and

the estimated share price upside from potential acquisition, we prefer WHB to

CHB for the M&A theme.

HSB as our top SELL

We initiate the coverage of HSB with a SELL rating. This was mainly due to: (i) HSB’s NIM is unlikely to rebound before any rise in short-term USD (and HKD) We initiate HSB with SELL interest rates; (ii) Hang Seng China has a slow penetration to local enterprises in due to small organic China China and we expect its operating profit contribution to remain below 2% in the contribution and potential capital constraint in the coming years; and (iii) the full impact of Basel III capital rules will lower HSB’s coming years core tier-1 CAR by 3.4ppts by 2018 and this may restrain growth in DPS of HSB in the coming years. Overall, with significant reduction in profit contribution from the investment in Industrial Bank, we forecast HSB’s core ROE to plunge from 21.4% in 2012 to 15% in 2014. . Based on a long-term ROE assumption of 16% in our GGM, we derive our target price at HKD107.25, equivalent to a projected Dec 2014 P/B of 1.8x.

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Hong Kong

18 October 2013 Initiating Coverage

Hold (new) Bank of East Asia Limited ROE Recovery In 2014 Share price: HKD32.95 (16 Oct 2013) Target price: HKD32.30 (new) Stable NIM ahead. Bank of East Asia’s (BEA) NIM widened from 1.70% in 2H12 to 1.83% in 1H13 following the decline in structured

deposits in China and strong growth in low-cost deposits in Hong Kong Steven CHAN (+10% HoH in 1H13). BEA China will shift towards supply chain [email protected] financing for SMEs, which should help lift its loan pricing power while (852) 2268 0645 absorbing low-cost deposits. This may mitigate the impact of rising HKD funding costs and the issue of RMB negotiable certificates of deposit (NCDs). We forecast NIM to be stable at 1.82-1.83% during 2H13-2014.

New China strategy to improve operating efficiency. BEA China will Stock Information maintain its network expansion at a moderate pace of 10 outlets pa in Description: Bank of East Asia is the 5th largest bank in the next few years. It will relocate outlets with limited retail customers Hong Kong. It is also one of the biggest foreign banks on from the ground floor to the upper floors. These branches will then mainland China, in terms of retail branch network. focus on corporate banking. Management estimates this should result in cost savings of HKD50m pa. We forecast BEA’s overall cost-income Ticker: 23 HK ratio to fall from 57.7% in 2012 to 57.0-57.5% over 2013-2015. Shares Issued (m): 2,227 Market Cap (USDm): 9,872.3 Uncertainty on asset quality. BEA’s NPLs in China and Hong Kong 3-mth Avg Daily Turnover (USDm): 9.9 HSI: 23,228.3 grew by HKD253m and HKD41m respectively in 1H13 while credit cost Free Float (%): 76.6 rose from 0.06% in 2H12 to 0.10% in 1H13. We believe the shift towards supply chain finance would give BEA a better understanding of Major Shareholders: % CaixaBank 15.9 its corporate clients’ operating and cash flow conditions. We forecast its Guoco Group 14.9 credit cost to stay at 0.10% over 2013-2014. In the worst-case scenario, SMBC 9.2 management anticipates its China NPL ratio would rise to over 1%

(0.4% in Jun 2013), which would raise its credit cost to 0.15-0.20%.

Key Indicators (2014) Potential cut in dividends. To keep its core Tier 1 CAR at above 10%, ROE (%): 9.4 BEA lowered its dividend payout ratio from 40.3% in 2012 to 30% in NIM: 1.82 1H13. Management intends to keep its core Tier 1 CAR at a similar Cost-income ratio: 57.5 level. To support loan growth of 10-11% pa, we estimate that BEA Credit cost: 0.10 needs to maintain its dividend payout ratio at 30% during 2013-2015.

Initiate with HOLD. With the cost of credit projected to increase and Historical Chart trading profit and cost-income ratio on the decline, we forecast BEA’s BANK EAST ASIA HSI core ROE will stay at 9.3-9.4% in 2013-2014 (9.5% in 2012). Based on 120 a long-term ROE assumption of 10% in our Gordon Growth Model 115 (GGM), we arrive at a target price of HKD32.30, which translates to Dec 110 2014 P/B of 1.1x. We initiate coverage with a HOLD rating.

105 BEA – Summary Earnings Table 100 FYE Dec 2012A 2013E 2014E 2015E Operating profit (HKDm) 6,384 7,005 7,554 8,325 95 Chg (%) 35.2 9.7 7.8 10.2 90 Net profit (HKDm) 5,725 5,731 5,960 6,622 Chg (%) 42.1 0.1 4.0 11.1 Oct 12 Dec 12 Feb 13 Apr 13 Jun 13 Aug 13 Oct 13 EPS (HKD) 2.72 2.57 2.68 2.97 Chg (%) 38.9 (5.4) 4.0 11.1 Performance: P/E (x) 12.1 12.8 12.3 11.1 52-week High/Low HKD34/HKD27 P/B (x) 1.28 1.20 1.12 1.05 ROE (%) 10.9 9.7 9.4 9.8 1-mth 3-mth 6-mth 1-yr YTD DPS (HKD) 1.04 0.77 0.80 0.89 Absolute (%) 6% 18% 11% 17% 13% Yield (%) 3.1 2.3 2.4 2.7 Relative (%) 4% 10% 6% 6% 10% Consensus net profit (HKDm) 5,599 5,816 6,562

Source: Company data, Maybank Kim Eng

SEE APPENDIX I FOR IMPORTANT DISCLOSURES AND ANALYST CERTIFICATIONS

Bank of East Asia

Investment positives

Making efforts to reduce NIM pressure: Continued reduction in costly structured deposits and shift towards high-yield supply chain finance in China.

A more diversified fee income base than peers: Less reliance on securities brokerage fees (7% of total gross fees vs market average of over 15% in 1H13).

New China strategy to lower cost-income ratio: Moderate the pace of branch opening and relocate branches with low retail traffic to corporate banking centres.

Investment concerns

Potential increase in credit cost: Export-oriented SME loans in Fujian and Zhejiang provinces in 1H13 are driving up credit costs. BEA will shift towards the less risky supply chain finance, particularly in Central and Western China.

Need to lower dividend payout ratio: To maintain core Tier 1 CAR at above 10% and annual loan growth of 10-11%, we believe BEA will need to cut its dividend payout ratio from 40% in 2012 to 30% in the coming years.

Valuation and recommendations We forecast BEA’s core net profit to grow at 12% CAGR over 2012-2015, driven by solid loan growth, healthy net fees and decline in cost-income ratio. Benefiting from the new China strategy, we forecast BEA China’s net profit to grow at 15.5% CAGR over the same period. Thus, BEA China’s net profit contribution will increase from 29.9% in 2012 to 33-39% during 2013-2015.

As BEA will need to retain more earnings to strengthen its capital positions, we forecast core ROE will only improve to 9.8% in 2015 from 9.5% in 2012. We project a long-term ROE of 10% for BEA in our GGM. This is close to its historical average ROE of 9.4% during 2002-2012. We arrive at a target price of HKD32.30, based on the fair Dec 2014 P/B of 1.1x estimated from the GGM. This is lower than BEA’s historical average P/B of 1.56x during 2002-2012, reflecting the bank’s increased China exposure. We initiate coverage of BEA with a HOLD rating. Key risks to our call include interest rate deregulation and economic slowdown in China, as well as a sharp rise in HKD short-term interest rates.

Figure 72: BEA – Gordon Growth Model Implied ROE 8.00% 9.00% 10.00% 11.00% 12.00% Long term dividend payout ratio (k) 30.0% Cost of Equity (CoE= Rf + Rm * B) 9.7% Long term sustainable growth (g) 7.0% Discount rate (CoE - g) 2.7% Target P/B (x): (ROE * k) / (CoE - g) 0.88 0.99 1.10 1.21 1.32 Dec14F BVPS 29.34 Target price based on 1.1x Dec14F P/B 25.84 29.07 32.30 35.53 38.76 Source: Company data, Maybank Kim Eng

Figure 73: BEA – trading P/E bands Figure 74: BEA – trading P/B bands

HKD HKD 30x 90 3.3x 80 80 70 25x 70 2.6x 60 60 50 20x 50 1.9x 40 15x 40 30 1.2x 10x 30 20 20 10 10 0.5x 0 0 Jan-02 Sep-03 May-05 Jan-07 Sep-08 May-10 Jan-12 Sep-13 Jan-02 Sep-03 May-05 Jan-07 Sep-08 May-10 Jan-12 Sep-13

Source: Company data, Maybank Kim Eng Source: Company data, Maybank Kim Eng

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Bank of East Asia

Figure 75: BEA – ROE and net profit breakdown Figure 76: BEA – SOTP valuation

2011 2012 2013E 2014E 2015E Dec14E BV Fair P/B Fair Value China 8.8 7.3 6.9 7.6 8.2 (HKDm) (x) (HKDm) 8.8 14.2 11.8 10.8 11.0 HK & Overseas China 28,699 1.00 28,699 Total 8.8 11.0 9.7 9.4 9.8 HK & Overseas 36,638 1.18 43,232 Net Profit Breakdown (%) 2011 2012 2013E 2014E 2015E Total 65,336 1.10 71,931 China 45.3 29.9 31.0 35.4 37.1 2,227 HK & Overseas 54.7 70.1 69.0 64.6 62.9 Number of shares (m) 32.30 Fair Value per share (HKD) Total 100.0 100.0 100.0 100.0 100.0

Source: Company data, Maybank Kim Eng Source: Company data, Maybank Kim Eng

Figure 77: BEA – income statement breakdown by geographic distribution BEA China 2011-15E (HK Dm) 2011 2012 2013E 2014E 2015E CAGR (%) Net interest income 4,812 4,865 5,352 5,887 6,475 7.7 Non-interest income 830 966 1,159 1,287 1,428 14.5 Total income 5,642 5,831 6,511 7,173 7,904 8.8 Expenses (3,306) (3,594) (3,893) (4,189) (4,516) 8.1 Pre-prov profit 2,336 2,237 2,618 2,984 3,388 9.7 Bad debt charge (161) (159) (310) (248) (198) 5.4 Post-prov profit 2,175 2,078 2,308 2,736 3,190 10.0 Others 160 61 - - - NA Associate profit 38 107 - - - NA Pre-tax profit 2,373 2,246 2,308 2,736 3,190 7.7 Tax (546) (517) (531) (629) (734) 7.7 MI - - - - - NA Net profit 1,827 1,729 1,777 2,107 2,456 7.7 BEA (HK & Overseas Business) 2011-15E (HK Dm) 2011 2012 2013E 2014E 2015E CAGR (%) Net interest income 4,451 4,859 6,088 6,418 6,925 11.7 Non-interest income 2,622 4,419 3,872 4,180 4,523 14.6 Total income 7,073 9,278 9,960 10,598 11,448 12.8 Expenses (4,686) (5,131) (5,573) (6,028) (6,511) 8.6 Pre-prov profit 2,387 4,147 4,387 4,569 4,937 19.9 Bad debt charge 86 (54) (76) (161) (227) NA Post-prov profit 2,473 4,093 4,311 4,409 4,711 17.5 Others 508 849 300 - - -100.0 Associate profit 397 429 697 766 843 20.7 Pre-tax profit 3,378 5,371 5,308 5,175 5,554 13.2 Tax (754) (894) (916) (874) (928) 5.3 MI (421) (429) (438) (449) (460) 2.3 Net profit 2,203 4,047 3,954 3,853 4,166 17.3 Whole BEA Group 2011-15E (HKDm) 2011 2012 2013E 2014E 2015E CAGR (%) Net interest income 9,263 9,724 11,440 12,304 13,401 9.7 Non-interest income 3,452 5,385 5,031 5,467 5,951 14.6 Total income 12,715 15,109 16,471 17,771 19,352 11.1 Expenses (7,992) (8,725) (9,466) (10,217) (11,026) 8.4 Pre-prov profit 4,723 6,384 7,005 7,554 8,325 15.2 Bad debt charge (75) (213) (386) (409) (425) 54.3 Post-prov profit 4,648 6,171 6,619 7,145 7,900 14.2 Others 668 910 300 - - -100.0 Associate profit 435 536 697 766 843 18.0 Pre-tax profit 5,751 7,617 7,616 7,912 8,743 11.0 Tax (1,300) (1,411) (1,447) (1,503) (1,661) 6.3 MI (421) (429) (438) (449) (460) 2.3 Net profit 4,030 5,777 5,731 5,960 6,622 13.2 Source: Bloomberg, Company data, Maybank Kim Eng

18 October 2013 Page 53 of 82

Bank of East Asia

INCOME STATEMENT BALANCE SHEET FYE Dec (HKDm) 2012A 2013F 2014F 2015F FYE Dec (HKDm) 2012A 2013F 2014F 2015F Cash & equivalent 155,951 164,803 174,630 184,546 Net interest income 9,724 11,440 12,304 13,401 Investment securities 152,330 160,342 172,574 188,934 Other operating income 5,385 5,031 5,467 5,951 Net loans and advances 349,801 389,871 432,697 475,922 Operating income 15,109 16,471 17,771 19,352 Fixed assets 12,552 13,180 13,839 14,531 Operating expenses (8,725) (9,466) (10,217) (11,026) Intangible assets 4,041 4,041 4,041 4,041 Operating profit 6,384 7,005 7,554 8,325 Other assets 17,439 18,905 20,472 22,054 Provisions for bad and doubtful debts (213) (386) (409) (425) Total assets 692,114 751,142 818,253 890,027 Operating profit after provisions 6,171 6,619 7,145 7,900 Non-operating income 1,394 997 766 843 Customer deposits 526,140 581,005 641,905 703,358 Pre-tax profit 7,565 7,616 7,912 8,743 Borrowings 30,597 30,597 30,597 30,597 Taxation (1,411) (1,447) (1,503) (1,661) 22,920 22,920 22,920 22,920 Minorities (429) (438) (449) (460) Other liabilities 50,818 50,862 52,782 58,337 Net profit to ordinary shareholders 5,725 5,731 5,960 6,622 Total liabilities 630,475 685,384 748,204 815,212 Minorities 4,486 4,594 4,712 4,843 Shareholders’ funds 57,153 61,165 65,336 69,972 Total liabilities and equity 692,114 751,142 818,253 890,027 GROWTH RATES IN KEY FINANCIALS FYE Dec 2012A 2013F 2014F 2015F KEY PERFORMANCE RATIOS Balance sheet FYE Dec 2012A 2013F 2014F 2015F Gross loans 11.2% 11.5% 11.0% 10.0% NPL 0.32% 0.38% 0.34% 0.30% Deposits 9.9% 10.4% 10.5% 9.6% Loan to deposit 66.7% 67.3% 67.6% 67.9% Income statement Core tier 1 CAR 10.7% 10.6% 10.4% 10.3% Net interest income 5.0% 17.6% 7.6% 8.9% Leverage 12.1 12.3 12.5 12.7 Other operating income 56.0% -6.6% 8.7% 8.9% NIM 1.67% 1.83% 1.82% 1.82% Total operating income 18.8% 9.0% 7.9% 8.9% Cost to income 57.7% 57.5% 57.5% 57.0% Operating expenses 9.2% 8.5% 7.9% 7.9% ROA 0.88% 0.79% 0.76% 0.78% Pre-provision profit 35.2% 9.7% 7.8% 10.2% ROE 10.9% 9.7% 9.4% 9.8% Net profit 42.1% 0.1% 4.0% 11.1% PER SHARE DATA FYE Dec (HKD) 2012A 2013F 2014F 2015F EPS 2.72 2.57 2.68 2.97 DPS 1.04 0.77 0.80 0.89 PROFITABILITY RATIOS BVPS 25.66 27.46 29.34 31.42 FYE Dec 2012A 2013F 2014F 2015F OPERATING RATIOS AND CAPITAL STRUCTURE Total income/avg assets 2.3% 2.3% 2.3% 2.3% FYE Dec 2012A 2013F 2014F 2015F

NII/avg assets 1.5% 1.6% 1.6% 1.6% Cost to income ratio 57.7% 57.5% 57.5% 57.0% Other oper income/avg assets 0.8% 0.7% 0.7% 0.7% Operating expense/avg assets -1.3% -1.3% -1.3% -1.3% Operating profit/avg assets 1.0% 1.0% 1.0% 1.0% Interest expense/interest income 57.0% 54.5% 55.9% 56.4% Op profit after prov/avg assets 0.9% 0.9% 0.9% 0.9% CAR 14.3% 13.9% 13.4% 13.1% Provisions/avg assets 0.0% -0.1% -0.1% 0.0% Capital/assets 8.3% 8.1% 8.0% 7.9% Pre-tax profit/avg assets 1.2% 1.1% 1.0% 1.0% Capital/total loans 16.3% 15.6% 15.1% 14.7% Net profit/avg assets (ROA) 0.9% 0.8% 0.8% 0.8% Fixed assets/shareholders’ funds 22.0% 21.5% 21.2% 20.8% NII/total income 64.4% 69.5% 69.2% 69.2% Other oper income/total income 35.6% 30.5% 30.8% 30.8% FUNDING AND CREDIT QUALITY Operating profit/total income 42.3% 42.5% 42.5% 43.0% FYE Dec 2012A 2013F 2014F 2015F Op profit after prov/total income 40.8% 40.2% 40.2% 40.8% Total deposits/total liabilities 83.5% 84.8% 85.8% 86.3% Provisions/total income 1.4% 2.3% 2.3% 2.2% LD ratio 66.7% 67.3% 67.6% 67.9% Pre-tax profit/total income 50.1% 46.2% 44.5% 45.2% (Borrowings + debentures)/deposits 10.2% 9.2% 8.3% 7.6% Net profit/total income 37.9% 34.8% 33.5% 34.2% Provision charges to total loans 0.06% 0.10% 0.10% 0.09% ROE 10.9% 9.7% 9.4% 9.8% NPL/total loans 0.32% 0.38% 0.34% 0.30% NIM 1.67% 1.83% 1.82% 1.82% Total reserve coverage 81.9% 77.3% 93.8% 112.9%

Source: Company data, Maybank Kim Eng

18 October 2013 Page 54 of 82

Hong Kong

18 October 2013 Initiating Coverage

Buy (new) BOC (Hong Kong) Still A Key Offshore RMB Business Play Share price: HKD25.10 (16 Oct 2013) Target price: HKD29.30 (new) Key beneficiary of offshore RMB business. The NIM of BOC (Hong Kong) (BOCHK) widened from 1.56% in 2H12 to 1.67% in 1H13 on better corporate loan pricing and lower funding cost. We forecast the Steven CHAN RMB deposits in Hong Kong to increase from CNY0.7t in 2012 to [email protected] CNY1t in 2013 and CNY1.3t in 2014. Given its 25% market share, we (852) 2268 0645 estimate BOCHK’s pre-tax profit will climb by 3.4% for every 10% increase in utilisation of these deposits. Still, we conservatively forecast

its NIM to stay at 1.67% during 2H13-2014.

