Hong Kong Banking Sector

Transcription

1 China / Hong Kong Industry Focus Hong Kong Banking Sector Refer to important disclosures at the end of this report DBS Group Research. Equity 10 Nov 2017 Last chance to get on board We expect HIBOR to rise further up in 3-6 months from progressive Fed Fund rate hikes and HKMA intervention; this is positive to HK banks Last interest rate up-cycle in 2004 leads us to believe that HIBOR-LIBOR gap will ultimately converge BOCHK is the best proxy to benefit from rate hike momentum; its valuation discount to HSB offers attractive risk-to-reward BOCHK (BUY, TP HK$ 50.2) and DSB (BUY, TP HK$ 20.4) are our top picks Last chance to get on to board. With ongoing Fed fund rates hike momentum (our house view is one more rate hike this year, followed by 3 times in 2018), HKMA intervention to absorb interbank liquidity and existing interest rate gap (1- month: 0.44% / 3-month: 0.41%), we believe that HIBOR is set to rise further based on expectations that the LIBOR will move up from Fed fund rate hike. Since September this year, HKMA has been more active in issuing exchange fund bills and notes to absorb interbank liquidity. We view this as a signal that HKMA intends to smoothen the rate hike momentum in Hong Kong so as to avoid potential market volatility arising from a widening LIBOR-HIBOR gap. In fact, we see some early signs of HIBOR bottoming out from weakening HKD, and decrease in HKMA s aggregate balance. The rise in HIBOR is positive to HK Banking sector. Winner of rate hikes: BOCHK offers highest risk-to-reward. Our sensitivity analysis indicates that HSB and BOCHK will benefit from the increase in HIBOR and LIBOR owing to their sizeable current account and saving account (CASA) ratio. The risk-toreward is higher for BOCHK as its valuation stands at a discount to HSB. Besides, BOCHK has expanded its footprint by acquiring multiple branches in ASEAN regions (Indonesia, Thailand and Malaysia), thus setting a strong foundation for BOCHK to capture opportunities from the One-Belt One-Road projects. Plus, there is potential re-rating opportunity for BOCHK as it emerges from a local bank to a regional bank. DSB under-appreciated franchise. DSB is the only bank trading below book value based on FY18F estimates, which we believe is unjustified for a banking franchise that delivered ROE of 10%/11% in FY16/1H17. As one of the two listed familyowned banks, DSB is the best candidate for a M&A play within the sector. Considering its scarcity premium (limited local banking franchise), we believe the potential tender offer can reach 1.9x P/B. HSI: 29,137 ANALYST Keith TSANG CFA, keith_tsang@dbs.com Ken SHIH kenshih@dbs.com Recommendation & valuation Closing Target FY18F Bank Ticker Rating price Price PB Yield ROE (HKD) (HKD) (X) (%) (%) BOCHK 2388 HK BUY HSB 11 HK BUY BEA 23 HK F.V DSB 2356 HK BUY Source: Thomson Reuters, DBS Vickers, Bloomberg Finance L.P. HIBOR set to bottom out (%) Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 HIBOR -3M Net interest margin (HK) Increase in Fed fund rate will lead to higher HIBOR, therefore net interest margin expansion Jan-13 Jan-15 Jan-17 Jan-19 Fed Fund rate target Source: Thomson Reuters, DBS Vickers, Bloomberg Finance L.P ed-js/ sa- CW

2 Industry Focus Hong Kong Banking Sector Table of Contents Weak Pass-through Is Not Something New 3 What can the last interest up-cycle tell us? 5 What s the Cause for Divergence? 6 The arbitrage process depends on exchange rate USDHKD 7 The question goes to how large the spread becomes meaningful for arbitrageur 8 HIBOR is Set to Bottom Out 9 Who Are the Winners of the Rate Hikes The Bigger, The Better 10 Sensitivity Analysis HIBOR / LIBOR Impact on Net Interest Income & Net Interest Margin 12 The conclusion from our analysis: 14 Valuation 15 Stock Profiles 17 BOC Hong Kong (2388) 17 Hang Seng Bank (11) 25 The Bank Of East Asia (23) 33 Dah Sing Banking Group (2356) 40 Page 2

3 Industry Focus Hong Kong Banking Sector Weak Pass-through Is Not Something New The widening gap between HIBOR-LIBOR has been a surprise to many, with Fed ending its easing monetary cycle in In theory, HIBOR rate should catch up from investors taking carry trades, meaning that borrowing HKD and taking a long position in USD simultaneously, thus profiting from the interest rate differential between these two currencies. The short-selling pressure on HKD can in turn create upward pressure on HIBOR. However, the gap between HKD HIBOR- 3M and USD LIBOR-3M has widened at most to 0.6% (Figure 1), reaching 7-year high. Still, weak pass-through should not be a big surprise if we look at past interest rate cycles. While interest rate movements will always point to the same direction because of the HKD-USD peg, the magnitude of change in HK interest rates has always been less than US interest rates in the past five interest rate cycles (Figure 2). The Fed increased its target fund rate by 25bps to 0.25%-0.5% in Dec 2015 marking the end of easing monetary cycle, followed by 3 hikes of 0.25% each. Going forward, our in-house economist forecasts that Fed will raise rates one more time later this year, and three times in The potential 1.00% increase in the Fed fund rate, assuming 0.25% each, signals a very high possibility for HIBOR to move up. Exchange fund bill issuance from HKMA at 1-year high. The widening interest rate differential between Hong Kong and the US points to potential high volatility in the Hong Kong market from unexpected and sharp money outflows. We believe HKMA is issuing extra exchange fund bills and notes in an attempt to artificially reduce interbank liquidity, as evidenced by issuance value reaching a 1-year high (HK$ 340bn) in October this year (same month as beginning of US Fed balance sheet normalisation). Reducing interbank liquidity can in turn create more upward pressure on the HIBOR, along with existing LIBOR-HIBOR differential. In fact, this reinforces our belief that HIBOR is set to rise from here. Fig 1: LIBOR-HIBOR Gap divergence (%) Apr-08 Apr-09 Apr-10 Apr-11 Apr-12 Apr-13 Apr-14 Apr-15 Apr-16 Apr-17 (%) Gap (RHS) HIBOR-3M (LHS) LIBOR-3M (LHS) Source: Bloomberg Finance L.P., DBS Vickers Page 3

