Hong Kong Financials:Stage Being Set for a Strong 2018

We expect all-around strength in earnings with good loan book progression,expanding NIMs and strong fees.

    1. Loan growth likely to remain strong in 2018: The all-around strength in loangrowth was a positive in 2017. As nominal GDP growth picked up, banks saw loandemand across sectors, within and outside HK. We expect economic growth toremain reasonably strong in 2018, which should help loan growth in the highsingle digits.

    2. HIBOR catch up to help retstart the uptrend in NIMs: Large banks reportedimproving NIMs in 2017, but the overall improvement was muted to an extent bythe sluggishness in HIBOR. But HIBOR has increased meaningfully in the last twomonths (which should help both loan and deposit margins). Some of the recentHIBOR increase may abate as IPO-related tightness goes away, but its unlikelythat all the recent increase will subside. Moreover, Fed futures curve is implyingFed rates at ~1.7% at end-2018, which should also help keep HIBOR high.

    3. Fees income progression should remain solid in the backdrop of good loangrowth and relatively stable capital market-related revenues.

    We expect asset quality to remain benign and costs to lag revenues, whichshould help fairly strong EPS growth in 2018.

    Stocks are not cheap compared to recent history, but improving returns shouldhelp them continue to do well: We look at ROCET1 as underlying profitability forHK banks. Both HSB and BOCHK continue to show improving trends and will be~20% over the next two years (depending on the pace of HIBOR catchup). Wewould expect a rerating given improving profitability, but even if they do notrerate and maintain current multiples, these stocks could deliver ~20% return.

    We stay OW on all the large HK banks – HSBC, BOCHK and HSB – and wouldavoid the smaller lenders, where we find it tough to see meaningfulimprovement in profitability (vis-à-vis multiples).