Proven track record of disciplined cost control. BOCHK has Stock Information successfully kept a tight lid on its core cost-income ratio during 2009- Description: BOCHK is one of the largest banks in HK, and it has the most extensive retail branch network. The company 1H13. With moderate China expansion and the potential slowdown in is 66% owned by Bank of China. revaluation surplus on its investment properties (which will affect depreciation charge), we forecast its cost-income ratio would fall from

Ticker: 2388 HK 32% in 2012 to 28-30% over 2013-2015. Shares Issued (m): 10,572.8 Market Cap – (USDm): 34,291.6 Credit cost to remain low. Credit cost contracted to 0.09% in 1H13 3-mth Avg Daily Turnover (USDm) 30.6 (0.2% in 2H12) thanks to a minimal increase in NPLs (+HKD66m in HSI: 23,228.3 Free float (%): 33.9 1H13). Management said there was no deterioration in special mention loans and short-term overdue loans during 1H13. Still, BOCHK has Major Shareholders: % raised its collective loan impairment allowance ratio to 0.4% in Jun Bank of China 66.1 2013 (0.38% in Dec 2012). We forecast its credit cost to slide from 12bps in 2012 to 8-10bps over 2013-2014.

BOCHK’s core Tier 1 CAR Fall in core Tier 1 CAR poses concern. Key Indicators (2014) fell from 12.3% in Dec 2012 to 11.0% in Jun 2013 due to some one-off ROE (%): 15.5 adjustments under the Basel III capital rules. We forecast the bank’s NIM: 1.67 core Tier 1 CAR will remain close to 11% during 2013-2015 even with Cost-income ratio: 29.3 loan growth of 10-11% pa and high dividend payout ratio of 63%. Credit cost: 0.08

Initiate with BUY. With NIM projected to widen, net fees to post solid growth and credit cost to fall, we forecast BOCHK’s core ROE to rise to Historical Chart 14.4-15.4% in 2013-2014 (vs 13.7% in 2012). Based on a long-term BOC HONG KONG HO HSI 120 ROE assumption of 16.25% in our Gordon Growth Model (GGM), we

115 arrive at a target price at HKD29.30, which translates to Dec 2014 P/BV of 1.85x. We initiate coverage with a BUY rating. 110

105 BOCHK – Summary Earnings Table FYE Dec 2012A 2013E 2014E 2015E 100 Operating profit (HKDm) 24,358 27,965 31,344 35,089 95 Chg (%) 6.0 14.8 12.1 12.0 Net profit (HKDm) 20,930 22,446 25,274 28,397 90 Chg (%) 2.4 7.2 12.6 12.4 Oct 12 Dec 12 Feb 13 Apr 13 Jun 13 Aug 13 Oct 13 EPS (HKD) 1.98 2.12 2.39 2.69 Chg (%) 2.4 7.2 12.6 12.4 P/E (x) 12.7 11.8 10.5 9.3 Performance: P/B (x) 1.76 1.67 1.59 1.50 52-week High/Low HKD28/HKD23 ROE (%) 14.9 14.5 15.5 16.5 DPS (HKD) 1.24 1.33 1.49 1.68 1-mth 3-mth 6-mth 1-yr YTD Yield (%) 4.9 5.3 6.0 6.7 Absolute (%) -2% 3% -2% 4% 4% Consensus net profit (HKDm) 21,749 23,433 25,696 Relative (%) -3% -5% -7% -7% 2% Source: Company data, Maybank Kim Eng

SEE APPENDIX I FOR IMPORTANT DISCLOSURES AND ANALYST CERTIFICATIONS

BOC Hong Kong

Investment positives Room to improve NIM: BOCHK has improved its asset and liability management in recent years. It is also a key beneficiary of offshore RMB business and interest rate hikes.

Disciplined cost control: Tight control on staff cost and administrative expenses to keep cost-income ratio low. The bank will benefit from the slowdown in revaluation surplus of its investment properties in the coming years.

Benign asset quality: Total amount of special mention loans and overdue loans remained stable in 1H13, minimising the risk of new NPLs in 2H13. Still, BOCHK raised its collective loan loss provisions in anticipation of weakening asset quality.

Investment concerns Slower loan growth in 1H13: Loan growth rate trailed the market average at 6.7% HoH in 1H13. Management intends to continue to strike a balance between loan growth and NIM pressure in the coming years.

Hit by Basel III capital rules: Core Tier 1 CAR fell to 11.0% in Jun 2013. We believe this is a one-off and would not undermine BOCHK’s capital strength or dividend payout ratio in the coming years.

Valuation and recommendations We forecast BOCHK’s core net profit to grow at 14% CAGR over 2012-2015, driven by NIM widening, recovery in net fee growth and lower credit cost. At the same time, its core ROE should improve gradually from 13.7% in 2012 to 15.4% in 2014 and 16.4% in 2015.

We project a long-term ROE of 16.25% for BOCHK in our GGM. This is higher than its historical average of 14.8% during 2002-2012. We arrive at a target price at HKD29.30, based on the fair Dec 2014 P/B of 1.85x estimated from the GGM. This is close to BOCHK’s historical average P/B of 1.96x during 2002-2012. We initiate coverage of BOCHK with a BUY rating. Key risks to our call include significant loss of market share in Hong Kong’s offshore RMB business and softening in short-term HKD interest rates.

Figure 78: BOCHK – Gordon Growth Model Implied ROE 14.3% 15.3% 16.3% 17.3% 18.3% Long term dividend payout ratio (k) 62.5% Cost of Equity (CoE= Rf + Rm * B) 11.6% Long term sustainable growth (g) 6.1% Discount rate (CoE - g) 5.5% Target P/B (x): (ROE * k) / (CoE - g) 1.62 1.74 1.85 1.96 2.08 Dec14E BVPS 15.83 Target price based on 1.85x Dec14E P/B 25.69 27.49 29.30 31.10 32.90 Source: Company data, Bloomberg, Maybank Kim Eng

Figure 79: BOCHK – trading P/E bands Figure 80: BOCHK – trading P/B bands

HKD HKD 45 22x 55 40 50 3.5x 35 18x 45 40 2.8x 30 14x 35 25 30 2.0x 20 10x 25 15 20 1.3x 15 10 6x 10 0.5x 5 5 0 0 Jul-02 Mar-04 Nov-05 Jul-07 Mar-09 Nov-10 Jul-12 Jul-02 Mar-04 Nov-05 Jul-07 Mar-09 Nov-10 Jul-12

Source: Company data, Maybank Kim Eng Source: Company data, Maybank Kim Eng

18 October 2013 Page 56 of 82

BOC Hong Kong

INCOME STATEMENT BALANCE SHEET FYE Dec (HKDm) 2012A 2013F 2014F 2015F FYE Dec (HKDm) 2012A 2013F 2014F 2015F Cash & equivalent 264,773 282,538 301,526 321,825 Net interest income 24,708 27,180 30,094 33,302 Investment securities 608,215 624,025 656,842 690,528 Other operating income 11,052 12,956 14,238 15,648 Net loans and advances 774,559 859,107 953,832 1,060,157 Operating income 35,760 40,136 44,331 48,951 Fixed assets 63,107 63,444 63,782 64,122 Operating expenses (11,402) (12,171) (12,988) (13,861) Intangible assets - - - - Operating profit 24,358 27,965 31,344 35,089 Other assets 37,179 41,215 45,733 50,799 Provisions for bad and doubtful debts (854) (802) (754) (715) Total assets 1,747,833 1,870,328 2,021,714 2,187,431 Operating profit after provisions 23,504 27,163 30,589 34,374 Non-operating income 2,017 227 230 233 Customer deposits 1,229,131 1,340,726 1,462,461 1,595,260 Pre-tax profit 25,521 27,390 30,819 34,607 Borrowings 179,206 179,206 179,206 179,206 Taxation (3,974) (4,265) (4,799) (5,389) Debentures 34,678 26,343 26,343 26,343 Minorities (617) (679) (747) (821) Other liabilities 149,744 160,594 180,820 203,165 Net profit to ordinary shareholders 20,930 22,446 25,274 28,397 Total liabilities 1,592,759 1,706,869 1,848,830 2,003,975 Minorities 4,105 4,784 5,530 6,351 Shareholders’ funds 150,969 158,676 167,354 177,105 Total liabilities and equity 1,747,833 1,870,328 2,021,714 2,187,431 GROWTH RATES IN KEY FINANCIALS FYE Dec 2012A 2013F 2014F 2015F KEY PERFORMANCE RATIOS Balance sheet FYE Dec 2012A 2013F 2014F 2015F Gross loans 11.3% 10.9% 11.0% 11.1% NPL 0.26% 0.25% 0.23% 0.20% Deposits 7.2% 9.1% 9.1% 9.1% Loan to deposit 63.3% 64.4% 65.5% 66.8% Income statement Core tier 1 CAR 12.3% 11.1% 10.8% 10.7% Net interest income 12.4% 10.0% 10.7% 10.7% Leverage 11.6 11.8 12.1 12.4 Other operating income 24.6% 17.2% 9.9% 9.9% NIM 1.60% 1.67% 1.67% 1.67% Total operating income 15.9% 12.2% 10.5% 10.4% Cost to income 31.9% 30.3% 29.3% 28.3% Operating expenses 45.0% 6.7% 6.7% 6.7% ROA 1.22% 1.24% 1.30% 1.35% Pre-provision profit 6.0% 14.8% 12.1% 12.0% ROE 14.9% 14.5% 15.5% 16.5% Net profit 2.4% 7.2% 12.6% 12.4% PER SHARE DATA FYE Dec (HKD) 2012A 2013F 2014F 2015F EPS 1.98 2.12 2.39 2.69 DPS 1.24 1.33 1.49 1.68 PROFITABILITY RATIOS BVPS 14.28 15.01 15.83 16.75 FYE Dec 2012A 2013F 2014F 2015F OPERATING RATIOS AND CAPITAL STRUCTURE Total income/avg assets 1.9% 2.1% 2.2% 2.3% FYE Dec 2012A 2013F 2014F 2015F

NII/avg assets 1.3% 1.4% 1.5% 1.5% Cost to income ratio 31.9% 30.3% 29.3% 28.3% Other oper income/avg assets 0.5% 0.6% 0.7% 0.7% Operating expense/avg assets -0.7% -0.7% -0.7% -0.7% Operating profit/avg assets 1.4% 1.4% 1.5% 1.6% Interest expense/interest income 30.2% 30.6% 30.5% 30.9% Op profit after prov/avg assets 1.4% 1.4% 1.5% 1.6% CAR 16.8% 16.5% 15.9% 15.3% Provisions/avg assets 0.0% 0.0% 0.0% 0.0% Capital/assets 8.6% 8.5% 8.3% 8.1% Pre-tax profit/avg assets 1.5% 1.5% 1.5% 1.6% Capital/total loans 19.4% 18.4% 17.5% 16.6% Net profit/avg assets (ROA) 1.2% 1.2% 1.2% 1.3% Fixed assets/shareholders’ funds 41.8% 40.0% 38.1% 36.2% NII/total income 71.3% 69.1% 67.7% 67.9% Other oper income/total income 28.7% 30.9% 32.3% 32.1% FUNDING AND CREDIT QUALITY Operating profit/total income 74.5% 68.1% 69.7% 70.7% FYE Dec 2012A 2013F 2014F 2015F Op profit after prov/total income 73.3% 65.7% 67.7% 69.0% Total deposits/total liabilities 77.2% 78.5% 79.1% 79.6% Provisions/total income 1.2% 2.4% 2.0% 1.7% LD ratio 63.3% 64.4% 65.5% 66.8% Pre-tax profit/total income 80.0% 71.4% 68.2% 69.5% (Borrowings + debentures)/deposits 14.6% 13.4% 12.3% 11.2% Net profit/total income 66.2% 58.5% 55.9% 57.0% Provision charges to total loans 0.12% 0.10% 0.08% 0.07% ROE 16.7% 14.9% 14.5% 15.5% NPL/total loans 0.26% 0.25% 0.23% 0.20% NIM 1.32% 1.60% 1.67% 1.67% Total reserve coverage 183.1% 196.0% 215.2% 245.0%

Source: Company data, Maybank Kim Eng

18 October 2013 Page 57 of 82

Hong Kong

18 October 2013 Initiating Coverage

Buy (new) Chong Hing Bank Get Ready For Sale Share price: HKD34.15 (16 Oct 2013) Target price: HKD38.35 (new) NIM lowest among peers. CHB has made efforts to raise its loan-to- deposit ratio by shifting towards high-yield assets in 1H13. As a result, its NIM expanded to 1.19% from 1.13% in 2H12. Nevertheless, its NIM Steven CHAN is still the lowest among peers given its concentration of low-yield [email protected] property and syndicated loans. With HKD funding cost edging up, we (852) 2268 0645 forecast its NIM will slip to 1.17% in 2H13.

Heavy reliance on -related fees. CHB has not made

efforts to diversify its fee income. It is still heavily reliant on securities brokerage and equity-linked wealth management businesses. These Stock Information fees accounted for 58.2% of its total gross fees in 1H13. We estimate Description: Chong Hing Bank is a small local bank which operates 52 retail branches in Hong Kong. It also has small that a 10% decline in these fees will lower its 2014 pre-tax profit by 3%. operations in Macau and mainland China. Benign asset quality. Probably due to its focus on less risky loans and Ticker: 1111 HK prudent provisioning policy, CHB has a good track record of asset Shares Issued (m): 435 Market Cap (USDm): 1,884.9 quality. The bank recorded net write-back in loan loss provisions during 3-mth Avg Daily Turnover (USDm): 2.5 2011-2012. Credit cost remained low at 9bps in 1H13. We forecast its HSI: 23,228.3 credit cost to stay low at 7-9bps in 2013-2014, given that the collateral Free Float (%): 28.7 coverage of its loans was high at 74.4% in Jun 2013. Major Shareholders: % Liu Chong Hing Investment 50.2 Non-bank China conglomerate as potential buyer. According to COSCO 20.0 media reports, Yue Xiu Group is keen to acquire a 60% stake in CHB. Bank of T. Mitsubishi UFJ 9.2 We believe this is possible because: (i) Yue Xiu’s subsidiaries and other companies (the suppliers and customers of its subsidiaries) in Guangdong province could help enlarge CHB’s deposit pool and lower Key Indicators (2014) its funding costs; (ii) CHB could develop cross-border banking business ROE (%): 6.7 NIM: 1.17 for the suppliers and customers of Yue Xiu’s subsidiaries; and (iii) CHB Cost-income ratio: 55.6 could cooperate with the financial arm of Yue Xiu to develop cross- Credit cost: 0.07 border RMB business.

Initiate with BUY. With limited improvement in NIM and fee income, we Historical Chart forecast CHB’s core ROE to stay at 7% in 2013-2014. Media reports CHONG HING BANK HSI said Yue Xiu Group may borrow USD1b in loans (with funding cost of 270 USD LIBOR + 300bps) to finance its acquisition of CHB. Using this 250 230 funding cost and CHB’s 1H13 ROE of 7.4%, we estimate the potential 210 acquisition P/B for CHB to be 2.24x, or a potential acquisition price of 190 HKD38.35. We use this as our target price for CHB. Initiate with BUY. 170 150 CHB – Summary Earnings Table 130 FYE Dec 2012A 2013F 2014F 2015F 110 Operating profit (HKDm) 534 599 636 693 90 Chg (%) (1.3) 12.1 6.1 9.0 Oct 12 Dec 12 Feb 13 Apr 13 Jun 13 Aug 13 Oct 13 Net profit (HKDm) 543 490 526 578 Chg (%) (3.1) (9.8) 7.4 9.8 Performance: EPS (HKD) 1.25 1.13 1.21 1.33 52-week High/Low HKD35/HKD13 Chg (%) (3.1) (9.8) 7.4 9.8 P/E (x) 27.3 30.3 28.2 25.7 1-mth 3-mth 6-mth 1-yr YTD P/B (x) 2.01 1.94 1.86 1.78 Absolute (%) 16% 59% 70% 158% 106% ROE (%) 7.6 6.5 6.7 7.1 Relative (%) 15% 51% 65% 148% 104% DPS (HKD) 0.46 0.45 0.48 0.53 Yield (%) 1.3 1.3 1.4 1.6 Consensus net profit (HKDm) 509 521 541 Source: Company data, Maybank Kim Eng

SEE APPENDIX I FOR IMPORTANT DISCLOSURES AND ANALYST CERTIFICATIONS

Chong Hing Bank

Investment positives

Low credit cost: Benefiting from its focus on less risky property lending, residential mortgages and syndicated loans, CHB’s credit cost should remain low at 7-9bps in 2013-2014.

Tightening cost control: With tight control of staff cost (+2.4% YoY in 1H13) and the non-recurrence of set-up cost for wealth management centres, we forecast CHB’s cost-income ratio to fall from 59.6% in 2012 to 56% in 2013-2014.

Investment concerns

Limited NIM improvement: Despite its shift to high-yield assets, CHB’s NIM was still lower than its peers at 1.19% in 1H13. With HKD funding cost edging up, we forecast its NIM to narrow to 1.17% in 2H13-2014.