4 Industry Focus Hong Kong Banking Sector Fig 2: HK rate movements have always lagged US Fed fund rate in past cycles Fig 3: Exchange fund bills and notes issuance reaching a 12-month high 6.0% HK$ mil 4.0% 2.0% 0.0% -2.0% -4.0% -6.0% Sep 98 Nov 98 Jun 99 May 00 Jan 01 Jun 03 Jun 04 Jun 06 Change in US Fed Funds Target Rate Change in HSBC Prime Lending Rate Sep 07 Dec , , , , , , , , , , ,000 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Source: Bloomberg Finance L.P., DBS Vickers Source: HKMA, Bloomberg Finance L.P., DBS Vickers Page 4

5 Industry Focus Hong Kong Banking Sector Fig 4: What the last interest rate up-cycle in 2004 can tell us Speculation on HKD appreciating along with RMB causing severe deviation of HIBOR and LIBOR LIBOR-HIBOR Gap (RHS) USDHKD (LHS) US$ LIBOR 3M (RHS) HK$ HIBOR 3M (RHS) Source: Bloomberg Finance L.P., DBS Vickers What can the last interest up-cycle tell us? Back in late 2003, HKD strengthened to 7.70 from 7.8, and the HKMA stepped in to stabilise the exchange rate by conducting strong-side monetary operations. As a result, HKMA s aggregate balance was boosted to HK$ 55bn in early 2004, pushing HIBOR to nearly zero. The negative interest rate gap between LIBOR and HIBOR did not close because of market speculation on HKD appreciating along with RMB. The gap later widened to 2% in late 2014 despite US Fed rate hikes taking place. In May 2005, HKMA introduced the three refinements to the Linked Exchange Rate System (LERS), establishing a strong-side Convertibility Undertaking (CU) at HK$7.75/US$, shifting the weak-side CU from HK$7.80/US$ to HK$7.85/US$, and creating a Convertibility Zone defined by CUs, within which the HKMA may conduct market operations consistent with Currency Board principles. The new refinement ended the speculation of HKD following the appreciation of RMB, pushing HIBOR to be in line with LIBOR movements. While the large interest rate differential could be present for different reasons (speculation on strengthening HKD in last upcycle or rich liquidity in HK during this time), we believe that with the additional 4 rate hikes expected by end of 2018 (one more time in 2017 and three times in 2018), plus the current negative interest differential of 0.4%, the chance of HIBOR picking up is very likely in our view. Page 5

6 Industry Focus Hong Kong Banking Sector What s the Cause for Divergence? In fact, the HIBOR-LIBOR gap is caused by several factors including liquidity, interest rate arbitrage activities, exchange rate and relative risk between the US and HK (Figure 5). Among all these factors, abundant liquidity level is the main hindrance for HIBOR to pick up. The idea of excess liquidity can be illustrated by analysing: 1. HKMA s aggregate balance (interbank liquidity) and 2. Exchange Fund bills and notes. Recall that Fed s quantitative easing has caused hot money to flow into the city, and in order to prevent a surge in supply of HKD, HKMA issued more Exchange Fund bills and notes (Figure 5). The issuance of exchange fund bills and notes aims to avoid the rise in currency circulation which in turn lowers inflationary pressure, in our view. Since the global financial crisis, HKMA s aggregate balance has recorded a sharp increase to c. HKD 223bn along with rising balance of exchange fund bills and notes to HKD 964bn as of end-jul 2017 (Figure 6). These two together, measure of excess liquidity, jumped to c. HKD 1.2tn. And in fact, the abundant liquidity is the reason for HIBOR rate failing to catch up LIBOR rate movements, thus creating a 7-year high interest rate differential. Fig 6: Excess Liquidity Situation HK$ bn Dec-07 Aug-08 Apr-09 Dec-09 Aug-10 Apr-11 Dec-11 Aug-12 Apr-13 Dec-13 Aug-14 Source: HKMA, Bloomberg Finance L.P., DBS Vickers Apr-15 HKMA Aggregate balance HKMA Exchange Fund bills and notes Fig 7: Factors affecting HIBOR-LIBOR spread Dec-15 Aug-16 Apr-17 Fig 5: Hot money flows Source: DBS Vickers Source: DBS Vickers Page 6

7 Industry Focus Hong Kong Banking Sector The arbitrage process depends on exchange rate USDHKD Fig 8: Incentive of taking a short position In Hong Kong, HKMA operates convertibility undertakings on both the strong-side and the weak-side of the linked rate of 7.8. Under the strong-side Convertibility Undertaking, the HKMA undertakes to buy US dollars at 7.75, while under the weak-side Convertibility Undertaking, the HKMA undertakes to sell US dollars at We have seen HKD weakening since the beginning of this year from to in end-oct which makes a lot of sense due to the rate differential between HIBOR and LIBOR. But in our view, the closer the spot rate to the weak-side of USDHKD rate of 7.85, the lower the potential profit that short sellers can make, thus lowering arbitrage opportunities (unless you are betting on USD/HKD de-peg, which is not likely what the major investors are speculating). Source: DBS Vickers Page 7

8 Industry Focus Hong Kong Banking Sector The question goes to how large the spread becomes meaningful for arbitrageur We all basically expect LIBOR is going to move up with Fed fund rate increase. So how far can the gap widen? We try to illustrate an example below to see how stubborn HIBOR can be (Figure 9). To do that, we are trying to compare the maximum upside vs maximum downside from the carry trade. The maximum downside is the potential FX loss from HKD strengthening from 7.80 to 7.75 (0.64%) plus interest rate differential. While the maximum upside of the trade is USDHKD weakening to 7.85 from 7.80 plus the interest rate differential between LIBOR-3M and HIBOR-3M (currently 0.1% in 3-months period). Note that we conservatively take into account of the delta of 0.8x between Fed fund rate hike and increase in LIBOR-3M. It means increase in LIBOR-3M lags Fed fund rate hike by 0.8x. With 2 times Fed fund rate hike, the maximum return (0.84%) offered from carry trade is attractively higher than the maximum downside (-0.44%) form the trade. Thus, we believe that increase in arbitrage activities from increasing risk-toreward can push HIBOR to be higher in 3-6 months. Fig 9: How stubborn HIBOR can be? Input: Current 1st Rate hike 2nd rate hike Current 3M - LIBOR (%) Current 3M - HIBOR (%) <- Assume HIBOR stays at this point USDHKD 7.80 Delta of Fed fund rate hike and LIBOR 3M (x) 0.80 * Assume each Fed fund rate hike by 25bps translates to LIBOR-3M rising by 20bps (0.8*25bps) What is the maximum upside for carry trade? Current 1st Rate hike 2nd rate hike 1) The gain under current interest rate differential 0.10% 0.15% 0.20% 2) HKD to weaken from 7.80 to % 0.64% 0.64% Total 0.74% 0.79% 0.84% What is the biggest downside for carry trade? Current 1st Rate hike 2nd rate hike 1) The gain under current interest rate differential 0.10% 0.15% 0.20% 2) HKD to strenghten from 7.80 to % -0.64% -0.64% Total -0.54% -0.49% -0.44% Conclusion -> Risk-reward increases along with each Fed fund rate hike With max upside of 0.84% much higher than max downside of -0.44% under second Fed fund rate hike, We view that 2 times Fed fund rate hike offers attractive abitrage opportunity to enter the trade ===> It's highly likely HIBOR going to move up in the coming 3-6 months Source: DBS Vickers Page 8

