The results in the first half of the year were mixed.
Bea earned HK $10.1 billion in the first half of 2019, up 18.5 per cent from a year earlier and 18.2 per cent month-on-month, exceeding market expectations of 14.8 per cent. Net profit was HK $643 million, down 82.3% from a year earlier and down 70.2% from a month earlier, mainly affected by a heavy loss of HK $5.2 billion from its mainland business (HK $33-HK $4 billion previously forecast). We believe that this will further arouse investors' concerns about the quality of their assets and their exposure to the mainland real estate sector. Maintain the outperform industry rating and lower the target price to HK $19.
Trend of development
The strong revenue performance was mainly due to the recovery of net interest margin in the mainland and the rapid growth in insurance fee income. The net interest margin increased by 14bp to 1.90% month-on-month in the first half of the year, mainly driven by mainland business (net interest margin 2.32%, month-on-month growth 62bp). Net interest income was HK $7.406 billion, up 18.5 per cent year-on-year and 10.4 per cent month-on-month; total assets rose 6 per cent year-on-year.
As market sentiment improved, fee revenue increased by 6.2% year-on-year and 0.7% month-on-month.
Other non-interest income grew strongly by 45 per cent year-on-year, mainly due to the insurance business.
Balance sheets expand more slowly than big banks. In the first half of 2019, the loan / deposit balance of the Bank of East Asia increased by 2.1% / 1.4% month-on-month, respectively, lower than the industry loan / deposit growth rate (3.3% / 5.0%). Due to increased competition for deposits, CASA fell to 33.4% in the first half of 2019, down 1.8% from the previous month and 3.6% from a year earlier.
The quality of assets is worrying. The defect rate in the first half of 2019 was 1.63%, with a month-on-month increase of 93bp:
The default rate of Bank of East Asia in Hong Kong remained at a low of 0.26 per cent, while the mainland defect rate of Bank of East Asia soared to 4.89 per cent, a month-on-month increase in 316bp. According to its early profit warning, non-performing loans in the mainland are mainly related to commercial real estate loans. (for details, please refer to our report: warning of significant impairment losses; lowering the target price to HK $21.7). The cost of credit in the first half of 2019 was 2%, a month-on-month increase of 164bp and a year-on-year increase of 188bp.
Capital is still plentiful. The common equity tier one capital ratio and the total capital ratio were 15.3% and 20.3% respectively in the first half of 2019, slightly down 0.4 and 0.5 percentage points from the previous month.
A dividend of HK $0.11 is proposed for the first half of 2019 (HK $0.51 for the first half of 2018).
Profit forecast and valuation
Bea is currently trading at 0.64 times 2020 market-to-book ratio. We kept our earnings forecast unchanged, but taking into account concerns about the quality of the company's mainland assets and the decline in Hong Kong market share, we lowered our target price by 12% to HK $19 (0.58 times 2020 market-to-book ratio, which is 9% lower than the current share price). Maintain the rating of the outperforming industry.
Risk
Upside risks: stronger-than-expected loan growth and net interest margin expansion.