Net fees subject to stock market sentiment: Historically, CHB has relied more on stock market-related fees (securities brokerage and equity-related wealth management fees) than peers. These fees accounted for 58.2% of its total fees in 1H13. We estimate that a 10% decline in these fees will lower CHB’s 2014 pre- tax profit by 3%.

Valuation and recommendations We forecast CHB’s core net profit to grow at 2.5% CAGR over 2012-2015, driven by tight cost control and low credit cost. Its core ROE for the period would therefore remain low at 7%.

CHB has been approached by Yue Xiu Group and other independent third parties seeking to acquire a stake in the bank. According to media reports, Yue Xiu may borrow USD1b in loans (with funding cost of USD LIBOR + 300bps), equivalent to a funding cost of 3.3% to finance the acquisition. Using this funding cost and CHB’s 1H13 ROE of 7.4%, we estimate the potential acquisition P/B for CHB to be 2.24x, or a potential acquisition price of HKD38.35. We have used this as our target price for CHB. We initiate coverage of CHB with a BUY rating, based purely on the M&A theme. Key risks to our call include acquisition talks being called off or potential buyers offering a lower-than-expected acquisition price.

Figure 81: CHB – trading P/E bands Figure 82: CHB – trading P/B bands

HKD HKD 60 35 55 2.0x 50 30 45 25 1.6x 40 35 40x 20 1.2x 30 32x 25 15 20 24x 0.8x 10 15 16x 0.4x 10 5 5 8x 0 0 Jan-02 Sep-03 May-05 Jan-07 Sep-08 May-10 Jan-12 Sep-13 Jan-02 Sep-03 May-05 Jan-07 Sep-08 May-10 Jan-12 Sep-13 Source: Company data, Maybank Kim Eng Source: Company data, Maybank Kim Eng

18 October 2013 Page 59 of 82

Chong Hing Bank

INCOME STATEMENT BALANCE SHEET FYE Dec (HKDm) 2012A 2013F 2014F 2015F FYE Dec (HKDm) 2012A 2013F 2014F 2015F Cash & equivalent 22,121 22,883 24,006 25,199 Net interest income 837 930 980 1,049 Investment securities 15,224 13,117 11,782 10,543 Other operating income 486 427 452 479 Net loans and advances 42,111 46,563 51,474 56,555 Operating income 1,323 1,357 1,431 1,529 Fixed assets 1,066 1,119 1,175 1,234 Operating expenses (789) (758) (796) (836) Intangible assets - - - - Operating profit 534 599 636 693 Other assets 234 234 234 234 Provisions for bad and doubtful debts 65 (37) (32) (30) Total assets 80,755 83,917 88,671 93,765 Operating profit after provisions 599 562 603 663 Non-operating income 47 21 23 25 Customer deposits 68,176 71,145 75,515 80,164 Pre-tax profit 646 583 626 687 Borrowings 2,277 2,277 2,277 2,277 Taxation (103) (93) (100) (110) Debentures 1,899 1,899 1,899 1,899 Minorities - - - - Other liabilities 1,029 928 996 1,094 Net profit to ordinary shareholders 543 490 526 578 Total liabilities 73,381 76,249 80,688 85,434 Minorities - - - - Shareholders’ funds 7,374 7,668 7,984 8,330 Total liabilities and equity 80,755 83,917 88,671 93,765 GROWTH RATES IN KEY FINANCIALS FYE Dec 2012A 2013F 2014F 2015F Balance sheet KEY PERFORMANCE RATIOS FYE Dec 2012A 2013F 2014F 2015F Gross loans -5.2% 11.1% 11.0% 10.3% NPL 0.06% 0.05% 0.05% 0.05% Deposits 2.7% 4.4% 6.1% 6.2% Loan to deposit 57.5% 61.2% 64.0% 66.5% Income statement Core tier 1 CAR 10.6% 9.9% 9.4% 9.0% Net interest income 2.6% 11.1% 5.3% 7.1% Leverage 11.0 10.9 11.1 11.3 Other operating income -2.7% -12.1% 5.8% 6.1% NIM 1.10% 1.18% 1.17% 1.17% Total operating income 0.6% 2.6% 5.5% 6.8% Cost to income 59.6% 55.9% 55.6% 54.7% Operating expenses 1.9% -3.9% 5.0% 5.0% ROA 0.69% 0.60% 0.61% 0.63% Pre-provision profit -1.3% 12.1% 6.1% 9.0% ROE 7.6% 6.5% 6.7% 7.1% Net profit -3.1% -9.8% 7.4% 9.8% PER SHARE DATA FYE Dec (HKD) 2012A 2013F 2014F 2015F EPS 1.25 1.13 1.21 1.33 DPS 0.46 0.45 0.48 0.53 PROFITABILITY RATIOS BVPS 16.95 17.63 18.35 19.15 FYE Dec 2012A 2013F 2014F 2015F OPERATING RATIOS AND CAPITAL STRUCTURE Total income/avg assets 1.7% 1.6% 1.7% 1.7% FYE Dec 2012A 2013F 2014F 2015F

NII/avg assets 1.1% 1.1% 1.1% 1.2% Cost to income ratio 59.6% 55.9% 55.6% 54.7% Other oper income/avg assets 0.6% 0.5% 0.5% 0.5% Operating expense/avg assets -1.0% -0.9% -0.9% -0.9% Operating profit/avg assets 0.7% 0.7% 0.7% 0.8% Interest expense/interest income 46.5% 44.4% 46.9% 48.5% Op profit after prov/avg assets 0.8% 0.7% 0.7% 0.7% CAR 15.3% 14.3% 13.5% 12.9% Provisions/avg assets 0.1% 0.0% 0.0% 0.0% Capital/assets 9.1% 9.1% 9.0% 8.9% Pre-tax profit/avg assets 0.8% 0.7% 0.7% 0.8% Capital/total loans 18.8% 17.6% 16.5% 15.6% Net profit/avg assets (ROA) 0.7% 0.6% 0.6% 0.6% Fixed assets/shareholders’ funds 14.5% 14.6% 14.7% 14.8% NII/total income 63.3% 68.5% 68.4% 68.6% Other oper income/total income 36.7% 31.5% 31.6% 31.4% FUNDING AND CREDIT QUALITY Operating profit/total income 40.4% 44.1% 44.4% 45.3% FYE Dec 2012A 2013F 2014F 2015F Op profit after prov/total income 45.3% 41.4% 42.1% 43.4% Total deposits/total liabilities 92.9% 93.3% 93.6% 93.8% Provisions/total income -4.9% 2.7% 2.3% 2.0% LD ratio 57.5% 61.2% 64.0% 66.5% Pre-tax profit/total income 48.9% 43.0% 43.7% 45.0% (Borrowings + debentures)/deposits 6.2% 5.9% 5.6% 5.3% Net profit/total income 41.1% 36.1% 36.8% 37.8% Provision charges to total loans -0.16% 0.09% 0.07% 0.06% ROE 7.6% 6.5% 6.7% 7.1% NPL/total loans 0.06% 0.05% 0.05% 0.05% NIM 1.10% 1.18% 1.17% 1.17% Total reserve coverage 801.9% 895.5% 820.5% 757.2%

Source: Company data, Maybank Kim Eng

18 October 2013 Page 60 of 82

Hong Kong

18 October 2013 Initiating Coverage

Buy (new) Dah Sing Banking Group ROE Shows Steady Recovery Share price: HKD14.16 (16 Oct 2013) Target price: HKD17.20 (new) Solid recovery in core revenue. Dah Sing Banking Group (DSB) reported solid loan growth of 8.3% HoH in 1H13. Management said it will continue to expand property lending, cross-border trade finance and Steven CHAN personal loans. We forecast loan growth of 10% pa during 2013-2014. [email protected] NIM rebounded sharply from 1.60% in 2H12 to 1.77% in 1H13 on lower (852) 2268 0645 HKD funding cost and higher corporate loan yield. DSB will continue to monitor its liability cost to avoid severe competition for deposits. We forecast its NIM to be 1.70-1.73% during 2013-2014. In recent years,

the bank has diversified into securities brokerage, bancassurance, wealth management and corporate treasury management businesses. Stock Information We forecast its net fees to grow at 17.4% CAGR over 2012-2015. Description: DSBG is 74% owned by Dah Sing Financial (440 HK). DSBG operates two separate banks, Dah Sing Making efforts to lower cost-income ratio. With administrative and Bank and MEVAS Bank in Hong Kong. It also owns Banco Comercial de Macau, and a 20% stake in Bank of Chongqing marketing expenses under tight control, DSB saw its cost-income ratio in China. falling from 60.4% in 1H12 to 50.0% in 1H13. It plans to moderate new hiring in Hong Kong and to keep a lid on other expenses. We forecast Ticker: 2356 HK Shares Issued (m): 1,223 its cost-income ratio to stay low at 53-54% during 2013-2015. Market Cap (USDm): 2,281.9 3-mth Avg Daily Turnover (USDm): 4.0 Asset quality set to improve. Due to a rise in NPLs for export-oriented HSI: 23,228.3 manufacturing loans, DSB’s NPL ratio rose to 0.40% in Jun 2013 (vs Free Float (%): 25.4 0.35% in Dec 2012). The bank has put in place an early-warning credit

Major Shareholders: % risk system to strengthen its risk management. As a result, the number Dah Sing Financial Group 74.6 of troubled accounts has stabilised in 3Q13. It also maintained a high Aberdeen Assets Management 8.0 loan collateral coverage ratio of 75.2% in Jun 2013. We forecast credit

cost to improve to 0.28% in 2013 and 0.22% in 2014.

Higher dividend payout unlikely. Under the Basel III capital rules, Key Indicators (2014) DSB’s core Tier 1 CAR eased to 10.0% in Jun 2013 (vs 10.4% in Dec ROE (%): 11.1 2012). Therefore, it lowered its core dividend payout ratio to 19.2% in NIM: 1.70 1H13. Management intends to maintain its core Tier 1 CAR at 10%. Cost-income ratio: 53.8 Credit cost: 0.22 This means there is little room for DSB to increase its dividend payout ratio to above 10%, assuming loan growth of 10% pa during 2013-2015.

Initiate with BUY. With NIM projected to widen, net fees to show solid Historical Chart growth and cost-income ratio to decline, we forecast DSB’s core ROE DAH SING BANKING HSI 190 will rebound gradually to 10.7-11.1% in 2013-2014 from 8.9% in 2012. Based on a long-term ROE assumption of 11.5% in our Gordon Growth 170 Model (GGM), we arrive at a target price of HKD17.20, which translates 150 to Dec 2014 P/B of 1.2x. We initiate coverage with a BUY rating.

130 Dah Sing Banking – Summary Earnings Table FYE Dec 2012A 2013F 2014F 2015F 110 Operating profit (HKDm) 1,127 1,616 1,737 1,935 Chg (%) 15.2 43.3 7.5 11.4 90 Net profit (HKDm) 1,411 1,651 1,910 2,173 Oct 12 Dec 12 Feb 13 Apr 13 Jun 13 Aug 13 Oct 13 Chg (%) 29.0 17.0 15.7 13.8 EPS (HKD) 1.15 1.35 1.56 1.78 Chg (%) 29.0 17.0 15.7 13.8 Performance: P/E (x) 12.3 10.5 9.1 8.0 52-week High/Low HKD14/HKD7 P/B (x) 1.15 1.07 0.99 0.91 ROE (%) 9.3 10.3 11.1 11.6 1-mth 3-mth 6-mth 1-yr YTD DPS (HKD) 0.32 0.40 0.47 0.53 Absolute (%) 24% 52% 34% 90% 68% Yield (%) 2.2 2.9 3.3 3.8 Relative (%) 23% 44% 29% 79% 65% Consensus net profit (HKDm) 1,628 1,676 1,835

Source: Company data, Maybank Kim Eng

SEE APPENDIX I FOR IMPORTANT DISCLOSURES AND ANALYST CERTIFICATIONS

Dah Sing Banking Group

Investment positives Making efforts to expand NIM: DSB is striving to improve its asset and liability management with less aggressive competition for time deposits and enhancing higher risk-adjusted returns for its lending business.

Actively exploring new fee income opportunities: DSB will continue to take advantage of its niche in bulk credit card and SME customer base to develop securities brokerage, bancassurance, wealth management and corporate treasury management businesses.

Room to lower cost-income ratio: This would be achieved through continued tight control of new hiring as well as administrative and marketing expenses.

Investment concerns Slight rise in credit cost: Credit cost was 0.31% in 1H13, up from 0.12% in 2H12. Management has strengthened its credit risk management system and no further deterioration in asset quality was seen in 3Q13.

Low dividend payout ratio: DSB’s core Tier 1 CAR fell to 10.0% in Jun 2013. To keep the ratio stable at this level, we expect the bank will maintain its dividend payout ratio at 30% during 2013-2015.

Valuation and recommendations We forecast DSB’s core net profit to grow at 17.3% CAGR over 2012-2015, driven by NIM expansion, strong net fee growth and tight cost control. Its core ROE should therefore improve to 11-12% during 2013-2015 from 8.9% in 2012.

We project a long-term ROE of 11.5% for DSB in our GGM. This is higher than its historical average of 8.5% during 2002-2012. We arrive at our target price of HKD17.20 based on the fair Dec 2014 P/B of 1.20x estimated from the GGM. This is in line with DSB’s 2002-2012 average P/BV. We initiate coverage of DSB with a BUY rating. Key risks to our call include a sharp rise in short-term HKD interest rates, rapid increase in Hong Kong unemployment rate and weakening global external trade conditions.

Figure 83: DSB – Gordon Growth Model Implied ROE 9.5% 10.5% 11.5% 12.5% 13.5% Long term dividend payout ratio (k) 30.0% Cost of Equity (CoE= Rf + Rm * B) 10.9% Long term sustainable growth (g) 8.1% Discount rate (CoE - g) 2.9% Target P/B (x): (ROE * k) / (CoE - g) 0.99 1.10 1.20 1.31 1.41 Dec14 BVPS 14.30 Target price based on 1.2x Dec13F P/B 14.21 15.71 17.20 18.70 20.19 Source: Company data, Maybank Kim Eng

Figure 84: DSB – trading P/E bands Figure 85: DSB – trading P/B bands

HKD HKD 30 30 2.0x

25 22x 25 1.6x 20 18x 20 1.2x 14x 15 15 10x 0.8x 10 10 6x 5 5 0.4x 0 0 Jan-05 Sep-06 May-08 Jan-10 Sep-11 May-13 Jan-05 Sep-06 May-08 Jan-10 Sep-11 May-13 Source: Company data, Maybank Kim Eng Source: Company data, Maybank Kim Eng

18 October 2013 Page 62 of 82

Dah Sing Banking Group

INCOME STATEMENT BALANCE SHEET FYE Dec (HKDm) 2012A 2013F 2014F 2015F FYE Dec (HKDm) 2012A 2013F 2014F 2015F Net interest income 2,204 2,601 2,739 2,982 Cash & equivalent 17,464 18,296 19,179 20,118 Other operating income 756 905 1,022 1,122 Investment securities 38,677 37,103 38,598 42,443 Operating income 2,961 3,506 3,761 4,104 Net loans and advances 94,079 102,722 112,846 123,885 Operating expenses (1,833) (1,890) (2,024) (2,169) Fixed assets 2,248 2,293 2,338 2,385 Operating profit 1,127 1,616 1,737 1,935 Intangible assets - - - - Provisions for bad and doubtful debts (82) (254) (217) (179) Other assets 3,372 3,372 3,372 3,372 Operating profit after provisions 1,046 1,362 1,521 1,757 Total assets 155,839 163,785 176,334 192,203 Non-operating income 520 475 610 671 Pre-tax profit 1,565 1,837 2,131 2,428 Customer deposits 123,689 129,220 139,072 152,041 Taxation (155) (186) (220) (255) Borrowings 2,646 2,646 2,646 2,646 Minorities 0 0 0 0 Debentures 6,692 6,692 6,692 6,692 Net profit to ordinary shareholders 1,411 1,651 1,910 2,173 Other liabilities 7,394 8,653 10,012 11,391 Total liabilities 140,420 147,211 158,423 172,770 Minorities 15 15 15 15 Shareholders’ funds 15,403 16,559 17,896 19,417 Total liabilities and equity 155,839 163,785 176,334 192,203 GROWTH RATES IN KEY FINANCIALS FYE Dec 2012A 2013F 2014F 2015F Balance sheet KEY PERFORMANCE RATIOS Gross loans 6.6% 9.7% 9.8% 9.8% FYE Dec 2012A 2013F 2014F 2015F Deposits 6.1% 4.5% 7.6% 9.3% NPL 0.35% 0.40% 0.37% 0.35% Income statement Loan to deposit 69.7% 73.1% 74.6% 74.9% Net interest income 14.9% 18.0% 5.3% 8.9% Core tier 1 CAR 10.4% 10.1% 10.1% 10.1% Other operating income 29.0% 19.7% 13.0% 9.8% Leverage 10.1 9.9 9.9 9.9 Total operating income 18.2% 18.4% 7.3% 9.1% NIM 1.54% 1.73% 1.70% 1.70% Operating expenses 20.1% 3.1% 7.1% 7.1% Cost to income 61.9% 53.9% 53.8% 52.8% Pre-provision profit 15.2% 43.3% 7.5% 11.4% ROA 0.93% 1.03% 1.12% 1.18% Net profit 29.0% 17.0% 15.7% 13.8% ROE 9.3% 10.3% 11.1% 11.6%

PER SHARE DATA FYE Dec (HKD) 2012A 2013F 2014F 2015F EPS 1.15 1.35 1.56 1.78 DPS 0.32 0.40 0.47 0.53 PROFITABILITY RATIOS BVPS 12.31 13.23 14.30 15.52 FYE Dec 2012A 2013F 2014F 2015F OPERATING RATIOS AND CAPITAL STRUCTURE Total income/avg assets 2.0% 2.2% 2.2% 2.2% FYE Dec 2012A 2013F 2014F 2015F