9 Industry Focus Hong Kong Banking Sector HIBOR is Set to Bottom Out FED agenda paints positive direction to HIBOR. Recall that the Federal Reserve started its Quantitative Easing (QE) program in 2008 to purchase trillions of bonds to lower the interest rate as a way to avoid a severe economic downturn. In Sep 2017, Federal Open Market Committee (FOMC) announced that it is officially starting its balance sheet normalisation campaign, unwinding its US$ 4.5tn balance sheet in October. Assuming 0.25% increase in each rate hike (usual practice in previous rate hikes), this will ultimately drive a 1% increase in the Fed fund rate by the end of Considering the current 3M- HIBOR-LIBOR gap of 0.4% and Fed s rate hike schedule, we see high probability of HIBOR moving upward by the end of 2018, thus benefiting banks net interest margin. The close correlation between HIBOR and net interest margin is shown in figure 10. Fig 10: HK Banks net interest margin is correlated with Fed fund rate and HIBOR 6.0 (%) Increase in Fed fund rate will lead to higher HIBOR, therefore net interest margin expansion Jan-03 Aug-03 Mar-04 Oct-04 May-05 Dec-05 Jul-06 Feb-07 Sep-07 Apr-08 Nov-08 Jun-09 Jan-10 Aug-10 Mar-11 Oct-11 May-12 Dec-12 Jul-13 Feb-14 Sep-14 Apr-15 Nov-15 Jun-16 Jan-17 Aug-17 Mar-18 Oct HIBOR - 3M Fed Fund rate target Net interest margin (HK) Source: Hang Seng Bank, DBS Vickers Weak HKD and shrinking HKMA aggregate balance has early implications. The interest rate differential between HIBOR and LIBOR has resulted in a weak HKD performance (YTD down 0.7% to 7.81). If HKD weakens to 7.85 against the USD, and triggers the Weak-side Convertibility Undertaking, it will lead to capital outflow, and therefore a decline in HKMA s aggregate balance. With on-going Fed fund rate hike driving up USD LIBOR, the interest rate differential will continue to put pressure on HKD, thus tightening the liquidity situation in HK. Fig 11: HKD has been weakening YTD USDHKD Source: DBS Bank, DBS Vickers Page 9

10 Industry Focus Hong Kong Banking Sector Who Are the Winners of the Rate Hikes The Bigger, The Better Naturally, on the asset side, the HIBOR upward movement leads to loans being repriced at a higher level and therefore higher interest income. So, who will be the winner among HK banks? We believe banks with 1. stronger deposit franchise and 2. larger proportion of USD/HKD assets are going to stand out. The larger the proportion of current and saving account deposit balance (CASA), the lower the cost of funding. Thus banks with a strong deposit franchise will stand out with stronger net interest margin expansion. In Figure 12, owing to strong deposits franchises, BOCHK and HSB stand out with CASA balance of 63% and 78% respectively while BEA and DSB had merely 38% and 40% respectively in 1H17. The lower cost of funding is a natural Fig 12: CASA ratio comparison for HK banks consequence from the large proportion of CASA as deposits funding is the key funding source for banks. We thus believe that BOCHK and HSB will benefit more under a rate hike environment. As for asset mix by currencies among HK banks, banks more tilted towards USD + HKD are set to benefit from US rate hikes. USD + HKD asset proportion ranking in 1H17: DSB (86%) > BOCHK (79%) = HSB (79%) > BEA (53%). On the face of it, DSB is thus more sensitive towards rate hikes but taking the strong CASA ratio into account, we believe HSB and BOCHK will stand out. We illustrate the interest rate sensitivity among HK banks in figure 17. Fig 13: Cost of Funding(CoF) comparison for HK banks % 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% HSB BOCHK BEA DSB CASA CASA % HSB BOCHK BEA DSB CoF (bps) CoF (bps) Source: Bloomberg Finance L.P., DBS Vickers Source: HKMA, Bloomberg Finance L.P., DBS Vickers Page 10

11 Industry Focus Hong Kong Banking Sector Fig 14: Asset breakdown by currencies Fig 15: Liabilities breakdown by currencies 100% 90% 10% 10% 7% 10% 100% 90% 4% 11% 10% 6% 80% 70% 60% 50% 40% 30% 47% 11% 29% 36% 55% 7% 63% 80% 70% 60% 50% 40% 30% 53% 14% 25% 38% 67% 72% 20% 10% 0% 31% 25% 32% 11% 15% BOCHK BEA DSB HSB 20% 10% 0% 7% 29% 8% 26% 16% 13% BOCHK BEA DSB HSB USD RMB HKD Other USD RMB HKD Other Source: Company Data, DBS Vickers Source: Company Data, DBS Vickers Page 11

