Moody's takes rating actions on nine Hong Kong banks

[Ericwt]

Global Credit Research - 24 Jun 2013

Hong Kong, June 24, 2013 -- Moody's Investors Service has changed the outlooks for the bank financial strength ratings (BFSRs)/Baseline Credit Assessments (BCAs) of eight Hong Kong banks to negative from stable, and one bank's BFSR outlook to stable from positive.

In addition, Moody's has lowered Wing Lung Bank's BFSR by one notch, and affirmed all other ratings of the nine banks.

Moody's has affirmed the deposit ratings of all the nine banks involved in this rating action. However, it has changed the outlooks on the deposit ratings for five of the nine banks concerned to negative from stable, while those for the other four banks are unchanged at stable. Please click here for a list of the affected credit ratings. http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_155742. This list is an integral part of this press release and identifies each affected issuer.

RATINGS RATIONALE

The rating actions follow Moody's decision to revise the outlook for Hong Kong's banking system to negative from stable.
The change in the banking system outlook reflects the agency's concerns regarding persistent negative real interest rates and potential property bubbles in Hong Kong, as well as Hong Kong banks' growing exposures to Mainland China. These factors could result in adverse operating conditions for Hong Kong banks over the outlook horizon.

Residential, commercial, and industrial property prices in Hong Kong have all more than doubled since 2009 and are currently at historically high levels. There is growing integration between Hong Kong's economy with that of the Mainland. While the economic integration creates business opportunities for banks and their customers, it also entails risks. The Mainland's transition from an export- and investment-driven economic growth model to a consumption-led model creates uncertainties and may expose overcapacity in certain industries.

A separate press release to be published today elaborates on the rationale for the change in the banking system outlook.

All of the nine affected banks reported problem loan ratios that were at or near historically low levels at end-2012, and their current asset quality metrics compare very favorably against global peers. However, latent risks are building in the banking system, as domestic leverage increases and the exposures to the Mainland grow.

Moody's anticipates a turning point during the outlook horizon when these banks' problem loans will rise from current low levels as conditions become more challenging. While the precise timing of the turning point cannot be determined with precision, a tightening of US monetary policy, which directly affects Hong Kong via the Hong Kong dollar peg, is likely to be one trigger for a cyclical deterioration in asset quality.

At end-2012, local property-related lending, trade and export finance, and Mainland exposures together accounted for more than half of the banks' total loans.
Nevertheless, Hong Kong banks remain among the highest-rated banks globally, and their credit ratings continue to reflect strengths such as solid levels of capitalization, sound funding profiles and liquidity positions, and established retail franchises.

Four of the nine rated banks affected by this rating action are subsidiaries of Mainland banks. Most of them have grown at a faster pace than their peers owing to customer referrals from their parents. Their Mainland corporate exposures are higher than the peer average, as they serve the offshore financing needs of their parent banks' corporate customers. The change in outlook for these banks' BFSRs takes into account these banks' increasing integration with their parents and the fact that the quality of their Mainland exposures have not been fully tested in an economic downturn.

The negative outlooks on deposits for five of the nine banks reflect the negative outlooks on their BFSRs. The outlooks for the other four banks are stable owing to expected strong support from these banks' overseas and Mainland parents, which would likely mitigate downward pressure on their standalone credit quality.

The Hong Kong subsidiaries are of strategic importance to their overseas and Mainland parents, given Hong Kong's position as a major regional financial hub, and the overlap in customers between the subsidiaries and their parents.

The subordinated debt ratings of four of the nine banks incorporate elements of systemic support, as they are currently notched off the banks' deposit ratings.
Moody's placed the subordinated debt ratings of these four banks on review for downgrade on 3 June 2013, as indicated in this press release. These banks' subordinated debt ratings remain on review for downgrade following today's rating actions.

Moody's Global Bank Rating Methodology published on 31 May 2013 indicated that going forward, the default approach for rating bank subordinated debt is to notch them off banks' adjusted baseline credit assessments. The update in methodology has led to simultaneous reviews for bank subordinated debt ratings in several Asian countries.

BANK-SPECIFIC RATING CONSIDERATIONS

BANK OF EAST ASIA, LTD
Bank of East Asia's C-/baa2 BFSR and BCA reflect its strong liquidity profile, improving, albeit below peer-average profitability, and its large and growing Mainland exposures. The bank's A2 long-term deposit ratings incorporate three notches of systemic support. The potential systemic support stems from the bank's market position as the largest independent local bank.

The outlooks on the BFSR/BCA and deposit ratings were changed to negative from stable reflecting Moody's concerns over the bank's large and growing Mainland exposures, as well as an expected more challenging operating condition in Hong Kong over the outlook horizon. Bank of East Asia has one of the largest branch networks in Mainland China among foreign banks. Mainland loan exposures accounted for 43% of overall loans at end-2012, and consisted largely of corporate loans. Given limited growth opportunities in Hong Kong and strong demand for credit in China, we expect Mainland exposures to account for an increasing share of overall loans. The bank's large and fast-growing Mainland exposures render it susceptible to potential adverse developments in the Mainland economy.

Due partially to its fast growth and modest internal capital generation, the bank has raised external capital on three different occasions since 2009. Nevertheless, fresh equity raising in 2012 and the sale of majority ownership in its US subsidiary brought the bank's Tier 1 ratio to a satisfactory 10.7% at end-2012.

Bank of East Asia's profitability has been modest, with three-year average return on risk-weighted assets of 1.42% between 2010-2012. In line with its Hong Kong peers, Bank of East Asia has a liquid balance sheet, with funding consisting largely of customer deposits.
What Could Change the Rating Up/Down

Bank of East Asia's deposit rating of A2 is high and is unlikely to be upgraded.
The bank's ratings may be downgraded if persistent strong loan and asset growth outweigh capital generation, leading to Tier 1 capitalization below 9.5%. Further increases in Mainland exposures, or a material slowdown in the Hong Kong and Mainland economies may also lead to downgrades.