NII/avg assets 1.5% 1.6% 1.6% 1.6% Cost to income ratio 61.9% 53.9% 53.8% 52.8% Other oper income/avg assets 0.5% 0.6% 0.6% 0.6% Operating expense/avg assets -1.2% -1.2% -1.2% -1.2% Operating profit/avg assets 0.7% 1.0% 1.0% 1.1% Interest expense/interest income 43.1% 38.2% 39.6% 40.1% Op profit after prov/avg assets 0.7% 0.9% 0.9% 1.0% CAR 14.9% 14.3% 13.9% 13.6% Provisions/avg assets -0.1% -0.2% -0.1% -0.1% Capital/assets 9.9% 10.1% 10.1% 10.1% Pre-tax profit/avg assets 1.0% 1.1% 1.3% 1.3% Capital/total loans 17.9% 17.5% 17.2% 17.0% Net profit/avg assets (ROA) 0.9% 1.0% 1.1% 1.2% Fixed assets/shareholders’ funds 14.6% 13.8% 13.1% 12.3% NII/total income 74.5% 74.2% 72.8% 72.7% Other oper income/total income 25.5% 25.8% 27.2% 27.3% FUNDING AND CREDIT QUALITY Operating profit/total income 38.1% 46.1% 46.2% 47.2% FYE Dec 2012A 2013F 2014F 2015F Op profit after prov/total income 35.3% 38.9% 40.4% 42.8% Total deposits/total liabilities 88.1% 87.8% 87.8% 88.0% Provisions/total income 2.8% 7.2% 5.8% 4.4% LD ratio 69.7% 73.1% 74.6% 74.9% Pre-tax profit/total income 52.9% 52.4% 56.6% 59.2% (Borrowings + debentures)/deposits 7.5% 7.2% 6.7% 6.1% Net profit/total income 47.6% 47.1% 50.8% 52.9% Provision charges to total loans 0.10% 0.28% 0.22% 0.16% ROE 9.3% 10.3% 11.1% 11.6% NPL/total loans 0.35% 0.40% 0.37% 0.35% NIM 1.54% 1.73% 1.70% 1.70% Total reserve coverage 86.6% 80.0% 81.1% 80.0%

Source: Company data, Maybank Kim Eng

18 October 2013 Page 63 of 82

Hong Kong

18 October 2013 Initiating Coverage

Hold (new) Dah Sing Financial Insurance Business The Weak Link

Share price: HKD47.60 (16 Oct 2013) Insurance business hit by rising long-term bond yields. The net Target price: HKD52.55 (new) profit of Dah Sing Financial’s (DSF) insurance business (including both life and general insurance in Hong Kong and Macau) fell 62.8% YoY to HKD58m in 1H13. This was due to mark-to-market losses on bond Steven CHAN investments as the US long-term bond yields surged in Jun 2013. Poor [email protected] investment return also saw the value of in-force (VIF) life policies (852) 2268 0645 declining 16% HoH in 1H13. But net insurance premium maintained

healthy growth of 15% YoY. Going forward, Dah Sing Life (DSL) will shift towards high-margin long-dated products. Given the 50bps QoQ

rise in US long-term bond yield in 3Q13, we forecast the net profit of Stock Information DSF’s insurance business to fall to HKD32m in 2H13 (HKD90m for the Description: Dah Sing Financial Holdings through its full year). We anticipate a slower increase in US long-term bond yield in subsidiaries, offers general banking services. The Company 2014. This, together with healthy growth in premium income, should also invests in properties and provides insurance broking and help lift the net profit of DSF’s insurance business to HKD155m for nominee services. 2014, making up 10.7% of our full-year net profit forecast for the group. Ticker: 440 HK Shares Issued (m): 296.5 Solid profit contribution from BCQ. DSB holds a 20% stake in Bank Market Cap (USDm): 1,864.2 of Chongqing (BCQ), which indirectly contributed 25% to DSF’s net 3-mth Avg Daily Turnover (USDm): 2.3 profit in 1H13. Management expects the operating environment in HSI: 23,228.3 Free Float (%): 58.9 Chongqing to remain sound given the city’s high GDP growth, lower reliance on export-oriented manufacturers and strong government Major Shareholders: % support. However, tightening capital constraints may see BCQ listing in DSI LTD 18.3 MITSUB UFJ 15.2 Hong Kong soon, which could dilute DSB’s shareholding in the bank. Aberdeen 8.9 We conservatively forecast BCQ’s net profit growth to moderate to 10% pa over 2013-2015 (1H13: +28.6% YoY). But this would still contribute

27% of our forecast net profit for DSF during this period. Key Indicators (2014) Dividend payout ratio to remain stable. Like DSB, DSF maintained a ROE (%): 8.6 low core dividend payout ratio of 20.3% in 1H13. Given management’s NIM: 1.68 Cost-income ratio: 55.2 intention to keep the core Tier 1 CAR of DSB at above 10% in the Credit cost: 0.22 coming years, we expect DSF will adopt a similar dividend policy to

DSB’s and keep dividend payout ratio at 30% during 2013-2015.

Historical Chart Initiate with HOLD. Mindful of the weak performance of the insurance business, we forecast DSF’s 2013-2014 core ROE to be lower than DAH SING FINANC HSI 190 DSB’s at 8-9%. Based on our sum-of-the parts (SOTP) valuation and a holding company discount of 18.7%, we arrive at a target price of 170 HKD52.55 for DSF, which translates to Dec 2014 P/B of 0.9x. We 150 initiate coverage with a HOLD rating.

130 DSF – Summary Earnings Table FYE Dec 2012A 2013F 2014F 2015F 110 Operating profit (HKDm) 1,282 1,704 1,836 2,054 Chg (%) 17.2 32.9 7.7 11.9 90 Net profit (HKDm) 1,236 1,301 1,449 1,632 Oct 12 Dec 12 Feb 13 Apr 13 Jun 13 Aug 13 Oct 13 Chg (%) 21.1 5.3 11.3 12.7 EPS (HKD) 4.22 4.44 4.95 5.57 Performance: Chg (%) 21.1 5.3 11.3 12.7 52-week High/Low HKD50/HKD28 P/E (x) 11.3 10.7 9.6 8.5 P/B (x) 0.91 0.86 0.80 0.76 1-mth 3-mth 6-mth 1-yr YTD ROE (%) 8.1 8.2 8.6 9.1 Absolute (%) 29% 53% 19% 74% 39% DPS (HKD) 1.20 1.33 1.48 1.67 Relative (%) 28% 45% 14% 64% 37% Yield (%) 2.5 2.8 3.1 3.5 Consensus net profit (HKDm) 1,288 1,360 1,475 Source: Company data, Maybank Kim Eng

SEE APPENDIX I FOR IMPORTANT DISCLOSURES AND ANALYST CERTIFICATIONS

Dah Sing Financial

Investment positives DSB remains a key profit contributor: DSF owns a 74.13% stake in DSB. With the earnings outlook for DSB improving, we forecast its net profit contribution to DSF will increase from 85% in 2012 to over 90% during 2013-2015.

Steady profit contribution from BCQ: BCQ indirectly contributed 25% of DSF’s net profit in 1H13. With operating conditions in Chongqing still promising, we expect BCQ’s net profit contribution to DSF will stay at 27% during 2013-2015.

Investment concerns Potential weakening in insurance business: In our view, DSF will continue to see the net profit of its insurance business undermined by the rise in US long- term bond yields in 2H13 and, to a lesser extent, in 2014. We forecast net profit contribution from the business to DSF will remain moderate at 10.7% in 2014.

Slightly higher cost-income ratio than DSB: Compensation of key management personnel in Dah Sing Group is included under DSF. This, coupled with the weak performance of its insurance business, means its cost-income ratio could come in at 54-55% during 2013-2015 (vs 53-54% for DSB).

Valuation and recommendations We forecast DSF’s core net profit to grow at 13% CAGR over 2012-2015, driven by strong profit contribution from both DSB and BCQ. However, with weaker performance in the insurance business, we forecast its core ROE to improve moderately from 7.3% in 2012 to 8-9% during 2013-2015.

In our SOTP valuation, we value DSB based on Dec 2014 P/B of 1.2x. To reflect the potential decline in investment return and VIF of existing policies, we apply a Dec 2014 P/B of 1x. Based on the stock’s 2004-2012 average, we also include a holding company discount of 18.7%. We thus arrive at a target price of HKD52.55 for DSF, which translates to Dec 2014 P/B of 0.9x. We initiate coverage of DSF with a HOLD rating. Key risks to our call include a sharp rise in short-term HKD interest rates, change in operating conditions in Chongqing and volatility of US long-term bond yields.

Figure 86: DSF – Sum-of-the-parts valuation Dec14E BV (HKDm) Fair P/B (x) Fair value (HKDm) % share Weighted fair value (HKDm) Dah Sing Banking Group 17,896 1.20 21,475 74.13 15,921 Dah Sing Life 1,771 1.00 1,771 100 1,771 Rest of DSF (Excluding goodwill) 1,233 1.00 1,233 100 1,233 SOP valuation of DSF 18,925 Holding company discount 18.7% Fair value of DSF 15,386 Fair value per share 52.55 Source: Company data, Maybank Kim Eng

Figure 87: DSF – trading P/E bands Figure 88: DSF – trading P/B bands

HKD HKD 140 140 2.0x 120 120 1.6x 100 22x 100 80 18x 80 1.2x

60 60 14x 0.8x 40 10x 40 0.4x 20 6x 20 0 0 Jan-02 Sep-03 May-05 Jan-07 Sep-08 May-10 Jan-12 Sep-13 Jan-02 Sep-03 May-05 Jan-07 Sep-08 May-10 Jan-12 Sep-13

Source: Company data, Maybank Kim Eng Source: Company data, Maybank Kim Eng

18 October 2013 Page 65 of 82

Dah Sing Financial

INCOME STATEMENT BALANCE SHEET FYE Dec (HKDm) 2012A 2013F 2014F 2015F FYE Dec (HKDm) 2012A 2013F 2014F 2015F Cash & equivalent 17,867 19,041 20,255 21,630 Net interest income 2,494 2,896 3,057 3,331 Investment securities 32,881 35,324 35,418 37,625 Other operating income 843 923 1,044 1,150 Net loans and advances 85,912 94,212 103,500 113,626 Operating income 3,336 3,820 4,101 4,481 Fixed assets 2,468 2,315 2,362 2,409 Operating expenses (2,054) (2,116) (2,265) (2,426) Intangible assets 1,044 1,044 1,044 1,044 Operating profit 1,282 1,704 1,836 2,054 Other assets 29,520 26,076 26,792 27,704 Provisions for bad and doubtful debts (82) (254) (217) (179) Total assets 169,692 178,012 189,370 204,039 Operating profit after provisions 1,200 1,450 1,619 1,876 Non-operating income 573 511 610 671 Customer deposits 122,279 129,220 139,072 152,041 Pre-tax profit 1,774 1,961 2,229 2,547 Borrowings 2,646 2,646 2,646 2,646 Taxation (175) (235) (290) (357) Debentures 6,648 6,692 6,692 6,692 Minorities (362) (424) (491) (558) Other liabilities 18,818 18,818 18,818 18,818 Net profit to ordinary shareholders 1,236 1,301 1,449 1,632 Total liabilities 150,391 157,376 167,229 180,197 Minorities 3,911 4,335 4,826 5,385 Shareholders’ funds 15,390 16,301 17,315 18,457 Total liabilities and equity 169,692 178,012 189,370 204,039 GROWTH RATES IN KEY FINANCIALS FYE Dec 2012A 2013F 2014F 2015F KEY PERFORMANCE RATIOS Balance sheet FYE Dec 2012A 2013F 2014F 2015F Gross loans 6.6% 9.7% 9.8% 9.8% NPL 0.35% 0.40% 0.37% 0.35% Deposits 6.5% 5.7% 7.6% 9.3% Loan to deposit 70.5% 73.1% 74.6% 74.9% Income statement Core tier 1 CAR 10.4% 10.1% 10.1% 10.1% Net interest income 14.1% 16.1% 5.6% 8.9% Leverage 11.0 10.9 10.9 11.1 Other operating income 36.2% 9.6% 13.0% 10.2% NIM 1.54% 1.70% 1.68% 1.71% Total operating income 19.0% 14.5% 7.4% 9.3% Cost to income 61.6% 55.4% 55.2% 54.1% Operating expenses 20.1% 3.0% 7.1% 7.1% ROA 0.75% 0.75% 0.79% 0.83% Pre-provision profit 17.2% 32.9% 7.7% 11.9% ROE 8.1% 8.2% 8.6% 9.1% Net profit 21.1% 5.3% 11.3% 12.7% PER SHARE DATA FYE Dec (HKD) 2012A 2013F 2014F 2015F EPS 4.22 4.44 4.95 5.57 DPS 1.20 1.33 1.48 1.67 PROFITABILITY RATIOS BVPS 52.56 55.67 59.13 63.04 FYE Dec 2012A 2013F 2014F 2015F OPERATING RATIOS AND CAPITAL STRUCTURE Total income/avg assets 2.0% 2.2% 2.2% 2.3% FYE Dec 2012A 2013F 2014F 2015F

NII/avg assets 1.5% 1.7% 1.7% 1.7% Cost to income ratio 61.6% 55.4% 55.2% 54.1% Other oper income/avg assets 0.5% 0.5% 0.6% 0.6% Operating expense/avg assets -1.2% -1.2% -1.2% -1.2% Operating profit/avg assets 0.8% 1.0% 1.0% 1.0% Interest expense/interest income 39.9% 35.8% 37.1% 37.5% Op profit after prov/avg assets 0.7% 0.8% 0.9% 1.0% CAR 14.9% 14.3% 13.9% 13.6% Provisions/avg assets 0.0% -0.1% -0.1% -0.1% Capital/assets 9.1% 9.2% 9.1% 9.0% Pre-tax profit/avg assets 1.1% 1.1% 1.2% 1.3% Capital/total loans 17.9% 17.2% 16.7% 16.2% Net profit/avg assets (ROA) 0.8% 0.7% 0.8% 0.8% Fixed assets/shareholders’ funds 16.0% 14.2% 13.6% 13.1% NII/total income 74.7% 75.8% 74.5% 74.3% Other oper income/total income 25.3% 24.2% 25.5% 25.7% FUNDING AND CREDIT QUALITY Operating profit/total income 38.4% 44.6% 44.8% 45.9% FYE Dec 2012A 2013F 2014F 2015F Op profit after prov/total income 36.0% 38.0% 39.5% 41.9% Total deposits/total liabilities 81.3% 82.1% 83.2% 84.4% Provisions/total income 2.4% 6.6% 5.3% 4.0% LD ratio 70.5% 73.1% 74.6% 74.9% Pre-tax profit/total income 53.2% 51.3% 54.4% 56.8% (Borrowings + debentures)/deposits 7.6% 7.2% 6.7% 6.1% Net profit/total income 37.1% 34.1% 35.3% 36.4% Provision charges to total loans 0.10% 0.28% 0.22% 0.16% ROE 8.1% 8.2% 8.6% 9.1% NPL/total loans 0.35% 0.40% 0.37% 0.35% NIM 1.54% 1.70% 1.68% 1.71% Total reserve coverage 86.6% 80.0% 81.1% 80.0%

Source: Company data, Maybank Kim Eng

18 October 2013 Page 66 of 82

Hong Kong

18 October 2013 Initiating Coverage

Sell (new) Hang Seng Bank Limited Near-term Positive Catalysts Share price: HKD128.3 (16 Oct 2013) Target price: HKD107.25 (new) Limited NIM recovery and potentially volatile net fees. Unlike BOCHK, the NIM of Hang Seng Bank (HSB) narrowed slightly from 1.85% in 1H12 to 1.84% in 1H13 due to lower yield on non-loan assets.

Steven CHAN We expect its NIM to stay at 1.83-1.84% in 2H13-2014 as short-term [email protected] USD interest rates should remain stable in 2014, thereby restraining the (852) 2268 0645 rebound of its deposit spread and yield on interest-free funds. Stock market-related fees (stock brokerage and investment funds distribution) accounted for 38% of HSB’s total fees in 1H13, up from 33% in 2012. We estimate a 10% decline in these fees will lower our forecast pre-tax

profit for HSB by 1.4% for 2014. Stock Information Description: Hang Seng Bank is one of the largest banks in Benign asset quality. Credit cost remained low at 0.07% in 1H13 Hong Kong and is 62%-owned by HSBC. (0.08% in 2012), mainly due to a fall in NPL ratio from 0.25% in Dec 2012 to 0.22% in Jun 2013. HSB has good track record of asset quality Ticker: 11 HK Shares Issued (m): 1,912 in recent years, given its prudent lending policy and high loan collateral Market Cap (USDm): 31,485 coverage. We forecast credit cost to stay low at 0.07% in 2013-2015. 3-mth Avg Daily Turnover (USDm): 18.4 HSI: 23,228.3 Low profit contribution from organic China business. With some Free Float (%): 37.9 NIM pressure driven by asymmetric interest rate cuts and interest rate

Major Shareholders: % liberalisation in China, the operating profit of Hang Seng China (HSC) HSBC 62.1 fell 35% YoY to HKD129m in 1H13, accounting for merely 1.4% of HSB’s operating profit. Unlike BEA China, HSC’s penetration of local enterprises in China is not as good. We forecast its operating profit

contribution to HSB will remain below 2% in the next few years.

Key Indicators (2014) Basel III impact not fully reflected yet. HSB’s core Tier 1 CAR rose to ROE (%): 14.8 13.6% in Jun 2013 as a result of the accounting gains arising from the NIM: 1.84 reclassification of its investment in Industrial Bank (IB). However, under Cost-income ratio: 32.8 the Basel III capital rules, its investment in IB will still be considered as Credit cost: 0.07 “significant investment” (even though it is classified as investment securities instead of associated company under IFRS). The capital deductions of IB will be gradually in place over 2014-2018. We estimate Historical Chart that this will finally lower HSB’s core Tier 1 CAR by 3.4ppts. HANG SENG BK HSI 115 Initiate with SELL. With the change in account booking on IB’s profit 110 contribution, HSB’s core ROE could plunge from 21.4% in 2012 to 15% in 2014. Based on a long-term ROE assumption of 16% in our Gordon 105 Growth Model (GGM), our target price for HSB is HKD107.25, which 100 translates to Dec 2014 P/B of 1.8x. We initiate coverage with a SELL.