12 Industry Focus Hong Kong Banking Sector Sensitivity Analysis HIBOR / LIBOR Impact on Net Interest Income & Net Interest Margin Usually banks are positively influenced by interest rate increases. In the sensitivity analysis in the table below, we quantify the impact of rate hikes on banks net interest income and net interest margin based on 3 different scenarios below, namely 1) 25bps increase in HIBOR, 2) 25bps increase in LIBOR, 3) Closer to real world example factoring in weak HIBOR-LIBOR pass-through (HIBOR up 25bps, and LIBOR up 50bps) Fig 16: Sensitivity Analysis of increase in HIBOR / LIBOR on Net Interest Income FY17H1 (HK$ mil) BOCHK BEA DSB HSB Total asset 2,639, , ,005 1,377,242 % of IBA / Total Assets 80% 95% 89% 91% % of IBA that will reprice / Total IBA 79% 59% 67% 78% % of IBA for relevant currencies / Total IBA that wil reprice 74% 55% 87% 82% Impact on Interest Income 3, ,016 Currency Mix % of HKD assets 43% 28% 57% 69% % of USD assets 31% 26% 30% 13% % of HKD + USD assets 74% 55% 87% 82% Impact by HIBOR / LIBOR Case 1: Increase in HIBOR by 25bps 1, ,707 Case 2: Increase in LIBOR by 25bps 1, Case 3: Increase in HIBOR by 25bps + LIBOR by 50bps 4, ,325 Total liabilities 2,398, , ,757 1,236,556 % of IBL / Total Liabilities 73% 89% 92% 85% % of IBL that will reprice / Total IBL 47% 67% 62% 29% % of IBL for relevant currencies / Total IBL that wil reprice 81% 51% 83% 86% Impact on Interest Expenses 1, Currency Mix % of HKD liabilities 53% 25% 67% 72% % of USD liabilities 29% 26% 16% 13% % of HKD + USD liabilities 81% 51% 83% 86% Impact by HIBOR / LIBOR Case 1: Increase in HIBOR by 25bps 1, Case 2: Increase in LIBOR by 25bps Case 3: Increase in HIBOR by 25bps + LIBOR by 50bps 2, Net Impact on Net Interest Income 1, ,372 Source: Company Data, DBS Vickers Page 12

13 Industry Focus Hong Kong Banking Sector Fig 17: Sensitivity Analysis of increase in HIBOR / LIBOR on Net Interest Income (con t) FY17H1 (HK$ mil) BOCHK BEA DSB HSB Impact on Net Interest Income from repricing Case 1: Increase in HIBOR by 25bps (1) 1,163 Case 2: Increase in LIBOR by 25bps Case 3: Increase in HIBOR by 25bps + LIBOR by 50bps 2, ,580 % change in Net Interest Income 32,323 11,143 3,888 24,432 Case 1: Increase in HIBOR by 25bps 2.2% 0.5% 0.0% 4.8% Case 2: Increase in LIBOR by 25bps 2.2% 0.2% 1.4% 0.9% Case 3: Increase in HIBOR by 25bps + LIBOR by 50bps 6.5% 0.9% 2.7% 6.5% Change in Net Interest Margin (bps) Case 1: Increase in HIBOR by 25bps (0.0) 9.2 Case 2: Increase in LIBOR by 25bps Case 3: Increase in HIBOR by 25bps + LIBOR by 50bps % change in Pre-Provisioning Profit 36,831 7,356 2,490 23,800 Case 1: Increase in HIBOR by 25bps 1.9% 0.8% 0.0% 4.9% Case 2: Increase in LIBOR by 25bps 1.9% 0.3% 2.1% 0.9% Case 3: Increase in HIBOR by 25bps + LIBOR by 50bps 5.7% 1.4% 4.3% 6.6% Source: Company Data, DBS Vickers Page 13

14 Industry Focus Hong Kong Banking Sector The conclusion from our analysis: 1)When HIBOR is up by 25bps => HSB > BOCHK > BEA > DSB (Figure 18) Fig 18: % change in NII (25 bps up in HIBOR) 5.0% 4.0% It is not surprising that local bank Hang Seng Bank (HSB) stands out with much higher sensitivity than the peers because of its large insensitive interest bearing liabilities thanks to its stronger CASA ratio (78% in FY17H1). Also, HSB has much larger assets that are denominated in HKD (69% of total assets vs BOCHK s 43%) 2) When LIBOR rate is up by 25bps => BOCHK > DSB > HSB > BEA (Figure 19) 3.0% 2.0% 1.0% 0.0% -1.0% BOCHK BEA DSB HSB Owing to large USD assets and strong deposit franchise (strong CASA balance), BOCHK stands out when LIBOR rate increases. However, what is worth noting is that Dah Sing Bank (DSB) also has high sensitivity towards LIBOR rate increases given that it has sizeable net assets denominated in USD (assets denominated in USD (30% of total) vs liabilities-denominated in USD (16% of total)) despite its weaker deposit franchise. 3) Closer-to-real-world example factoring in weak HIBOR-LIBOR pass-through (HIBOR up 25bps and LIBOR up 50bps) => BOCHK = HSB > DSB > BEA (Figure 20) Case 1: Increase in HIBOR by 25bps Source: Company Data, DBS Vickers Fig 19: % change in NII (25 bps up in LIBOR) 2.5% 2.0% 1.5% 1.0% While it is very likely that HIBOR will increase in the next 12 months because of US rate hike momentum (in-house forecast: 1 time in Dec and 3 times in 2018) and ongoing Fed balance sheet normalisation, we believe the issue of weak pass-through remains unavoidable (please look at past interest earnings cycle in figure 2). 0.5% 0.0% BOCHK BEA DSB HSB Case 2: Increase in LIBOR by 25bps While BOCHK and HSB would potentially enjoy similar benefits from this closer-to-real-world example, we believe BOCHK s valuation discount to HSB provides higher risk-to-reward for investors to capture the interest rate hike play. Source: Company Data, DBS Vickers Fig 20: % change in NII (closer-to-real-world example) 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% BOCHK BEA DSB HSB Case 3: Increase in HIBOR by 25bps + LIBOR by 50bps Source: Company Data, DBS Vickers Page 14

15 Industry Focus Hong Kong Banking Sector Valuation Figure 21: BOCHK Price to Book Figure 22: BEA Price to Book PB (x) 3.0 PB (x) SD SD 10 yr avg -1 SD -2 SD SD +1 SD 10 yr avg -1 SD -2 SD Source: Bloomberg Finance L.P., DBS Vickers Source: Bloomberg Finance L.P., DBS Vickers Figure 23: HSB Price to Book Figure 24: DSB Price to Book PB (x) 6.5 PB (x) SD SD yr avg SD SD Source: Bloomberg Finance L.P., DBS Vickers Source: Bloomberg Finance L.P., DBS Vickers +2 SD +1 SD 10 yr avg -1 SD -2 SD Page 15