CHINA CITIC BANK INTERNATIONAL LTD
China CITIC Bank International's standalone D+/baa3 BFSR and BCA reflect its good capitalization, revamped risk management framework and processes, and steadily improving asset quality metrics. The positive factors are offset by its high borrower concentration, below peer-average profitability, and increasing exposures to Chinese borrowers. The bank's Baa2 long-term deposit rating factors in very high parental support from China CITIC Bank Corporation Limited (deposits Baa2 stable, BFSR D/BCA ba2 stable)), which owns 70% of the bank.

The outlook on the bank's BFSR/BCA was changed to stable from positive and reflect risks associated with the bank's growing Mainland exposures. Mainland loans amounted to 32% of overall loans at end-2012, and are likely to increase further as the bank increasingly serves the cross border banking needs of its Mainland customers. Growth in Mainland exposures renders the bank susceptible to potential adverse developments in the Mainland economy.

The bank has maintained sound capitalization over the past three years. Its Tier 1 ratio was 11.8% at end-2012. In the event of stress, capital support from China CITIC Bank is likely. The impaired loan ratio at end-2012 was roughly in-line with the rated Hong Kong bank average at 0.45% of loans. Growing volume of Mainland business has contributed to improved margins and overall profitability. Nevertheless, profitability continues to lag behind the Hong Kong peer average with net return on average risk-weighted assets of 1.32%.

What Could Change the Rating Up/Down
China CITIC Bank International's deposit rating could be upgraded if the parent's deposit ratings were upgraded. An upward adjustment of the bank's standalone assessment will depend on the bank maintaining its good asset quality metrics and capitalization, and demonstrating the sustainability of its franchise serving the offshore banking needs of Mainland customers.

Any decline in parental support or a downgrade in the parent's rating could lead to a downgrade of the bank's deposit rating. A material increase in riskier Mainland exposures may lead to lower standalone assessment. A material deterioration in the bank's capitalization (Tier 1 ratio below 9.5%) and/or asset quality (with impaired loans accounting for more than 3% of overall loans) due to imprudent expansion or misjudged credit allocation could also lead to a lower standalone assessment.

CHINA CONSTRUCTION BANK (ASIA) CORP. LTD
China Construction Bank (Asia) Corp. Ltd. ("CCB Asia")'s standalone BFSR and BCA of C/a3 reflect its strong capitalization, good asset quality metrics, and growing Mainland exposures. The bank's A2 deposit rating incorporates very strong expected support from its parent China Construction Bank Corporation (deposits A1 stable, BFSR D+/BCA ba1 stable).

The outlook on the BFSR/BCA was revised to negative from stable reflecting expected further decline in the bank's capitalization, risks associated with the bank's growing Mainland exposures, and Moody's assessment of unfavorable operating conditions for small and medium sized enterprises in the Pearl River Delta. CCB Asia's Mainland bank exposures amounted to 39% of total assets while exposures to Mainland corporate borrowers represented an additional 13% at end-2012. As the bank continues to grow at a pace faster than the industry average, its capitalization is likely to decline further from a high level of 16.6% at end-2012. Nevertheless, the outlook on the bank's deposit rating remains stable given our expectation of very strong support from its parent.

CCB Asia has maintained sound asset quality metrics in recent years, and its impaired loan ratio was 0.22% at end-2012. CCB Asia's profitability has been below its peer average in Hong Kong. The bank's three-year average return on average risk-weighted assets between 2010 and 2012 was 0.91%. CCB Asia has a weaker funding profile than its peers. The bank's loan to deposit ratio was consistently above 90% between 2009 and 2011 due to strong customer loan growth.

What Could Change the Rating Up/Down
CCB Asia's deposit rating could be upgraded if the deposit ratings of its parent China Construction Bank were upgraded. The bank's BCA is high relative to its size and is unlikely to be upgraded.

CCB Asia's deposit rating could be downgraded if parental support diminishes. The bank's BCA will likely be adjusted downward if there is material shift away from its traditional focus on serving local Hong Kong customers, or if there is a weakening in its risk management and controls. Its BCA could also be adjusted downgraded if there is a material decline in its capitalization due to aggressive expansion, with Tier 1 capitalization falling below 12%.

DAH SING BANK, LTD
Dah Sing Bank's standalone BFSR/BCA of C/a3 reflects its sound asset quality, adequate capitalization and good liquidity profile. These positive factors are partially offset by its high borrower concentration and growing exposures to Mainland borrowers. The bank's long-term deposit rating is in line with its BCA at A3.

The outlooks on the bank's BFSR/BCA and deposit ratings were revised to negative from stable reflecting risks stemming from the potential asset bubbles in Hong Kong, and the unfavorable operating environment for small and medium sized enterprises in the Pearl River Delta due to rising land and labor costs, appreciating RMB, and slow growth in export orders.

Dah Sing Bank's overall impaired loan ratio was 0.35% at end-2012. The bank's large exposures to small and medium enterprises in the trading and export sectors and growing exposures to Mainland customers raise concerns and may pose challenges when the credit cycle turns. Dah Sing Bank has maintained satisfactory capitalization, with Tier 1 ratios of around 10% since 2009. The bank also maintains adequate liquidity and is funded primarily by deposits. The bank's loan-to-deposit ratio stood at a healthy level of 73% at end-2012. Intense competition, low interest rates, and elevated operating expenses have weighed on the bank's profitability. Net income over average risk-weighted assets was 1.46% in 2012.

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http://www.moodys.com/research/Moodys-takes-rating-actions-on-nine-Hong-Kong-banks--PR_275029