95 HSB – Summary Earnings Table FYE Dec 2012A 2013F 2014F 2015F 90 Operating profit (HKDm) 15,873 17,730 19,676 21,621 Oct 12 Dec 12 Feb 13 Apr 13 Jun 13 Aug 13 Oct 13 Chg (%) 8.0 11.7 11.0 9.9 Net profit (HKDm) 19,327 25,622 16,426 18,043 Chg (%) 14.5 32.6 (35.9) 9.8 Performance: EPS (HKD) 10.11 13.40 8.59 9.44 52-week High/Low HKD133/HKD111 Chg (%) 14.5 32.6 (35.9) 9.8 P/E (x) 12.7 9.6 14.9 13.6 1-mth 3-mth 6-mth 1-yr YTD P/B (x) 2.66 2.28 2.15 2.03 Absolute (%) 1% 8% 3% 8% 8% ROE (%) 22.5 25.6 14.8 15.3 Relative (%) 0% 0% -2% -2% 5% DPS (HKD) 5.30 5.30 5.30 5.83 Yield (%) 4.1 4.1 4.1 4.5 Consensus net profit (HKDm) 21,449 16,856 18,581 Source: Company data, Maybank Kim Eng

SEE APPENDIX I FOR IMPORTANT DISCLOSURES AND ANALYST CERTIFICATIONS

Hang Seng Bank

Investment positives Good track record of tight cost control: Due to tight control of staff cost and administrative expenses, as well as the sharing of a common IT platform with HSBC, HSB was able to keep its cost-income ratio at below 35% over the past decade. We forecast its cost-income ratio will remain low at 32-34% in 2013-2015.

Low credit cost: HSB’s main strength is its prudent lending policy and high loan collateral coverage. We forecast its credit cost to stay low at 7bps in 2013-2015.

Investment concerns Limited catalyst to widen NIM: Slight NIM pressure in 1H13 was due to lower yield on non-loan assets. HSB will be a key beneficiary of HIBOR increase given demand and savings deposits which account for 67% of its total deposits.

Weak organic China business: The bulk of HSC’s customers are Hong Kong SMEs which have manufacturing bases in China. Its slow penetration of local enterprises will keep its profit contribution to HSB at below 2% in the near term.

Gradual fall in core Tier 1 CAR: The capital deduction for HSB’s investment in IB will be gradually in place over 2014-2018. We estimate this will lower HSB’s core Tier 1 CAR by a total of 3.4ppts by 2018.

Valuation and recommendations Due to the change in account booking, HSB will reclassify its investment in IB as “equity investment” instead of “associated company”. We therefore forecast its core net profit to fall 4.4% in 2013 and 6.6% in 2014. In turn, its core ROE could also plunge from 21.4% in 2012 to 14.8-15.3% in 2014-2015.

We project a long-term ROE of 16% for HSB in our GGM. This is lower than the stock’s historical trough ROE of 22.4% during 2002-2012. Our target price of HKD107.25 is based on our GGM-derived fair Dec 2014 P/B of 1.8x, which is also below the stock’s historical trough P/B of 2.1x during 2002-2012. We initiate coverage of HSB with a SELL rating. Key risks to our call include a sharp rise in short-term HKD interest rates and the disposal of the investment in IB (which may result in the payment of a special dividend).

Figure 89: HSB – Gordon Growth Model Implied ROE 14.0% 15.0% 16.0% 17.0% 18.0% Long term dividend payout ratio (k) 57.0% Cost of Equity (CoE= Rf + Rm * B) 12.0% Long term sustainable growth (g) 6.9% Discount rate (CoE - g) 5.1% Target P/B(x): (ROE * k) / (CoE - g) 1.57 1.68 1.80 1.91 2.02 Dec 14F BVPS 59.68 Target price based on 1.8x Dec 14F P/B 93.84 100.54 107.25 113.95 120.65 Source: Company data, Maybank Kim Eng

Figure 90: HSB – trading PER bands Figure 91: HSB – trading P/BV bands

HKD HKD 5.6x 200 240 180 4.8x 20x 200 160 17.5x 4.0x 140 15x 160 3.2x 120 12.5x 100 120 2.2x 80 10x 80 60 40 40 Jan-02 Sep-03 May-05 Jan-07 Sep-08 May-10 Jan-12 Sep-13 Jan-02 Sep-03 May-05 Jan-07 Sep-08 May-10 Jan-12 Sep-13 Source: Company data, Maybank Kim Eng Source: Company data, Maybank Kim Eng

18 October 2013 Page 68 of 82

Hang Seng Bank

INCOME STATEMENT BALANCE SHEET FYE Dec (HKDm) 2012A 2013F 2014F 2015F FYE Dec (HKDm) 2012A 2013F 2014F 2015F Cash & equivalent 167,464 176,195 186,381 197,484 Net interest income 16,946 18,366 19,649 21,319 Investment securities 301,329 382,317 311,817 334,254 Other operating income 7,435 8,380 9,626 10,474 Net loans and advances 536,162 586,870 641,027 699,365 Operating income 24,381 26,746 29,275 31,793 Fixed assets 24,122 25,328 26,595 27,924 Operating expenses (8,508) (9,016) (9,599) (10,172) Intangible assets - - - - Operating profit 15,873 17,730 19,676 21,621 Other assets 48,019 35,889 37,509 39,201 Provisions for bad and doubtful debts (386) (421) (450) (503) Total assets 1,077,096 1,206,599 1,203,329 1,298,229 Operating profit after provisions 15,487 17,310 19,227 21,118 Non-operating income 6,507 10,031 445 490 Customer deposits 780,438 849,661 925,115 1,007,359 Pre-tax profit 21,994 27,340 19,672 21,608 Borrowings 19,845 19,845 19,845 19,845 Taxation (2,667) (1,719) (3,246) (3,565) Debentures 11,821 11,821 11,821 11,821 Minorities - - - - Other liabilities 172,669 217,461 132,444 138,204 Net profit to ordinary shareholders 19,327 25,622 16,426 18,043 Total liabilities 984,773 1,098,788 1,089,225 1,177,228 Minorities - - - - Shareholders’ funds 92,323 107,812 114,105 121,001 Total liabilities and equity 1,077,096 1,206,599 1,203,329 1,298,229 GROWTH RATES IN KEY FINANCIALS FYE Dec 2012A 2013F 2014F 2015F KEY PERFORMANCE RATIOS Balance sheet FYE Dec 2012A 2013F 2014F 2015F Gross loans 11.5% 9.5% 9.2% 9.1% NPL 0.38% 0.35% 0.32% 0.30% Deposits 10.1% 8.9% 8.9% 8.9% Loan to deposit 68.9% 69.3% 69.5% 69.6% Income statement Core tier 1 CAR 12.2% 14.0% 13.3% 12.5% Net interest income 7.7% 8.4% 7.0% 8.5% Leverage 11.7 11.2 10.5 10.7 Other operating income 8.4% 12.7% 14.9% 8.8% NIM 1.85% 1.83% 1.84% 1.84% Total operating income 7.9% 9.7% 9.5% 8.6% Cost to income 34.9% 33.7% 32.8% 32.0% Operating expenses 7.7% 6.0% 6.5% 6.0% ROA 1.88% 2.24% 1.36% 1.44% Pre-provision profit 8.0% 11.7% 11.0% 9.9% ROE 22.5% 25.6% 14.8% 15.3% Net profit 14.5% 32.6% -35.9% 9.8% PER SHARE DATA FYE Dec (HKD) 2012A 2013F 2014F 2015F EPS 10.11 13.40 8.59 9.44 DPS 5.30 5.30 5.30 5.83 PROFITABILITY RATIOS BVPS 48.29 56.39 59.68 63.29 FYE Dec 2012A 2013F 2014F 2015F OPERATING RATIOS AND CAPITAL STRUCTURE Total income/avg assets 2.4% 2.3% 2.4% 2.5% FYE Dec 2012A 2013F 2014F 2015F

NII/avg assets 1.7% 1.6% 1.6% 1.7% Cost to income ratio 34.9% 33.7% 32.8% 32.0% Other oper income/avg assets 0.7% 0.7% 0.8% 0.8% Operating expense/avg assets -0.8% -0.8% -0.8% -0.8% Operating profit/avg assets 1.5% 1.6% 1.6% 1.7% Interest expense/interest income 22.5% 22.6% 23.6% 24.9% Op profit after prov/avg assets 1.5% 1.5% 1.6% 1.7% CAR 14.0% 16.4% 15.8% 15.1% Provisions/avg assets 0.0% 0.0% 0.0% 0.0% Capital/assets 8.6% 8.9% 9.5% 9.3% Pre-tax profit/avg assets 2.1% 2.4% 1.6% 1.7% Capital/total loans 17.2% 18.3% 17.8% 17.3% Net profit/avg assets (ROA) 1.9% 2.2% 1.4% 1.4% Fixed assets/shareholders’ funds 26.1% 23.5% 23.3% 23.1% NII/total income 69.5% 68.7% 67.1% 67.1% Other oper income/total income 30.5% 31.3% 32.9% 32.9% FUNDING AND CREDIT QUALITY Operating profit/total income 65.1% 66.3% 67.2% 68.0% FYE Dec 2012A 2013F 2014F 2015F Op profit after prov/total income 63.5% 64.7% 65.7% 66.4% Total deposits/total liabilities 79.3% 77.3% 84.9% 85.6% Provisions/total income 1.6% 1.6% 1.5% 1.6% LD ratio 68.9% 69.3% 69.5% 69.6% Pre-tax profit/total income 90.2% 102.2% 67.2% 68.0% (Borrowings + debentures)/deposits 4.1% 3.7% 3.4% 3.1% Net profit/total income 79.3% 95.8% 56.1% 56.8% Provision charges to total loans 0.08% 0.07% 0.07% 0.07% ROE 22.5% 25.6% 14.8% 15.3% NPL/total loans 0.38% 0.35% 0.32% 0.30% NIM 1.85% 1.83% 1.84% 1.84% Total reserve coverage 69.0% 74.3% 81.3% 86.7%

Source: Company data, Maybank Kim Eng

18 October 2013 Page 69 of 82

Hong Kong

18 October 2013 Initiating Coverage

Hold (new) HSBC Renewed Concerns Over Regulatory Cost Share price: HKD84.90 (16 Oct 2013) Target price: HKD88.30 (new) NIM still under pressure. HSBC saw its NIM narrow to 2.17% in 1H13 from 2.27% in 2H12 following the USD3.7b sale of its non-real estate loan portfolio in the US coupled with lower yield on surplus liquidity. The

bank also plans to sell some of its US real estate secured loans Steven CHAN (USD5.8b with NIM of 2.3-2.4%) in the next 18 months. This, together [email protected] with the continued downsizing of its US personal loan portfolio (about (852) 2268 0645 USD5b pa), would lower HSBC’s NIM to 2.07% in 2H13 and 2% in 2014, based on our forecasts.

Cost savings as key earnings driver. Management targets total cost savings of USD4.6b for 2013 (USD3.6b in 2012; USD0.8b in 1H13) and Stock Information additional cost savings of USD2-3b pa during 2014-2016. This will be Description: HSBC is one of the world's largest banking and achieved through further lay-offs of 10k-20k employees and financial services organisations. Its main businesses include retail banking and wealth management, commercial banking, streamlining processes and procedures within the group. We forecast global banking and markets, and global private banking. its cost-income ratio will fall below 53% by 2015.

Ticker: 5 HK Potential new regulatory costs. Expenses for the UK customer Shares Issued (m): 18,764.7 redressal programmes with regard to Payment Protection Insurance Market Cap (USDm): 204.3 and Interest Rate Protection products fell to USD0.4b in 1H13 3-mth Avg Daily Turnover (USDm): 144.8 HSI: 23.218.3 (USD2.3b in 2012). However, HSBC may be subject to claims on other Free Float (%): 99.9 legal proceedings and investigations: (i) the securities litigation related to the acquisition of HSBC Finance in 2002 (maximum claims of Major Shareholders: % USD2.5b); (ii) the US mortgage securitisation litigation related to MBS JP Morgan 7.1 Blackrock 5.9 during 2005-2007 (maximum claims of USD1.6b); and (iii) redress package related to the misspelling of protection insurance to UK credit cardholders (claims of USD0.2b). We project total regulatory costs of USD1.3b for 2013 and USD0.5b for 2014 (USD4.2b in 2012).

Key Indicators (2014) Proactive capital management. Management estimates its core Tier 1 ROE (%): 10.1 CAR under the CRD IV rules to be 10.1% as of Jun 2013. Assuming a NIM: 2.00 dividend payout ratio of 60%, we estimate HSBC’s CRD IV core Tier 1 Cost-income ratio: 56.0 CAR will remain above 10% during 2013-2015. HSBC will also consider Credit cost: 0.57 a share buyback from 2014 onwards to sterilise the scrip dividends. If so, this would lower its core Tier 1 CAR by 30-40bps.

Historical Chart Initiate with HOLD. With additional cost savings and lower regulatory HSBC HLDGS PLC HSI costs, we forecast HSBC’s core ROE will to 10.1-11.3% in 2014-2015. 125 Based on a long-term ROE assumption of 11.5% in our Gordon Growth 120 Model (GGM), we arrive at a target price at HKD88.30, which translates 115 to Dec 2014 P/B of 1.1x. We initiate coverage with a HOLD rating. 110 HSBC – Summary Earnings Table 105 FYE Dec 2012A 2013F 2014F 2015F 100 Operating profit (USDm) 25,403 27,643 29,593 33,094 Chg (%) (17.3) 8.8 7.1 11.8 95 Net profit (USDm) 13,454 16,935 18,869 21,974 90 Chg (%) (17.1) 25.9 11.4 16.5 Oct 12 Dec 12 Feb 13 Apr 13 Jun 13 Aug 13 Oct 13 Pre-tax profit (USDm) 20,649 23,802 26,670 30,829 Chg (%) (5.6) 15.3 12.0 15.6 EPS (HKD) 5.78 7.13 7.95 9.25 Performance: Chg (%) (19.0) 23.5 11.4 16.5 52-week High/Low HKD91/HKD73 P/E (x) 14.7 11.9 10.7 9.2 P/B (x) 1.15 1.10 1.05 1.01 1-mth 3-mth 6-mth 1-yr YTD ROE (%) 8.1 9.4 10.1 11.3 Absolute (%) -1% -1% 3% 15% 4% DPS (HKD) 3.50 4.28 4.77 5.55 Relative (%) -2% -9% -2% 4% 1% Yield (%) 4.1 5.1 5.6 6.6

Consensus PBT (USDm) 25,499 27,549 30,956

Source: Company data, Maybank Kim Eng

SEE APPENDIX I FOR IMPORTANT DISCLOSURES AND ANALYST CERTIFICATIONS

HSBC

Investment positives Cost-income ratio on steady downtrend: Management is targeting total cost savings of USD4.6b for 2013 and additional cost savings of USD2-3b pa during 2014-2016. We forecast HSBC’s cost-income will fall below 53% by 2015. Sustainable high dividend payout: HSBC’s CRD IV core Tier 1 CAR will still be above 10% even if it keeps its dividend payout ratio at 60% during 2013-2015.

Investment concerns Slow loan growth and NIM pressure: With continued downsizing and disposal of its non-core personal loan portfolio in the US, we forecast HSBC’s loan growth will be low at 2-3% pa during 2014-2015 and its NIM will fall to 2% by 2014. Concerns over asset quality: HSBC increased its loan loss provisions to exposures in Brazil and Mexico in 1H13. Even as the asset quality of these loans stabilised in 3Q13, the market became worried about its asset quality in India and Indonesia (1.3% of HSBC’s total loans as of Jun 2013). We forecast HSBC’s credit cost will fall at a slower pace to 0.62% for 2013 and 0.57% for 2014. New regulatory costs ahead: HSBC may be subject to further claims on various legal proceedings and investigations in the US and the UK. We project total regulatory costs of USD1.3b for 2013 and USD0.5b for 2014 (USD4.2b in 2012).

Valuation and recommendations After factoring in additional cost savings and lower credit and regulatory costs, we forecast HSBC’s core net profit to grow at 31.3% CAGR over 2012-2015 (given a low base for comparison in 2012). In turn, its core ROE should rebound from 5.8% in 2012 to 10.1-11.3% in 2014-2015 (lower than our target of 12%). We project a long-term ROE of 11.5% for HSBC in our GGM. This is below the stock’s historical average ROE of 12% during 2002-2012. Our target price of HKD88.30 is based on our GGM-derived fair Dec 2014 P/B of 1.1x, which is also below the stock’s historical average P/B of 1.66x during 2002-2012. We initiate coverage of HSBC with a HOLD rating. Key risks to our call include volatility of global interest rates and currency exchange rates as well as deterioration in economic conditions in Latin America and the Asia Pacific.