16 Industry Focus Hong Kong Banking Sector STOCK PROFILES Page 16

17 China / Hong Kong Company Guide Bank of China Hong Kong Version 1 Bloomberg: 2388 HK EQUITY Reuters: 2388.HK Refer to important disclosures at the end of this report DBS Group Research. Equity 10 Nov 2017 BUY (Re-instating coverage) Last Traded Price ( 9 Nov 2017): HK$37.25 (HSI : 29,137) Price Target 12-mth: HK$50.20 (35% upside) Analyst Keith TSANG CFA, keith_tsang@dbs.com Ken SHIH kenshih@dbs.com Investment Thesis BOCHK s continuous ROE increment offers room for further re-rating Prime beneficiary of rising interest rate environment from high CASA ratio and large HKD/USD balance Expansion into ASEAN provides huge loan growth potential Reinstate coverage with BUY and TP of HK$ 50.2 equivalent to 2.0x FY18F BV Price Relative HK$ Nov-13 Nov-14 Nov-15 Nov-16 Nov-17 Bank of China Hong Kong (LHS) Relative HSI (RHS) Relative Index Forecasts and Valuation FY Dec (HK$ m) 2016A 2017F 2018F 2019F Pre-prov. Profit 29,449 36,831 43,865 50,340 Pre-prov. Profit Gth (%) Pretax Profit 60,852 36,245 43,208 49,597 Net Profit 55,410 30,084 35,862 41,166 EPS (HK$) EPS Gth (%) 107 (46) PE (X) DPS (HK$) Div Yield (%) BV Per Share (HK$) P/Book Value (x) ROAE (%) ROAE (ex-exceptional (%) ROA (%) Earnings Rev (%) New New New Consensus EPS (HK$) Other Broker Recs: B: 11 S: 2 H: 2 Source of all data on this page: Company, DBSV, Thomson Reuters, HKEX The best is yet to come A growth stock offering good yield. BOCHK has the best YTD performance within the sector. We believe upside remains present from BOCHK s stronger-than-peer loan growth and net interest margin (NIM) expansion, resulting in PPOP growth jumping 17.6% y-o-y in 9M17. BOCHK is also one of the best play towards rising rate environment from its high CASA ratio (FY1H17: 64%, second to HSB) and large HKD/USD balance (74% of total assets). We believe the share price correction concerning q-o-q NIM contraction in 3Q17 is just a shortterm headwind considering lower average HIBOR level (average HIBOR- 3M of 0.9% in 1H17 vs 0.76% in 3Q17). Considering rising HIBOR since late September, we believe the share price correction provides entry opportunity for BOCHK. Penetration into ASEAN is the long-term driver. Post disposing Chiyu and Nanyang Commercial Bank, BOCHK has acquired businesses in Indonesia, Thailand and Malaysia. The acquisitions have shown initial success (ASEAN institutions loan up 18% h-o-h, net operating income up 15% y-o-y). We believe BOCHK will continue to expand its footprint into South East Asia by capturing the loan growth opportunity arising from infrastructure investment in one-belt-one-road initiatives. Potential catalysts: HIBOR catch-up driving NIM expansion; ASEAN expansion being the long-term driver. BOCHK is the prime beneficiary from rate hike owing to high CASA ratio and large HKD/USD balances. The business exposure to ASEAN remains insignificant currently but the scale will increase with more acquisitions underway (Manila and Ho Chi Minh Branch) helping BOCHK to capture the loan growth opportunity in ASEAN. Valuation: BOCHK is our top pick with TP of HK$50.20 based on the Dividend Growth Model, assuming 15% ROE, 3.5% growth and 9% cost of equity, implying 2x FY18 BV. Key Risks to Our View: Weaker-than-expected HIBOR movement. Unsuccessful synergistic deliveries from its ASEAN acquisitions. At A Glance Issued Capital (m shrs) 10,573 Mkt. Cap (HK$m/US$m) 393,836 / 50,506 Major Shareholders Bank of China (%) 66.1 Free Float (%) m Avg. Daily Val. (US$m) 60.0 ICB Industry : Financials / Banks ed-th / sa- CW

18 Bank of China Hong Kong CRITICAL FACTORS TO WATCH Critical Factors Prime beneficiary of rate hike. Owing to strong banking franchise and abundant HKD/USD balance, BOCHK is set to be one of the prime beneficiaries of the rising rate environment. Our scenario analysis suggests that BOCHK will enjoy a similar benefit with HSB as HIBOR lags behind LIBOR. Margin Trends HK$ m 40, % 35, % 30,000 25, % 20,000 15, % 10, % 5, % Net Interest Income Net Interest Income Margin Highest CASA ratio after Hang Seng Bank. BOCHK has a strong deposit franchise, with CASA ratio of about 60%. We expect deposit growth to track loan growth, at c.10%, keeping loan-todeposit ratio below 70%. 1,400,000 HK$ m Gross Loan& Growth 20% 1,200,000 15% Strong correlation with USD LIBOR-3M Since early this year, USD LIBOR-3M has shown strong correlation of 0.98x with BOCHK share price performance. With progressive Fed fund rate hike, increasing LIBOR is believed to be positive to its share price performance. 1,000, , , , , % 5% 0% -5% -10% Gross Loan (LHS) Gross Loan Growth (%) (YoY) (RHS) Correlation with Loan and advances growth in HK HK represents ~80% of BOCHK s loan book. BOCHK share price has strong correlation of 0.9x with loans and advances growth (YoY) in HK since Jan 15. This is caused by net interest income representing 48% of the bank s total operating income. Customer Deposit & Growth HK$ m 2,000,000 1,500,000 1,000, ,000 0 Customer Deposits (LHS) Customer Deposits Growth (%) (YoY) (RHS) 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% Loan-to-Deposit Ratio Trend HK$ bn 2,628,193 2,428,193 2,228,193 2,028,193 1,828,193 1,628,193 1,428,193 1,228,193 1,028, ,193 Loans Deposit Loan-to-Deposit Ratio (RHS) 76% 74% 72% 70% 68% 66% 64% 62% 60% 58% HK$ m 60,000 50,000 40,000 30,000 20,000 10,000 Cost & Income Structure 35% 30% 25% 20% 15% 10% 5% 0 0% Net Interest Income Non-interest Income Cost-to-income Ratio Page 18

19 Bank of China Hong Kong Appendix 1: A look at Company's listed history what drives its share price? Share Price History Fed announced Operation Twist HKMA imposed R.W. floor of 15%, effective in Jun 16 First Fed rate hike since 2006 Proposed disposal of Chiyu Taper announced D-SIB requirement Proposed of HSB at 1.5% disposalof announced NCB Acquisition of Malaysia business Acquisition of Thailand business Acquisition of Indonesia business 0 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Share price (HK$) Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Oct-17 Source: Bloomberg Finance, DBS Vickers Critical Factor #1 USD 3-month LIBOR Correl: 0.98 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep BOCHK share price (LHS) USD LIBOR 3mth (RHS) Source: Bloomberg Finance, DBS Vickers Page 19