Figure 92: HSBC – Gordon Growth Model Implied ROE 9.50% 10.50% 11.50% 12.50% 13.50% Long term dividend payout ratio (k) 60.0% Cost of Equity (CoE= Rf + Rm * B) 10.9% Long term sustainable growth (g) 4.6% Discount rate (CoE - g) 6.3% Target P/B (x): (ROE * k) / (CoE - g) 0.91 1.00 1.10 1.19 1.29 Dec14F BVPS 80.34 Target price based on 1.1x Dec14F PBR 72.94 80.62 88.30 95.98 103.65 Source: Company data, Maybank Kim Eng

Figure 93: HSBC – trading P/E bands Figure 94: HSBC – trading P/B bands

HKD HKD 218 220 32x 178 2.4x 180 26x 138 1.9x 140 20x 1.4x 100 14x 98 0.9x 58 60 8x 0.5x 20 18 Jan-02 Sep-03 May-05 Jan-07 Sep-08 May-10 Jan-12 Sep-13 Jan 02 Sep 03 May 05 Jan 07 Sep 08 May 10 Jan 12 Sep 13 Source: Company data, Maybank Kim Eng Source: Company data, Maybank Kim Eng

18 October 2013 Page 71 of 82

HSBC

INCOME STATEMENT BALANCE SHEET FYE Dec (USDm) 2012A 2013F 2014F 2015F FYE Dec (USDb) 2012A 2013F 2014F 2015F Net interest income 37,672 34,941 34,734 36,075 Other operating income 30,658 31,014 32,477 34,159 Cash & equivalent 301 301 301 301 Operating income 68,330 65,955 67,211 70,234 Investment securities 1,221 1,339 1,406 1,486 Operating expenses (42,927) (38,313) (37,618) (37,140) Net loans and advances 998 986 1,010 1,043 Operating profit 25,403 27,643 29,593 33,094 Fixed assets 11 11 12 12 Provisions for bad and doubtful debts (8,160) (6,283) (5,732) (5,496) Intangible assets 30 30 30 30 Other provisions (151) - - - Other assets 109 105 108 111 Operating profit after provisions 17,092 21,359 23,861 27,599 Total assets 2,670 2,772 2,867 2,984 Non-operating income 3,557 2,443 2,809 3,230 Pre-tax profit 20,649 23,802 26,670 30,829 Customer deposits 1,340 1,407 1,477 1,559 Taxation (5,315) (5,117) (5,933) (6,859) Borrowings 107 107 107 107 Minorities (1,880) (1,749) (1,867) (1,996) Debentures 149 149 149 149 Net profit 13,454 16,935 18,869 21,974 Other liabilities 890 918 935 961 Total liabilities 2,487 2,581 2,668 2,776 GROWTH RATES IN KEY FINANCIALS Minorities 8 8 8 8 FYE Dec 2012A 2013F 2014F 2015F Shareholders’ funds 175 183 191 200 Balance sheet Total liabilities and equity 2,670 2,772 2,867 2,984 Gross loans 5.8% -1.3% 2.3% 3.1% Deposits 6.9% 5.0% 5.0% 5.5% Income statement Net interest income -7.4% -7.2% -0.6% 3.9% KEY PERFORMANCE RATIOS Other operating income -3.0% 1.2% 4.7% 5.2% Total operating income -5.5% -3.5% 1.9% 4.5% FYE Dec 2012A 2013F 2014F 2015F Operating expenses 3.3% -10.7% -1.8% -1.3% NPL 3.55% 3.13% 2.61% 2.36% Pre-provision profit -17.3% 8.8% 7.1% 11.8% Loan to deposit 75.6% 71.1% 69.2% 67.7% Net profit -17.1% 25.9% 11.4% 16.5% Core tier 1 CAR 13.4% 13.6% 11.2% 11.4% Leverage 15.2 15.1 15.0 15.0 PROFITABILITY RATIOS NIM 2.32% 2.11% 2.00% 1.95% FYE Dec 2012A 2013F 2014F 2015F Cost to income 62.8% 58.1% 56.0% 52.9% Total income/avg assets 2.6% 2.4% 2.4% 2.4% ROA 0.52% 0.62% 0.67% 0.75% NII/avg assets 1.4% 1.3% 1.2% 1.2% ROE 8.1% 9.4% 10.1% 11.3% Other oper income/avg assets 1.2% 1.1% 1.2% 1.2% RONTA 9.8% 11.3% 12.0% 13.3% Operating profit/avg assets 1.0% 1.0% 1.0% 1.1% Op profit after prov/avg assets 0.7% 0.8% 0.8% 0.9% Provisions/avg assets -0.3% -0.2% -0.2% -0.2% Pre-tax profit/avg assets 0.8% 0.9% 0.9% 1.1% PER SHARE DATA Net profit/avg assets (ROA) 0.5% 0.6% 0.7% 0.8% FYE Dec (HKD) 2012A 2013F 2014F 2015F

NII/total income 55.1% 53.0% 51.7% 51.4% Other oper income/total income 44.9% 47.0% 48.3% 48.6% EPS 5.78 7.13 7.95 9.25 Operating profit/total income 37.2% 41.9% 44.0% 47.1% DPS 3.50 4.28 4.77 5.55 Op profit after prov/total income 25.0% 32.4% 35.5% 39.3% BVPS 73.77 77.16 80.34 84.04 Provisions/total income 11.9% 9.5% 8.5% 7.8% NTAPS 61.22 64.59 67.77 71.47 Pre-tax profit/total income 30.2% 36.1% 39.7% 43.9% Net profit/total income 19.7% 25.7% 28.1% 31.3% ROE 8.1% 9.4% 10.1% 11.3% NIM 2.32% 2.11% 2.00% 1.95% OPERATING RATIOS AND CAPITAL STRUCTURE FYE Dec 2012A 2013F 2014F 2015F FUNDING AND CREDIT QUALITY FYE Dec 2012A 2013F 2014F 2015F Cost to income ratio 62.8% 58.1% 56.0% 52.9% Total deposits/total liabilities 53.9% 54.5% 55.4% 56.1% Operating expense/avg assets -1.6% -1.4% -1.3% -1.3% LD ratio 75.6% 71.1% 69.2% 67.7% Interest expense/interest income 33.6% 42.2% 48.5% 49.4% (Borrowings + debentures)/deposits 19.1% 18.2% 17.4% 16.4% CAR 16.1% 16.2% 13.4% 13.5% Provision charges to total loans 0.83% 0.62% 0.57% 0.53% Capital/assets 6.6% 6.6% 6.7% 6.7% NPL/total loans 3.55% 3.13% 2.61% 2.36% Capital/total loans 17.3% 18.3% 18.7% 18.9% Total reserve coverage 43.5% 44.8% 45.5% 46.2% Fixed assets/shareholders’ funds 6.0% 6.1% 6.1% 6.1%

Source: Company data, Maybank Kim Eng

18 October 2013 Page 72 of 82

Hong Kong

18 October 2013 Initiating Coverage

Hold (new) Standard Chartered PLC Gloomy Outlook In India And Korea Share price: HKD182.70 Target price: HKD189.00 (new) Healthy loan growth with stable NIM. Standard Chartered Bank (SCB) reported loan growth of 2.5% HoH in 1H13. Loan growth remained solid in 3Q13, particularly in Hong Kong and Africa. We project loan growth

of 6-8% pa in 2013-2014. NIM narrowed across most regions during Steven CHAN 2Q12-1Q13 (2.19% in 1H13; 2.28% in 1H12), mainly in credit card [email protected] advances and trade finance. NIM for new business has stabilised since (852) 2268 0645 2Q13. We forecast SCB’s NIM to stay at 2.16-2.17% during 2013-2014.

Concerns over exchange rate and credit risk in India. The onshore and offshore loans in India amounted to, respectively, USD12.1b (30% denominated in USD) and USD11.5b (mostly denominated in USD) in Stock Information Jun 2013, accounting for 8% of SCB’s total loans. The NPLs of onshore Description: Standard Chartered PLC is an international wholesale loans increased to USD859m in Jun 2013 (USD754m in Dec banking group operating principally in Asia, Africa and the Middle East. 2012), mainly due to a small number of exposures. Management remains cautious over the asset quality of SME loans in India (USD2.1b in Jun 2013). We project a rise in credit cost of SCB’s Indian exposure Ticker: 2888 HK Shares Issued (m): 2,424.3 to 2.2-2.4% during 2013-2014 (1.9% in 1H13). Meanwhile, the INR has Market Cap (USDm): 57.1 depreciated against the USD by 5.4% in 3Q13 (-8% HoH in 1H13). The 3-mth Avg Daily Turnover (USDm): 17.0 India business contributed 13.5% of SCB’s pre-tax profit in 1H13. We HSI: 23,228.3 estimate that for every 10% depreciation of the INR against the USD, Free Float (%): 81.9 the negative impact on SCB’s pre-tax profit will be 0.9%. Major Shareholders: % Temasek Holdings 18.1% Slow earnings recovery in Korea. Excluding the USD1b goodwill Aberdeen 8.2% write-offs, SCB saw the pre-tax profit of its Korea business fall by half to Blackrock 6.4% USD158m in 1H13, dented by shrinking loan growth, NIM pressure and higher credit cost. Management remains cautious over the asset quality

of unsecured personal loans in Korea (USD6.4b in Jun 2013) as Key Indicators (2014) individual filings under the Personal Debt Rehabilitation Scheme has not moderated. Overdue personal loans that have not been classified ROE (%): 11.5 NIM: 2.16 as NPLs totalled USD0.8b in Jun 2013. We forecast the credit cost of Cost-income ratio: 54.9 the Korea business to rise to 1.2-1.3% in 2013-2014 (1.13% in 1H13; Credit cost: 0.47 0.7% in 2012). Thus, we expect 2013-2014 pre-tax profit contribution of

this business to fall below 5% of group total (7.5% in 2012).

Historical Chart Initiate with HOLD. With solid revenue growth and tight cost control, we forecast SCB’s core ROE to rise to 11.8% by 2015. Based on a STANDARD CHARTER HSI 130 long-term ROE assumption of 11.75% in our Gordon Growth Model (GGM), we arrive at a target price of HKD189.00, equivalent to Dec 120 2014 P/B of 1.15x. We initiate coverage with a HOLD rating.

Standard Chartered – Summary Earnings Table 110 FYE Dec 2012A 2013F 2014F 2015F Operating profit (USDm) 8,061 9,239 9,562 10,153 100 Chg (%) 4.4 14.6 3.5 6.2 Net profit (USDm) 4,786 4,646 5,702 6,263 90 Chg (%) 0.8 (2.9) 22.7 9.8 Oct 12 Dec 12 Feb 13 Apr 13 Jun 13 Aug 13 Oct 13 Pre-tax profit (USDm) 6,851 6,935 8,340 9,020 Chg (%) 0.8 12.7 4.6 7.9 EPS (HKD) 15.54 14.98 18.38 20.19 Performance: Chg (%) (0.6) (3.6) 22.7 9.8 52-week High/Low HKD215/HKD167 P/E (x) 11.8 12.2 9.9 9.0 P/B (x) 1.25 1.18 1.11 1.03 1-mth 3-mth 6-mth 1-yr YTD ROE (%) 11.1 10.0 11.5 11.8 Absolute (%) 0% 3% -8% 6% -7% DPS (HKD) 6.50 7.02 7.58 8.19 Relative (%) -1% -6% -13% -5% -9% Yield (%) 3.6 3.8 4.1 4.5

Consensus PBT (USDm) 7,527 8,488 9,375

Source: Company data, Maybank Kim Eng

SEE APPENDIX I FOR IMPORTANT DISCLOSURES AND ANALYST CERTIFICATIONS

Standard Chartered PLC

Investment positives Stronger revenue growth than HSBC: With healthy loan growth, easing NIM pressure and recovery in wealth management and fees, we forecast total revenue of SCB to grow at 6.2% CAGR (HSBC: 0.9% CAGR) over 2012-2015. Disciplined cost control: SCB has a proven track record of keeping expense growth in line with or below underlying revenue growth. Excluding the fair value gain on its own debt liabilities (USD237m in 1H13), we forecast SCB’s underlying cost-income ratio to stay at about 54-55% during 2013-2014 (53.8% in 2012).

Investment concerns Asset quality in India and Korea poses concern: Management remains cautious over the asset quality of SME loans in India (USD2.1b in Jun 2013) and unsecured personal loans in Korea (USD6.4b in Jun 2013). We forecast SCB’s overall credit cost to rise from 0.43% in 2012 to 0.47-0.51% during 2013-2014. Lower dividend payout than HSBC: To keep its core Tier 1 CAR above 10% under the CRD IV capital rules (10.6% in Jun 2013), we expect SCB will maintain its dividend payout ratio at 40% in the next few years.

Valuation and recommendations After factoring in the recovery in total revenue and higher credit cost, we forecast SCB’s core net profit to grow at 11% CAGR over 2012-2015. Accordingly, its core ROE should post a slight improvement from 10.7% in 2012 to 11.5-11.8% during 2014-2015. We project a long-term ROE of 11.75% for SCB in our GGM. This is slightly above the stock’s historical trough ROE of 11.1% during 2002-2012. Our target price of HKD189.00 is based on our GGM-derived fair Dec 2014 P/B of 1.15x, which is also higher than the stock’s historical average P/B of 0.8x during 2002- 2012. We initiate coverage of SCB with a HOLD rating. Key risks to our call include volatility in interest rates, currency exchange rates and economic conditions in the Asia-Pacific region.

Figure 95: SCB – Gordon Growth Model Implied ROE 9.75% 10.75% 11.75% 12.75% 13.75% Long term dividend payout ratio (k) 40.0% Cost of Equity (CoE= Rf + Rm * B) 11.2% Long term sustainable growth (g) 7.1% Discount rate (CoE - g) 4.1% Target P/B(x): (ROE * k) / (CoE - g) 0.95 1.05 1.15 1.24 1.34 Dec14F BVPS 165.02 Target price based on 1.15x Dec14F P/B 156.83 172.92 189.00 205.09 221.17 Source: Company data, Maybank Kim Eng

Figure 96: SCB – trading P/E bands Figure 97: SCB – trading P/B bands

HKD HKD 380 21x 500 3.4x 340 440 2.9x 300 17x 380 2.4x 260 13x 320 220 1.7x 260 180 9x 200 140 1.0x 100 5x 140 60 80 20 20 Oct-02 Jun-04 Feb-06 Oct-07 Jun-09 Feb-11 Oct-12 Oct-02 Jun-04 Feb-06 Oct-07 Jun-09 Feb-11 Oct-12

Source: Company data, Maybank Kim Eng Source: Company data, Maybank Kim Eng

18 October 2013 Page 74 of 82

Standard Chartered PLC

INCOME STATEMENT BALANCE SHEET FYE Dec (USDm) 2012A 2013F 2014F 2015F FYE Dec (USDm) 2012A 2013F 2014F 2015F Net interest income 10,781 11,744 12,460 13,404 Other operating income 8,002 8,374 8,758 9,104 Cash & equivalent 128,334 131,191 135,479 139,998 Operating income 18,783 20,118 21,217 22,508 Investment securities 175,796 173,872 180,037 183,143 Operating expenses (10,722) (10,879) (11,655) (12,355) Net loans and advances 279,638 298,800 320,785 344,668 Operating profit 8,061 9,239 9,562 10,153 Fixed assets 6,620 6,951 7,299 7,663 Provisions for bad and doubtful debts (1,196) (1,502) (1,472) (1,421) Intangible assets 7,302 7,302 7,302 7,302 Other provisions 6,865 7,738 8,090 8,732 Other assets 33,518 35,710 38,225 40,957 Operating profit after provisions (14) (803) 250 287 Total assets 631,208 653,826 689,126 723,731 Non-operating income 6,851 6,935 8,340 9,020 Pre-tax profit (1,866) (2,080) (2,419) (2,525) Customer deposits 372,874 391,518 415,009 439,909 Taxation (98) (108) (119) (130) Borrowings 92,406 94,227 96,522 98,955 Minorities (101) (101) (101) (101) Debentures 18,588 18,588 18,588 18,588 Net profit 4,786 4,646 5,702 6,263 Other liabilities 101,285 100,862 106,906 110,326 Total liabilities 585,153 605,195 637,025 667,778 GROWTH RATES IN KEY FINANCIALS FYE Dec 2012A 2013F 2014F 2015F Minorities 693 801 919 1,050 Balance sheet Shareholders’ funds 45,362 47,830 51,181 54,904 Gross loans 4.7% 6.0% 7.5% 7.5% Total liabilities and equity 631,208 653,826 689,126 723,731 Deposits 7.9% 5.0% 6.0% 6.0% Income statement Net interest income 6.2% 8.9% 6.1% 7.6% KEY PERFORMANCE RATIOS Other operating income 6.9% 4.6% 4.6% 4.0% Total operating income 6.5% 7.1% 5.5% 6.1% FYE Dec 2012A 2013F 2014F 2015F Operating expenses 8.1% 1.5% 7.1% 6.0% Pre-provision profit 4.4% 14.6% 3.5% 6.2% NPL 1.94% 1.75% 1.65% 1.50% Net profit 0.8% -2.9% 22.7% 9.8% Loan to deposit 76.5% 77.3% 78.4% 79.5% Core tier 1 CAR 13.4% 12.6% 12.7% 12.6% PROFITABILITY RATIOS Leverage 13.9 13.7 13.5 13.2 FYE Dec 2012A 2013F 2014F 2015F NIM 2.23% 2.17% 2.16% 2.16% Total income/avg assets 1.5% 1.6% 1.6% 1.6% Cost to income 57.1% 54.1% 54.9% 54.9% NII/avg assets 1.8% 1.8% 1.9% 1.9% ROA 0.78% 0.72% 0.85% 0.89% Other oper income/avg assets 1.3% 1.3% 1.3% 1.3% ROE 11.1% 10.0% 11.5% 11.8% Operating profit/avg assets 1.3% 1.4% 1.4% 1.4% RONTA 13.3% 11.8% 13.5% 13.7% Op profit after prov/avg assets 1.1% 1.2% 1.2% 1.2% Provisions/avg assets -0.2% -0.2% -0.2% -0.2% Pre-tax profit/avg assets 1.1% 1.1% 1.2% 1.3% PER SHARE DATA Net profit/avg assets (ROA) 0.8% 0.7% 0.8% 0.9% FYE Dec (HKD) 2012A 2013F 2014F 2015F