20 Bank of China Hong Kong Critical Factor #2 HK loans and advance (YoY) growth % Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Hong Kong loans and advances YoY growth (LHS) BOCHK share price (RHS) Source: Bloomberg Finance, DBS Vickers Page 20

21 Bank of China Hong Kong Balance Sheet: BOCHK has the lowest non-performing loan (NPL) ratio in the industry of 0.2% (vs industry s 0.6%). BOCHK s asset quality is largely based on its Hong Kong operations with some derived from ASEAN countries. We expect asset quality to stabilise going forward, with slight upticks in credit cost (from 6bps to 8bps across FY17-19F). BOCHK also sits on a comfortable buffer, with loan loss coverage of more than 100%. 1.0% 0.9% 0.8% 0.7% 0.6% 0.5% 0.4% 0.3% 0.2% 0.1% 0.0% Asset Quality NPL Ratio Provision Charge-Off Rate Highly capitalised position. BOCHK s CET-1/CAR stood at 17.66%/21.76%, enabling BOCHK to maintain its dividend policy to pay out 40-60% of its profits. We have assumed a payout ratio of 50%, which represents a decent yield of c.4%. Share Price Drivers: Strong correlation with USD LIBOR-3 month The US interest rate movement is an important indicator of HIBOR movement, and therefore net interest margin trend. Strong correlation with HK loan growth The loan growth in HK influences the share price performance as the loan expansion affects the bank s net interest income (48% of operating income) Key Risks: Weaker-than-expected HIBOR movement; Unsuccessful synergistic deliveries from its ASEAN acquisitions. Company Background BOCHK is the second largest commercial bank in Hong Kong by total assets, but commands a strong market share in all major businesses. It is an indirect wholly-owned subsidiary of Bank of China Limited. BOCHK is one of the three note-issuing banks in Hong Kong and is the PBOC-appointed clearing bank for RMB business in HK. 22.0% 20.0% 18.0% 16.0% 14.0% 12.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% (x) 17.7 Capitalisation (%) Tier-1 CAR Total CAR ROE (%) PE Band sd: 15.7x sd: 14.1x Avg: 12.5x 1sd: 10.9x 2sd: 9.4x (x) PB Band sd: 1.87x +1sd: 1.68x Avg: 1.48x 1sd: 1.29x 2sd: 1.09x 0.9 Nov-13 Nov-14 Nov-15 Nov-16 Nov-17 Page 21

22 Bank of China Hong Kong Key Assumptions FY Dec NIM (%) Loan growth (%) (7) Cost-to-income (%) Credit cost (%) Customer Deposits Growth (%) Growth (%) (5) Yld. On Earnings Assets (%) Avg Cost Of Funds (%) Income Statement (HK$ m) FY Dec Net Interest Income 25,739 25,428 32,323 38,268 43,198 Non-Interest Income 15,203 16,392 17,251 18,722 20,660 Operating Income 40,942 41,820 49,573 56,990 63,859 Operating Expenses (11,836) (12,371) (12,742) (13,124) (13,518) Pre-provision Profit 29,106 29,449 36,831 43,865 50,340 Provisions (931) (578) (675) (764) (871) Associates Exceptionals 3,550 31, Pre-tax Profit 31,779 60,852 36,245 43,208 49,597 Taxation (4,284) (4,622) (5,437) (6,481) (7,440) Minority Interests (699) (820) (725) (864) (992) Preference Dividend Net Profit 26,796 55,410 30,084 35,862 41,166 Net Profit bef Except 23,246 23,503 30,084 35,862 41,166 Growth (%) Net Interest Income Gth (3.70) (1.21) Net Profit Gth (45.71) Margins, Costs & Efficiency (%) Spread Net Interest Margin Cost-to-Income Ratio Business Mix (%) Net Int. Inc / Opg Inc Non-Int. Inc / Opg inc Fee Inc / Opg Income Oth Non-Int Inc/Opg Inc Profitability (%) ROAE Pre Ex ROAE ROA Pre Ex ROA Page 22

23 Bank of China Hong Kong Interim Income Statement (HK$ m) FY Dec 1H2015 2H2015 1H2016 2H2016 1H2017 Net Interest Income 15,672 14,787 11,972 13,558 16,879 Non-Interest Income 8,016 7,508 8,539 7,853 6,445 Operating Income 23,688 22,295 20,511 21,411 23,324 Operating Expenses (6,576) (7,511) (5,801) (6,570) (6,105) Pre-Provision Profit 17,112 14,784 14,710 14,841 17,219 Provisions (809) (755) (514) (72) (353) Associates Exceptionals 0 0 (31,190) (302) (2,623) Pretax Profit 16,782 14,364 14,349 15,105 17,785 Taxation (2,991) (1,776) (2,288) (2,334) (2,805) Minority Interests (404) (295) (414) (406) (387) Net Profit 13,387 12,293 11,647 12,365 14,593 Growth (%) Net Interest Income Gth (23.6) (8.3) 41.0 Net Profit Gth (13.0) Balance Sheet (HK$ m) FY Dec Cash/Bank Balance 332, , , , ,665 Government Securities Inter Bank Assets 64,208 70,392 81,436 91, ,569 Total Net Loans & Advs. 920, ,754 1,163,372 1,305,226 1,465,268 Investment 574, , , , ,077 Associates Fixed Assets 65,695 64,017 64,017 64,017 64,017 Goodwill Other Assets 409, , , , ,399 Total Assets 2,367,864 2,336,757 2,662,788 2,900,412 3,161,637 Customer Deposits 1,404,989 1,508,881 1,735,213 1,908,734 2,099,608 Inter Bank Deposits 207, , , , ,941 Debts/Borrowings 26,398 20,135 20,135 20,739 21,361 Others 530, , , , ,437 Minorities 5,415 5,907 5,907 5,907 5,907 Shareholders' Funds 192, , , , ,383 Total Liab& S/H s Funds 2,367,864 2,336,757 2,662,788 2,900,412 3,161,637 Page 23

24 Bank of China Hong Kong Financial Stability Measures (%) FY Dec Balance Sheet Structure Loan-to-Deposit Ratio Net Loans / Total Assets Investment / Total Assets Cust. Dep./Int. Bear. Liab Interbank Dep / Int. Bear Asset Quality NPL / Total Gross Loans NPL / Total Assets Loan Loss Reserve Coverage Provision Charge-Off Rate Capital Strength Total CAR Tier-1 CAR Page 24

25 China / Hong Kong Company Guide Hang Seng Bank Version 1 Bloomberg: 11 HK EQUITY Reuters: 0011.HK Refer to important disclosures at the end of this report DBS Group Research. Equity 10 Nov 2017 BUY (Re-instating coverage) Last Traded Price ( 9 Nov 2017): HK$ (HSI : 29,137) Price Target 12-mth: HK$202 (9% upside) Analyst Keith TSANG CFA, keith_tsang@dbs.com Ken SHIH kenshih@dbs.com Investment Thesis Well positioned for rate hike from its strong deposit franchise (CASA ratio 78%) and large USD/HKD assets Robust capital adequacy (CET-1/CAR: 16.2%/20.2%) provides room for increase in dividend payout The continuous ROE improvement can support HSB s ongoing re-rating Reinstate coverage with BUY and TP of HK$202 Best for HIBOR catch-up play Best for HIBOR catch-up play. Hang Seng Bank is the prime beneficiary for HIBOR catch-up play, thanks to its highest CASA ratio (78% in FY1H17) and sizeable HKD-denominated assets on its balance sheet. The rising HIBOR will generate a positive impact on the bank s net interest margin (NIM) expansion. At the same time, the robust capital adequacy (CET-1/CAR: 16.2%/20.2% in FY1H17) will provide room for HSB to increase its dividend payout going forward (HSB lifted its quarterly dividend to HK$1.2/share this year from the HK$1.1/share adopted for more than ten years). At the same time, improving market sentiment can drive strong fee income momentum (Fee income up 15% y-o-y in FY1H17) through its securities broking and retail investment funds segment. We expect its improving ROE outlook (FY17F/18F/19F: 13.7%/14.8%/15.5%) to support the ongoing re-rating for the bank. Price Relative HK$ Relative Index Potential catalyst: Faster-than-expected NIM expansion. HIBOR is set to move up in 3-6 months despite the weak passthrough issue. This could translate into stronger net interest margin expansion. HSB, being the best HIBOR catch-up play bank, is the prime beneficiary of the theme Nov-13 Nov-14 Nov-15 Nov-16 Nov-17 Hang Seng Bank (LHS) Relative HSI (RHS) Forecasts and Valuation FY Dec (HK$ m) 2016A 2017F 2018F 2019F Pre-prov. Profit 20,347 24,361 27,415 30,079 Pre-prov. Profit Gth (%) (1) Pretax Profit 19,090 23,065 26,079 28,633 Net Profit 16,212 19,605 22,167 24,338 EPS (HK$) EPS Gth (%) (42) PE (X) DPS (HK$) Div Yield (%) BV Per Share (HK$) P/Book Value (x) ROAE (%) ROAE (ex-exceptional (%) ROA (%) Earnings Rev (%) New New New Consensus EPS (HK$) Other Broker Recs: B: 3 S: 6 H: 5 Source of all data on this page: Company, DBSV, Thomson Reuters, HKEX Valuation: Reinstate coverage with BUY and TP of HK$ based on the Dividend Growth Model (15% ROE, 3% growth and 8% cost of equity). Our TP implies 2.5x FY18 BV. Key Risks to Our View: Downside risk could emerge from weaker-than-expected HIBOR movement, therefore weakening the NIM improvement trend; deterioration of asset quality. At A Glance Issued Capital (m shrs) 1,912 Mkt. Cap (HK$m/US$m) 355,603 / 45,603 Major Shareholders HSBC Holdings (%) 62.1 Free Float (%) m Avg. Daily Val. (US$m) 21.5 ICB Industry : Financials / Banks ed-th / sa- CW

26 Hang Seng Bank CRITICAL FACTORS TO WATCH Critical Factors HSB is the prime beneficiary of rising interest rates, mainly due to its large proportion of HKD and USD assets, as well as high CASA ratio. There could be short-term headwinds from a relatively lower average HIBOR in the second half (vs first half) but we believe the NIM trend will be more favourable given ongoing Fed fund rate hike. HSB has the highest CASA ratio, at 77% (vs industry average of sub-60%). We expect deposit growth to track loan growth relatively closely, at 7% p.a. With that, we expect HSB to remain fairly liquid, with loan-to-deposit ratio of around 70%, close to the past three years' level. Strong correlation with USD LIBOR-3M Since early this year, USD LIBOR-3M has shown strong correlation of 0.93x with HSB share price performance. With progressive Fed fund rate hike, increasing LIBOR is believed to be positive to its share price performance. 25,000 20,000 15,000 10,000 5,000 0 HK$ m 800, , , , , , , ,000 0 Margin Trends HK$ m Net Interest Income Gross Loan& Growth Net Interest Income Margin Gross Loan (LHS) Gross Loan Growth (%) (YoY) (RHS) 2.1% 2.0% 2.0% 1.9% 1.9% 1.8% 1.8% 1.7% 1.7% 1.6% 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% Correlation with Loan and advances growth in HK HK represents ~80% of HSB s loan book. HSB share price has strong correlation of 0.82x with loans and advances growth (YoY) in HK since Jan 15. This is caused by net interest income representing 55% of the bank s total operating income. Customer Deposit & Growth HK$ m 1,200,000 1,000, , , , ,000 0 Customer Deposits (LHS) Customer Deposits Growth (%) (YoY) (RHS) 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% HK$ bn Loan-to-Deposit Ratio Trend 1,320,051 1,220,051 1,120,051 1,020, , , , ,051 Loans Deposit Loan-to-Deposit Ratio (RHS) 79% 77% 75% 73% 71% 69% 67% 65% 63% Cost & Income Structure HK$ m 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5, % 35% 30% 25% 20% 15% 10% 5% 0% Net Interest Income Non-interest Income Cost-to-income Ratio Page 26