NII/total income 57.4% 58.4% 58.7% 59.6% Other oper income/total income 42.6% 41.6% 41.3% 40.4% EPS 15.54 14.98 18.38 20.19 Operating profit/total income 42.9% 45.9% 45.1% 45.1% DPS 6.50 7.02 7.58 8.19 Op profit after prov/total income 36.5% 38.5% 38.1% 38.8% BVPS 146.26 154.21 165.02 177.02 Provisions/total income -6.4% -7.5% -6.9% -6.3% NTAPS 122.71 130.67 141.47 153.48 Pre-tax profit/total income 36.5% 34.5% 39.3% 40.1% Net profit/total income 25.5% 23.1% 26.9% 27.8% ROE 11.1% 10.0% 11.5% 11.8% NIM 2.23% 2.17% 2.16% 2.16% OPERATING RATIOS AND CAPITAL STRUCTURE FYE Dec 2012A 2013F 2014F 2015F FUNDING AND CREDIT QUALITY FYE Dec 2012A 2013F 2014F 2015F Cost to income ratio 57.1% 54.1% 54.9% 54.9% Total deposits/total liabilities 63.7% 64.7% 65.1% 65.9% Operating expense/avg assets -1.8% -1.7% -1.7% -1.7% LD ratio 76.5% 77.3% 78.4% 79.5% Interest expense/interest income 39.5% 41.0% 41.0% 40.8% (Borrowings + debentures)/deposits 29.8% 28.8% 27.7% 26.7% CAR 17.5% 16.2% 16.0% 15.7% Provision charges to total loans 0.43% 0.51% 0.47% 0.42% Capital/assets 7.2% 7.3% 7.4% 7.6% NPL/total loans 1.94% 1.75% 1.65% 1.50% Capital/total loans 15.9% 15.8% 15.7% 15.7% Total reserve coverage 57.0% 71.7% 82.4% 95.7% Fixed assets/shareholders’ funds 14.6% 14.5% 14.3% 14.0%

Source: Company data, Maybank Kim Eng

18 October 2013 Page 75 of 82

Hong Kong

18 October 2013 Initiating Coverage

Buy (new) Wing Hang Bank An Undervalued M&A Play Share price: HKD113.1 (16 Oct 2013) Target price: HKD156.60 (new) Room for NIM to improve. Higher asset yield, lower funding costs and rise in loan-to-deposit ratio caused Wing Hang Bank’s (WHB) NIM to

widen from 1.58% in 2H12 to 1.69% in 1H13. WHB redeemed one Steven CHAN subordinated note amounting to USD225m (with coupon rate of 9.375%) [email protected] in Sep 2013. We expect this will help widen its NIM to 1.72% in 2014. (852) 2268 0645 Slow recovery in net fees and cost-income ratio. Unlike DSB, WHB did not explore any new fee income opportunities during 2007-2012, resulting in limited net fee growth. In 1H13, its net fee growth remained

moderate at 3.2% YoY on a decline in credit and trade-related fees. As Stock Information a result, its core cost-income ratio climbed to 49.6% even though it kept Description: Wing Hang Bank is Hong Kong's sixth biggest a tight lid on core expense growth (+5.3% YoY in 1H13). We do not see bank by total assets. It has material presences in Macau, via any new fee income development for WHB in the near term. We its subsidiary Banco Weng Hang. forecast its net fees to grow at 4.2% CAGR over 2012-2014 and its Ticker: 302 HK cost-income ratio to stay at 48-49% during 2013-2014. Shares Issued (m): 307.4 Market Cap (USDm): 1,864.2 Sound asset quality. Like HSB, WHB has a good track record of asset 3-mth Avg Daily Turnover (USDm): 2.3 quality over the past decade, thanks to its focus on property lending, HSI: 23,228.3 Free Float (%): 77.3 prudent lending policy and high loan collateral coverage ratio. Its credit cost remained low at 7bps in 1H13 and its loan collateral coverage ratio Major Shareholders: % was high at 81.3% in Jun 2013. We believe it will be more cautious Fung’s Family 21.6 Bank of New York 20.3 about new loans in China in 2H13 and forecast its credit cost to remain Aberdeen 9.0 low at 6-7bps during 2013-2014.

Potential rise in dividend payout. WHB’s core Tier 1 CAR rose to 10.8% under the Basel III capital rules. The bank therefore increased its Key Indicators (2014) dividend payout ratio to 14.0% in 1H13 (13.5% in 1H12). We forecast ROE (%): 9.3 NIM: 1.72 WHB’s core Tier 1 CAR will remain above 10% even if its dividend Cost-income ratio: 47.7 payout ratio were to rise to 40% during 2013-2015 (35% in 2012). Credit cost: 0.06 Initiate with BUY. With limited improvement in net fee growth and cost-

income ratio, we forecast WHB’s core ROE to stay at 9% in 2013-14 Historical Chart (9.8% in 2012). WHB said it has been approached by independent third WING HANG BANK HSI parties in Sep 2013 in relation to a possible acquisition of stake in the 160 bank. Using a funding cost of 3.15-4.25% and WHB’s 1H13 core ROE of 8.5%, we estimate the potential acquisition P/B to be 2.01-2.71x. We 140 use the middle of this range to derive our target price of HKD156.60 for WHB. We initiate coverage with a BUY rating. 120 Wing Hang Bank – Summary Earnings Table 100 FYE Dec 2012A 2013F 2014F 2015F Operating profit (HKDm) 2,039 2,114 2,361 2,594 80 Chg (%) (0.6) 3.7 11.7 9.8 Net profit (HKDm) 1,802 1,924 1,969 2,173 Oct 12 Dec 12 Feb 13 Apr 13 Jun 13 Aug 13 Oct 13 Chg (%) (16.1) 6.8 2.3 10.4 EPS (HKD) 6.00 6.07 6.52 7.19 Performance: Chg (%) (17.0) 1.1 7.3 10.4 52-week High/Low HKD50/HKD28 PER (x) 18.8 18.6 17.4 15.7 PBV (x) 1.75 1.66 1.57 1.48 1-mth 3-mth 6-mth 1-yr YTD ROE (%) 9.8 9.6 9.3 9.7 Absolute (%) 29% 53% 19% 74% 39% DPS (HKD) 2.08 2.43 2.61 2.88 Relative (%) 28% 45% 14% 64% 37% Yield (%) 1.8 2.1 2.3 2.5 Consensus net profit (HKDm) 1,879 1,965 2,076

Source: Company data, Maybank Kim Eng

SEE APPENDIX I FOR IMPORTANT DISCLOSURES AND ANALYST CERTIFICATIONS

Wing Hang Bank

Investment positives Expect NIM to further widen: WHB redeemed one subordinated note amounting to USD225m (with coupon rate of 9.375%) in Sep 2013. We expect this will help widen its NIM to 1.72% in 2014 (1.69% in 1H13).

Excellent asset quality: WHB has maintained a prudent lending policy, high loan collateral coverage and a niche in property lending (including residential mortgages). We forecast its credit cost to stay low at 7bps in 2013-2015.

Strong capital positions: We forecast WHB’s core Tier 1 CAR to stay above 10% even if its dividend payout ratio were to increase to 40% during 2013-2015.

Investment concerns Slow to seek out new fee income business: Management has no intention to explore new fee income opportunities. We thus forecast net fees to grow at 4.2% CAGR over 2012-2014.

Low profit contribution from China operation: Due to significant NIM narrowing in China (2.19% in 1H12 vs 1.99% in 1H13), the pre-tax profit contribution of WHB China was low at 4% of group total in 1H13. With outlet openings in China kept a moderate pace (1-2 pa) and further interest rate deregulation, we expect the pre-tax profit contribution of WHB China to stay below 5% during 2013-2014.

Valuation and recommendations We forecast WHB’s core net profit to grow at 6.4% CAGR over 2012-2015, driven by solid loan growth, NIM widening and low credit cost. Its core ROE should stay at 9-10% during 2013-2015.

As WHB has been approached by independent third parties interested in acquiring a stake in the bank, we estimate the potential acquisition price and use it as our target price for WHB. We assume a funding cost of between 3.15% (the average yield of government bonds in Hong Kong, China, the US, Singapore and Malaysia; the opportunity cost of cash-rich buyers) and 4.25% (the average coupon rate of subordinated debt of banks; for buyers who need to finance the acquisition through borrowings) for the acquisition. Based on WHB’s 1H13 ROE of 8.5%, we estimate the potential acquisition P/B to be 2.01-2.71x (when the ROI is similar to the funding cost). We use the middle of this range to derive our target price of HKD156.60 for WHB, which translates to Jun 2013 P/B of 2.36x. We initiate coverage of WHB with a BUY rating, based purely on the M&A theme. Key risks to our call include the termination of acquisition talks or potential buyers offering a lower-than-expected acquisition price.

Figure 98: WHB – trading P/E bands Figure 99: WHB – trading P/B bands

HKD HKD 160 3.2x 140 22x 200 120 18x 160 2.6x 100 14x 120 2.0x 80 1.4x 60 10x 80 40 0.8x 6x 40 20 0 0 Jan-02 Sep-03 May-05 Jan-07 Sep-08 May-10 Jan-12 Sep-13 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 Source: Company data, Maybank Kim Eng Source: Company data, Maybank Kim Eng

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Wing Hang Bank

INCOME STATEMENT BALANCE SHEET FYE Dec (HKDm) 2012A 2013F 2014F 2015F FYE Dec (HKDm) 2012A 2013F 2014F 2015F Cash & equivalent 24,810 26,158 27,678 29,384 Net interest income 2,954 3,235 3,578 3,914 Investment securities 49,586 49,333 51,264 53,768 Other operating income 937 895 935 976 Net loans and advances 113,716 125,074 137,806 151,952 Operating income 3,891 4,130 4,512 4,890 Fixed assets 5,533 5,533 5,533 5,533 Operating expenses (1,852) (2,016) (2,151) (2,296) Intangible assets 1,306 1,306 1,306 1,306 Operating profit 2,039 2,114 2,361 2,594 Other assets 2,412 2,630 2,873 3,144 Provisions for bad and doubtful debts (236) (81) (77) (73) Total assets 197,364 210,035 226,461 245,087 Operating profit after provisions 1,803 2,033 2,284 2,520 Non-operating income 317 214 31 36 Customer deposits 168,499 181,675 196,576 213,414 Pre-tax profit 2,120 2,247 2,316 2,556 Borrowings 1,091 1,178 1,276 1,387 Taxation (317) (323) (347) (383) Debentures 4,950 3,200 3,200 3,200 Minorities - - - - Other liabilities 3,289 3,347 3,593 3,966 Net profit to ordinary shareholders 1,802 1,924 1,969 2,173 Total liabilities 177,830 189,401 204,645 221,967 Minorities - - - - Shareholders’ funds 19,534 20,634 21,816 23,120 Total liabilities and equity 197,364 210,035 226,461 245,087 GROWTH RATES IN KEY FINANCIALS FYE Dec 2012A 2013F 2014F 2015F KEY PERFORMANCE RATIOS Balance sheet FYE Dec 2012A 2013F 2014F 2015F Gross loans 3.1% 10.0% 10.1% 10.2% NPL 0.45% 0.36% 0.35% 0.32% Deposits 5.0% 7.8% 8.2% 8.6% Loan to deposit 67.7% 69.0% 70.3% 71.3% Income statement Core tier 1 CAR 10.0% 10.4% 10.2% 10.0% Net interest income 2.9% 9.5% 10.6% 9.4% Leverage 10.1 10.2 10.4 10.6 Other operating income 2.5% -4.5% 4.4% 4.5% NIM 1.62% 1.69% 1.72% 1.72% Total operating income 2.8% 6.1% 9.3% 8.4% Cost to income 47.6% 48.8% 47.7% 47.0% Operating expenses 6.8% 8.8% 6.7% 6.7% ROA 0.94% 0.94% 0.90% 0.92% Pre-provision profit -0.6% 3.7% 11.7% 9.8% ROE 9.8% 9.6% 9.3% 9.7% Net profit -16.1% 6.8% 2.3% 10.4% PER SHARE DATA FYE Dec (HKD) 2012A 2013F 2014F 2015F EPS 6.00 6.07 6.52 7.19 DPS 2.08 2.43 2.61 2.88 PROFITABILITY RATIOS BVPS 64.65 68.29 72.20 76.51 FYE Dec 2012A 2013F 2014F 2015F OPERATING RATIOS AND CAPITAL STRUCTURE Total income/avg assets 2.0% 2.0% 2.1% 2.1% FYE Dec 2012A 2013F 2014F 2015F

NII/avg assets 1.5% 1.6% 1.6% 1.7% Cost to income ratio 47.6% 48.8% 47.7% 47.0% Other oper income/avg assets 0.5% 0.4% 0.4% 0.4% Operating expense/avg assets -1.0% -1.0% -1.0% -1.0% Operating profit/avg assets 1.1% 1.0% 1.1% 1.1% Interest expense/interest income 48.6% 46.6% 45.8% 46.1% Op profit after prov/avg assets 0.9% 1.0% 1.0% 1.1% CAR 15.7% 14.3% 13.7% 13.3% Provisions/avg assets -0.1% 0.0% 0.0% 0.0% Capital/assets 9.9% 9.8% 9.6% 9.4% Pre-tax profit/avg assets 1.1% 1.1% 1.1% 1.1% Capital/total loans 17.1% 16.5% 15.8% 15.2% Net profit/avg assets (ROA) 0.9% 0.9% 0.9% 0.9% Fixed assets/shareholders’ funds 28.3% 26.8% 25.4% 23.9% NII/total income 75.9% 78.3% 79.3% 80.0% Other oper income/total income 24.1% 21.7% 20.7% 20.0% FUNDING AND CREDIT QUALITY Operating profit/total income 52.4% 51.2% 52.3% 53.0% FYE Dec 2012A 2013F 2014F 2015F Op profit after prov/total income 46.3% 49.2% 50.6% 51.5% Total deposits/total liabilities 94.8% 95.9% 96.1% 96.1% Provisions/total income 6.1% 2.0% 1.7% 1.5% LD ratio 67.7% 69.0% 70.3% 71.3% Pre-tax profit/total income 54.5% 54.4% 51.3% 52.3% (Borrowings + debentures)/deposits 3.6% 2.4% 2.3% 2.1% Net profit/total income 46.3% 46.6% 43.6% 44.5% Provision charges to total loans 0.21% 0.07% 0.06% 0.05% ROE 9.8% 9.6% 9.3% 9.7% NPL/total loans 0.45% 0.36% 0.35% 0.32% NIM 1.62% 1.69% 1.72% 1.72% Total reserve coverage 65.9% 76.2% 68.5% 62.7%

Source: Company data, Maybank Kim Eng

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RESEARCH OFFICES REGIONAL ECONOMICS WONG Chew Hann, CA Suhaimi ILIAS JUNIMAN Regional Head, Institutional Research Chief Economist Chief Economist, BII (603) 2297 8686 [email protected] . Singapore | Malaysia . Indonesia (603) 2297 8682 [email protected] (62) 21 29228888 ext 29682 [email protected] Alexander GARTHOFF Institutional Product Manager Luz LORENZO Josua PARDEDE (852) 2268 0638 [email protected] . Philippines Economist / Industry Analyst, BII (63) 2 849 8836 [email protected] . Indonesia ONG Seng Yeow Regional Head, Retail Research Tim LEELAHAPHAN (62) 21 29228888 ext 29695 [email protected] (65) 6432 1453 [email protected] . Thailand (662) 658 1420 [email protected]

MALAYSIA SINGAPORE THAILAND WONG CHEW HANN, CA Head of Research Gregory YAP Head of Research Sukit UDOMSIRIKUL Head of Research (603) 2297 8686 [email protected] (65) 6432 1450 [email protected] (66) 2658 6300 ext 5090 . Strategy . Technology & Manufacturing [email protected]

DESMOND CH’NG, ACA . Telcos Maria LAPIZ Head of Institutional Research (603) 2297 8680 [email protected] IEW Wilson L Dir (66) 2257 0250 | (66) 2658 6300 ext 1399 . Banking & Finance (65) 6432 1454 [email protected] [email protected] IAW HONG UNG . Property Developers L T J . Consumer/ Big Caps (603) 2297 8688 [email protected] James KOH . Oil & Gas – Regional (65) 6432 1431 [email protected] Mayuree CHOWVIKRAN . Shipping . Consumer - Regional (66) 2658 6300 ext 1440 [email protected] ONG CHEE TING, CA YEAK Chee Keong, CFA . Strategy (603) 2297 8678 [email protected] (65) 6432 1460 [email protected] Padon Vannarat . Plantations – Regional . Offshore & Marine (66) 2658 6300 ext 1450 [email protected] MOHSHIN AZIZ Alison FOK . Strategy (603) 2297 8692 [email protected] (65) 6432 1447 [email protected] Surachai PRAMUALCHAROENKIT . Aviation – Regional . Small & Mid Caps (66) 2658 6300 ext 1470 [email protected] . Petrochem . Construction . Auto YIN SHAO YANG, CPA ONG Kian Lin . Conmat (603) 2297 8916 [email protected] (65) 6432 1470 [email protected] . Contractor . Gaming – Regional . S-REITs . Steel . Media Wei Bin Suttatip PEERASUB TAN CHI WEI, CFA (65) 6432 1455 [email protected] (66) 2658 6300 ext 1430 [email protected] (603) 2297 8690 [email protected] . Commodity . Media . Power . Logistics . Commerce . Telcos . S-chips Sutthichai KUMWORACHAI WONG WEI SUM, CFA Derrick HENG (66) 2658 6300 ext 1400 [email protected] (603) 2297 8679 [email protected] (65) 6432 1446 [email protected] . Energy . Property & REITs . Transport (Land, Shipping & Aviation) . Petrochem LEE YEN LING John CHEONG Termporn TANTIVIVAT (603) 2297 8691 [email protected] (65) 6432 1461 [email protected] (66) 2658 6300 ext 1520 [email protected] . Building Materials . Small & Mid Caps . Property . Glove producers . Healthcare Woraphon WIROONSRI (66) 2658 6300 ext 1560 [email protected] CHAI LI SHIN INDONESIA . Banking & Finance (603) 2297 8684 [email protected] Lucky ARIESANDI, CFA Jaroonpan WATTANAWONG . Plantation (62) 21 2557 1127 [email protected] (66) 2658 6300 ext 1404 [email protected] . Construction & Infrastructure . Base metals . Transportation ANG HUN E . Mining K C E . Small cap. (603) 2297 8675 [email protected] . Oil & Gas Chatchai JINDARAT . Consumer . Wholesale (66) 2658 6300 ext 1401 [email protected] IVAN YAP Pandu ANUGRAH . Electronics (603) 2297 8612 [email protected] (62) 21 2557 1137 [email protected]