27 Hang Seng Bank Appendix 1: A look at Company's listed history what drives its share price? Share price history Disposal of 5% of Industrial Bank HKMA imposed R.W. floor of 15%, effective in J un 16 First Fedrate hike since Fed announced Operation Twist Equity holding in Industrial Bank was reduced from 12.8% to 10.9%. Taper announced D-SIB requirement of HSB at 1.5% announced Disposal of 4.99% of Industrial Bank Retirement of Ms. Rose Lee and Mr. Andrew Fung Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Oct-17 HSB's share price (HK$) Source: Bloomberg Finance, L.P., DBS Vickers Critical Factor#1 USD 3-month LIBOR Correl: Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Oct-17 HSB share price (LHS) USD LIBOR 3mth (RHS) Source: Bloomberg Finance, L.P., DBS Vickers Page 27

28 Hang Seng Bank Critical Factor#2 HK loans and advance (YoY) growth % Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Hong Kong loans and advances YoY growth (LHS) HSB share price (RHS) Source: Bloomberg Finance, L.P., DBS Vickers Page 28

29 Hang Seng Bank Balance Sheet: Benign asset quality. Impaired loan ratio for HSB has been relatively steady. There was an uptick in 1H16, but we understand the issue is contained within individual companies. Loan loss coverage stands at sub-60% and HSB appears comfortable with this given that it is backed by collaterals. 1.0% 0.9% 0.8% 0.7% 0.6% 0.5% 0.4% 0.3% 0.2% 0.1% 0.0% Asset Quality NPL Ratio Provision Charge-Off Rate Share Price Drivers: HIBOR/LIBOR movement. HSB's share price has shown strong correlation with the US$ LIBOR rate and we believe the market appreciates the positive impact from rising rates on net interest margin and therefore earnings growth. Strong correlation with HK loan growth The loan growth in HK influences the share price performance as the loan expansion affects the bank s net interest income (55% of operating income) Key Risks: Downside risk could emerge from weak HIBOR therefore weakening the NIM trend. Quicker-than-expected NIM upward momentum would pose upside risk to our earnings forecasts. Company Background Founded in 1933, Hang Seng Bank (HSB) is one of the largest banks in Hong Kong by asset size and is a principal member of the HSBC Group. Its subsidiary, Hang Seng Bank (China) Limited operates a network of 50 branches around China. 23.0% 22.0% 21.0% 20.0% 19.0% 18.0% 17.0% 16.0% 18.0% 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% Capitalisation (%) Tier-1 CAR Total CAR ROE (%) 21.6 (x) PE Band sd: 19.3x +1sd: 17.7x Avg: 16.1x 1sd: 14.5x sd: 13x (x) PB Band sd: 2.38x +1sd: 2.2x Avg: 2.02x 1sd: 1.83x 2sd: 1.65x 1.4 Nov-13 Nov-14 Nov-15 Nov-16 Nov-17 Page 29

30 Hang Seng Bank Key Assumptions FY Dec NIM (%) Loan growth (%) Cost-to-income (%) Credit cost (%) Customer Deposits Growth (%) Growth (%) Yld. On Earnings Assets (%) Avg Cost Of Funds (%) Income Statement (HK$ m) FY Dec Net Interest Income 21,165 22,254 24,589 27,106 29,487 Non-Interest Income 9,888 8,345 10,422 11,372 12,085 Operating Income 31,053 30,599 35,011 38,478 41,572 Operating Expenses (10,482) (10,252) (10,650) (11,063) (11,493) Pre-provision Profit 20,571 20,347 24,361 27,415 30,079 Provisions (1,108) (1,313) (1,398) (1,448) (1,570) Associates Exceptionals 10,897 (37) Pre-tax Profit 30,512 19,090 23,065 26,079 28,633 Taxation (2,994) (2,886) (3,460) (3,912) (4,295) Minority Interests Preference Dividend Net Profit 27,518 16,212 19,605 22,167 24,338 Net Profit bef Except 16,621 16,249 19,605 22,167 24,338 Growth (%) Net Interest Income Gth Net Profit Gth (41.09) Margins, Costs & Efficiency (%) Spread Net Interest Margin Cost-to-Income Ratio Business Mix (%) Net Int. Inc / Opg Inc Non-Int. Inc / Opg inc Fee Inc / Opg Income Oth Non-Int Inc/Opg Inc Profitability (%) ROAE Pre Ex ROAE ROA Pre Ex ROA Page 30

31 Hang Seng Bank Interim Income Statement (HK$ m) FY Dec 1H2015 2H2015 1H2016 2H2016 1H2017 Net Interest Income 10,441 10,724 11,003 11,251 11,814 Non-Interest Income 6,109 3,779 4,214 4,131 5,843 Operating Income 16,550 14,503 15,217 15,382 17,657 Operating Expenses (5,136) (5,346) (4,980) (5,272) (5,255) Pre-Provision Profit 11,414 9,157 10,237 10,110 12,402 Provisions (594) (514) (721) (592) (670) Associates (136) Exceptionals 10, (77) Pretax Profit 21,720 8,792 9,499 9,591 11,646 Taxation (1,672) (1,322) (1,494) (1,392) (1,812) Minority Interests Net Profit 20,048 7,470 8,005 8,207 9,838 Growth (%) Net Interest Income Gth Net Profit Gth (60.1) Page 32

32 Hang Seng Bank Balance Sheet (HK$ m) FY Dec Cash/Bank Balance 10,118 23,299 10,687 11,435 12,236 Government Securities Inter Bank Assets 123, , ,220 98, ,480 Total Net Loans & Advs. 688, , , , ,337 Investment 432, , , , ,760 Associates 2,275 2,274 2,376 2,489 2,613 Fixed Assets 36,261 36,732 40,405 43,638 45,819 Goodwill 12,221 14,443 16,176 17,794 19,217 Other Assets 28,475 30,260 26,497 33,815 14,864 Total Assets 1,334,429 1,377,242 1,473,857 1,567,333 1,667,327 Customer Deposits 959, ,539 1,068,702 1,143,511 1,223,557 Inter Bank Deposits 18,780 15,880 17,150 18,351 19,635 Debts/Borrowings 7,516 7,443 7,592 7,744 7,899 Others 105, , , , ,316 Minorities Shareholders' Funds 141, , , , ,459 Total Liab& S/H s Funds 1,334,429 1,377,242 1,473,857 1,567,333 1,667,327 Financial Stability Measures (%) FY Dec Balance Sheet Structure Loan-to-Deposit Ratio Net Loans / Total Assets Investment / Total Assets Cust. Dep./Int. Bear. Liab Interbank Dep / Int. Bear Asset Quality NPL / Total Gross Loans NPL / Total Assets Loan Loss Reserve Coverage Provision Charge-Off Rate Capital Strength Total CAR Tier-1 CAR Page 33