. Automotive . Automotive LEE Cheng Hooi, Regional Chartist . Heavy equipment VIETNAM (603) 2297 8694 [email protected] . Plantation Nguyen Thi Ngan Tuyen Tee Sze Chiah, Head of Retail Research . Toll road (84) 844 55 58 88 x 8081 [email protected] . Food and Beverage (603) 2297 6858 [email protected] Rahmi MARINA . (62) 21 2557 1128 [email protected] Oil and Gas HONG KONG / CHINA . Banking Hang Vu ONG Head of Research Howard W . Multifinance (84) 844 55 58 88 x 8087 [email protected] (852) 2268 0648 [email protected] . Banking Adi N. WICAKSONO . Oil & Gas - Regional (62) 21 2557 1128 [email protected] Trinh Thi Ngoc Diep Alexander LATZER . Generalist (84) 844 55 58 88 x 8242 [email protected] (852) 2268 0647 [email protected] . Technology Anthony YUNUS . Metals & Mining - Regional . (62) 21 2557 1139 [email protected] Utilities O . Jacqueline K , CFA . Cement Construction (852) 2268 0633 [email protected] . Infrastructure Dang Thi Kim Thoa . Consumer . Property (84) 844 55 58 88 x 8083 [email protected] Terence LOK . Consumer (852) 2268 0630 [email protected] PHILIPPINES Nguyen Trung Hoa . Consumer Luz LORENZO Head of Research (84) 844 55 58 88 x 8088 [email protected] Jeremy TAN (63) 2 849 8836 [email protected] . Steel (852) 2268 0635 [email protected] . Strategy . Sugar . Gaming Laura DY-LIACCO . Resources Karen KWAN (63) 2 849 8840 [email protected] (852) 2268 0640 [email protected] . Utilities . HK & China Property . Conglomerates Philip TSE . Telcos (852) 2268 0643 [email protected] Lovell SARREAL . HK & China Property (63) 2 849 8841 [email protected] Simon QIAN . Consumer (852) 2268 0634 [email protected] . Media . Telecom & Internet . Cement Steven CHAN Luz LORENZO (852) 2268 0645 [email protected] (63) 2 849 8836 [email protected] . Banking & Financials . Conglomerates Warren LAU . Property (852) 2268 0644 [email protected] . Ports/ Logistics . Technology – Regional . Gaming Katherine TAN (63) 2 849 8843 [email protected] INDIA . Banks HAH Head of Research Jigar S . Construction (91) 22 6623 2601 [email protected] Ramon ADVIENTO . Oil & Gas (63) 2 849 8845 [email protected] . Automobile . Mining . Cement Anubhav GUPTA (91) 22 6623 2605 [email protected] . Metal & Mining . Capital goods . Property Urmil SHAH (91) 22 6623 2606 [email protected] . Technology . Media

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APPENDIX I: TERMS FOR PROVISION OF REPORT, DISCLAIMERS AND DISCLOSURES

DISCLAIMERS This research report is prepared for general circulation and for information purposes only and under no circumstances should it be considered or intended as an offer to sell or a solicitation of an offer to buy the securities referred to herein. Investors should note that values of such securities, if any, may fluctuate and that each ’s price or value may rise or fall. Opinions or recommendations contained herein are in form of technical ratings and fundamental ratings. Technical ratings may differ from fundamental ratings as technical valuations apply different methodologies and are purely based on price and volume-related information extracted from the relevant jurisdiction’s in the equity analysis. Accordingly, investors’ returns may be less than the original sum invested. Past performance is not necessarily a guide to future performance. This report is not intended to provide personal investment advice and does not take into account the specific investment objectives, the financial situation and the particular needs of persons who may receive or read this report. Investors should therefore seek financial, legal and other advice regarding the appropriateness of investing in any securities or the investment strategies discussed or recommended in this report. The information contained herein has been obtained from sources believed to be reliable but such sources have not been independently verified by Maybank Investment Bank Berhad, its subsidiary and affiliates (collectively, “MKE”) and consequently no representation is made as to the accuracy or completeness of this report by MKE and it should not be relied upon as such. Accordingly, MKE and its officers, directors, associates, connected parties and/or employees (collectively, “Representatives”) shall not be liable for any direct, indirect or consequential losses or damages that may arise from the use or reliance of this report. Any information, opinions or recommendations contained herein are subject to change at any time, without prior notice. This report may contain forward looking statements which are often but not always identified by the use of words such as “anticipate”, “believe”, “estimate”, “intend”, “plan”, “expect”, “forecast”, “predict” and “project” and statements that an event or result “may”, “will”, “can”, “should”, “could” or “might” occur or be achieved and other similar expressions. Such forward looking statements are based on assumptions made and information currently available to us and are subject to certain risks and uncertainties that could cause the actual results to differ materially from those expressed in any forward looking statements. Readers are cautioned not to place undue relevance on these forward-looking statements. MKE expressly disclaims any obligation to update or revise any such forward looking statements to reflect new information, events or circumstances after the date of this publication or to reflect the occurrence of unanticipated events. MKE and its officers, directors and employees, including persons involved in the preparation or issuance of this report, may, to the extent permitted by law, from time to time participate or invest in financing transactions with the issuer(s) of the securities mentioned in this report, perform services for or solicit business from such issuers, and/or have a position or holding, or other material interest, or effect transactions, in such securities or options thereon, or other investments related thereto. In addition, it may make markets in the securities mentioned in the material presented in this report. MKE may, to the extent permitted by law, act upon or use the information presented herein, or the research or analysis on which they are based, before the material is published. One or more directors, officers and/or employees of MKE may be a director of the issuers of the securities mentioned in this report. This report is prepared for the use of MKE’s clients and may not be reproduced, altered in any way, transmitted to, copied or distributed to any other party in whole or in part in any form or manner without the prior express written consent of MKE and MKE and its Representatives accepts no liability whatsoever for the actions of third parties in this respect. This report is not directed to or intended for distribution to or use by any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation. This report is for distribution only under such circumstances as may be permitted by applicable law. The securities described herein may not be eligible for sale in all jurisdictions or to certain categories of investors. Without prejudice to the foregoing, the reader is to note that additional disclaimers, warnings or qualifications may apply based on geographical location of the person or entity receiving this report. Malaysia Opinions or recommendations contained herein are in the form of technical ratings and fundamental ratings. Technical ratings may differ from fundamental ratings as technical valuations apply different methodologies and are purely based on price and volume-related information extracted from Bursa Malaysia Securities Berhad in the equity analysis. Singapore This report has been produced as of the date hereof and the information herein may be subject to change. Kim Eng Securities Research Pte. Ltd. (“Maybank KERPL”) in Singapore has no obligation to update such information for any recipient. For distribution in Singapore, recipients of this report are to contact Maybank KERPL in Singapore in respect of any matters arising from, or in connection with, this report. If the recipient of this report is not an accredited investor, expert investor or (as defined under Section 4A of the Singapore Securities and Futures Act), Maybank KERPL shall be legally liable for the contents of this report, with such liability being limited to the extent (if any) as permitted by law. Thailand The disclosure of the survey result of the Thai Institute of Directors Association (“IOD”) regarding corporate governance is made pursuant to the policy of the Office of the Securities and Exchange Commission. The survey of the IOD is based on the information of a company listed on the Stock Exchange of Thailand and the market for disclosed to the public and able to be accessed by a general public investor. The result, therefore, is from the perspective of a third party. It is not an evaluation of operation and is not based on inside information. The survey result is as of the date appearing in the Corporate Governance Report of Thai Listed Companies. As a result, the survey may be changed after that date. Kim Eng Securities Securities (Thailand) Public Company Limited (“MBKET”) does not confirm nor certify the accuracy of such survey result. Except as specifically permitted, no part of this presentation may be reproduced or distributed in any manner without the prior written permission of MBKET. MBKET accepts no liability whatsoever for the actions of third parties in this respect. US This research report prepared by MKE is distributed in the United States (“US”) to Major US Institutional Investors (as defined in Rule 15a-6 under the Securities Exchange Act of 1934, as amended) only by Kim Eng Securities Securities USA Inc (“Maybank KESUSA”), a broker-dealer registered in the US (registered under Section 15 of the Securities Exchange Act of 1934, as amended). All responsibility for the distribution of this report by Maybank KESUSA in the US shall be borne by Maybank KESUSA. All resulting transactions by a US person or entity should be effected through a registered broker-dealer in the US. This report is not directed at you if MKE is prohibited or restricted by any legislation or regulation in any jurisdiction from making it available to you. You should satisfy yourself before reading it that Maybank KESUSA is permitted to provide research material concerning investments to you under relevant legislation and regulations. UK This document is being distributed by Kim Eng Securities Securities (London) Ltd (“Maybank KESL”) which is authorized and regulated, by the Financial Services Authority and is for Informational Purposes only. This document is not intended for distribution to anyone defined as a Retail Client under the Financial Services and Markets Act 2000 within the UK. Any inclusion of a third party link is for the recipients convenience only, and that the firm does not take any responsibility for its comments or accuracy, and that access to such links is at the individuals own risk. Nothing in this report should be considered as constituting legal, accounting or tax advice, and that for accurate guidance recipients should consult with their own independent tax advisers.

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DISCLOSURES Legal Entities Disclosures Malaysia: This report is issued and distributed in Malaysia by Maybank Investment Bank Berhad (15938-H) which is a Participating Organization of Bursa Malaysia Berhad and a holder of Capital Markets and Services License issued by the Securities Commission in Malaysia. Singapore: This material is issued and distributed in Singapore by Maybank KERPL (Co. Reg No 197201256N) which is regulated by the Monetary Authority of Singapore. Indonesia: PT Kim Eng Securities (“PTKES”) (Reg. No. KEP-251/PM/1992) is a member of the Indonesia Stock Exchange and is regulated by the BAPEPAM LK. Thailand: MBKET (Reg. No.0107545000314) is a member of the Stock Exchange of Thailand and is regulated by the Ministry of Finance and the Securities and Exchange Commission. Philippines: Maybank ATRKES (Reg. No.01-2004-00019) is a member of the Philippines Stock Exchange and is regulated by the Securities and Exchange Commission. Vietnam: Kim Eng Securities Securities JSC (License Number: 71/UBCK-GP) is licensed under the State Securities Commission of Vietnam. Hong Kong: KESHK (Central Entity No AAD284) is regulated by the Securities and Futures Commission. India: Kim Eng Securities India Private Limited (“KESI”) is a participant of the National Stock Exchange of India Limited (Reg No: INF/INB 231452435) and the Bombay Stock Exchange (Reg. No. INF/INB 011452431) and is regulated by Securities and Exchange Board of India. KESI is also registered with SEBI as Category 1 Merchant Banker (Reg. No. INM 000011708) US: Maybank KESUSA is a member of/ and is authorized and regulated by the FINRA – Broker ID 27861. UK: Maybank KESL (Reg No 2377538) is authorized and regulated by the Financial Services Authority.

Disclosure of Interest Malaysia: MKE and its Representatives may from time to time have positions or be materially interested in the securities referred to herein and may further act as market maker or may have assumed an underwriting commitment or deal with such securities and may also perform or seek to perform investment banking services, advisory and other services for or relating to those companies. Singapore: As of 18 October 2013, Maybank KERPL and the covering analyst do not have any interest in any companies recommended in this research report. Thailand: MBKET may have a business relationship with or may possibly be an issuer of derivative warrants on the securities /companies mentioned in the research report. Therefore, Investors should exercise their own judgment before making any investment decisions. MBKET, its associates, directors, connected parties and/or employees may from time to time have interests and/or underwriting commitments in the securities mentioned in this report. Hong Kong: KESHK may have financial interests in relation to an issuer or a new listing applicant referred to as defined by the requirements under Paragraph 16.5(a) of the Hong Kong Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission. As of 18 October 2013, KESHK and the authoring analyst do not have any interest in any companies recommended in this research report. MKE may have, within the last three years, served as manager or co-manager of a public offering of securities for, or currently may make a primary market in issues of, any or all of the entities mentioned in this report or may be providing, or have provided within the previous 12 months, significant advice or investment services in relation to the investment concerned or a related investment and may receive compensation for the services provided from the companies covered in this report.

OTHERS Analyst Certification of Independence The views expressed in this research report accurately reflect the analyst’s personal views about any and all of the subject securities or issuers; and no part of the research analyst’s compensation was, is or will be, directly or indirectly, related to the specific recommendations or views expressed in the report.

Reminder Structured securities are complex instruments, typically involve a high degree of risk and are intended for sale only to sophisticated investors who are capable of understanding and assuming the risks involved. The market value of any structured security may be affected by changes in economic, financial and political factors (including, but not limited to, spot and forward interest and exchange rates), time to maturity, market conditions and volatility and the credit quality of any issuer or reference issuer. Any investor interested in purchasing a structured product should conduct its own analysis of the product and consult with its own professional advisers as to the risks involved in making such a purchase.

No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior consent of MKE.

Definition of Ratings Kim Eng Securities Research uses the following rating system: BUY Return is expected to be above 10% in the next 12 months (excluding dividends) HOLD Return is expected to be between - 10% to +10% in the next 12 months (excluding dividends) SELL Return is expected to be below -10% in the next 12 months (excluding dividends) Applicability of Ratings The respective analyst maintains a coverage universe of stocks, the list of which may be adjusted according to needs. Investment ratings are only applicable to the stocks which form part of the coverage universe. Reports on companies which are not part of the coverage do not carry investment ratings as we do not actively follow developments in these companies. Some common terms abbreviated in this report (where they appear): Adex = Advertising Expenditure FCF = Free Cashflow PE = Price Earnings BV = Book Value FV = Fair Value PEG = PE Ratio To Growth CAGR = Compounded Annual Growth Rate FY = Financial Year PER = PE Ratio Capex = Capital Expenditure FYE = Financial Year End QoQ = Quarter-On-Quarter CY = Calendar Year MoM = Month-On-Month ROA = Return On Asset DCF = Discounted Cashflow NAV = ROE = Return On Equity DPS = Dividend Per Share NTA = Net Tangible Asset ROSF = Return On Shareholders’ Funds EBIT = Earnings Before Interest And Tax P = Price WACC = Weighted Average Cost Of Capital EBITDA = EBIT, Depreciation And Amortisation P.A. = Per Annum YoY = Year-On-Year EPS = Earnings Per Share PAT = Profit After Tax YTD = Year-To-Date EV = Enterprise Value PBT = Profit Before Tax

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 Malaysia  Singapore  London  New York Maybank Investment Bank Berhad Maybank Kim Eng Securities Pte Ltd Maybank Kim Eng Securities Maybank Kim Eng Securities (A Participating Organisation of Maybank Kim Eng Research Pte Ltd (London) Ltd USA Inc Bursa Malaysia Securities Berhad) 9 Temasek Boulevard 6/F, 20 St. Dunstan’s Hill 777 Third Avenue, 21st Floor 33rd Floor, Menara Maybank, #39-00 Suntec Tower 2 London EC3R 8HY, UK New York, NY 10017, U.S.A. 100 Jalan Tun Perak, Singapore 038989 50050 Kuala Lumpur Tel: (44) 20 7621 9298 Tel: (212) 688 8886 Tel: (603) 2059 1888; Tel: (65) 6336 9090 Dealers’ Tel: (44) 20 7626 2828 Fax: (212) 688 3500 Fax: (603) 2078 4194 Fax: (65) 6339 6003 Fax: (44) 20 7283 6674

Stockbroking Business:  Hong Kong  Indonesia  India Level 8, Tower C, Dataran Maybank, Kim Eng Securities (HK) Ltd PT Maybank Kim Eng Securities Kim Eng Securities India Pvt Ltd No.1, Jalan Maarof Level 30, Plaza Bapindo 2nd Floor, The International 16, 59000 Kuala Lumpur Three Pacific Place, Citibank Tower 17th Floor Maharishi Karve Road, Tel: (603) 2297 8888 1 Queen’s Road East, Jl Jend. Sudirman Kav. 54-55 Churchgate Station, Fax: (603) 2282 5136 Hong Kong Jakarta 12190, Indonesia Mumbai City - 400 020, India

Tel: (852) 2268 0800 Tel: (62) 21 2557 1188 Tel: (91).22.6623.2600 Fax: (852) 2877 0104 Fax: (62) 21 2557 1189 Fax: (91).22.6623.2604

 Philippines  Thailand  Vietnam  Saudi Arabia Maybank ATR Kim Eng Securities Maybank Kim Eng Securities In association with In association with Inc. (Thailand) Public Company Maybank Kim Eng Securities JSC Anfaal Capital 17/F, Tower One & Exchange Plaza Limited 1st Floor, 255 Tran Hung Dao St. Villa 47, Tujjar Jeddah Ayala Triangle, Ayala Avenue 999/9 The Offices at Central World, District 1 Prince Mohammed bin Abdulaziz Makati City, Philippines 1200 20th - 21st Floor, Ho Chi Minh City, Vietnam Street P.O. Box 126575 Rama 1 Road Pathumwan, Jeddah 21352 Tel: (63) 2 849 8888 Bangkok 10330, Thailand Tel : (84) 844 555 888 Fax: (63) 2 848 5738 Fax : (84) 838 38 66 39 Tel: (966) 2 6068686 Tel: (66) 2 658 6817 (sales) Fax: (966) 26068787 Tel: (66) 2 658 6801 (research)

 South Asia Sales Trading  North Asia Sales Trading Kevin FOY Alex TSUN [email protected] [email protected] Tel: (65) 6336-5157 Tel: (852) 2268 0228 US Toll Free: 1-866-406-7447 US Toll Free: 1 877 837 7635 www.maybank-ke.com | www.maybank-keresearch.com

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