MARC AFFIRMS ITS FINANCIAL INSTITUTION RATINGS OF AAA/MARC-1 ON THE BANK OF EAST ASIA, LIMITED

MARC AFFIRMS ITS FINANCIAL INSTITUTION RATINGS OF AAA/MARC-1 ON THE BANK OF EAST ASIA, LIMITED

MARC has affirmed its long-term and short-term financial institution ratings of AAA/MARC-1 on Hong Kong-based The Bank of East Asia, Limited (BEA). The outlook on the ratings is stable. The affirmed ratings reflect the bank’s capacity to meet its financial obligations on the Malaysian national rating scale.

The ratings incorporate MARC’s expectations of systemic support being extended to the bank based on its moderate systemic importance in Hong Kong. The ratings also consider BEA’s weakening loan growth and declining asset quality as well as its fairly strong capital position and sound funding profile.

During the period under review, BEA’s performance was impacted by the challenging economic conditions in Hong Kong and mainland China, reflected in the bank’s weak loan growth and declining asset quality metrics. As at end-2016, BEA’s total loan book increased slightly by 2.9% to HK$454.2 billion with the growth from Hong Kong and overseas, offsetting the loans from mainland China where BEA’s exposure accounted for a sizeable 38.0%. BEA's asset quality weakened further in 2016 with the gross impaired loans ratio increasing to 1.5% (2015: 1.1%); Hong Kong operations saw faster growth in gross impaired loans which increased by more than threefold while mainland China operations recorded a lower growth at 6.8%. Nonetheless, gross impairment from mainland China accounted for 63.7% of the bank’s total gross impaired loans (2015: 81.2%), underscoring the risks the bank faces should economic conditions deteriorate in the country.

MARC understands the bank has implemented measures to manage its increased credit risk by tightening its lending criteria and reducing exposure to sectors with heightened risk. This notwithstanding, given that property segments (property development, investment and purchases) accounted for 53.1% and 41.2% of loans used in Hong Kong and mainland China respectively, a sharp downturn in the property market would negatively impact the bank. As at end-2016, collateral cover as reflected by market value of security held against impaired loans stood at 1.5 times (2015: 1.7 times).

BEA’s operating performance has come under pressure from higher impairment charges and lower loan growth, with operating income declining by 6.4% year-on-year (y-o-y) to HK$14,850 million. Net interest margin narrowed to 1.5% from 1.6%, largely on account of the impact from BEA China’s weakening net interest margin, while impairment charges rose by 69.1% y-o-y to HK$3,463 million.  However, operating expenses were down by 6.3% to HK$8,342 million as the bank continued its cost-saving initiatives, which include realigning certain business operations by consolidating underperforming areas and eliminating redundant processes. For 2016, profit after tax fell by 32.1% y-o-y to HK$3,829 million (2015: HK$5,638 million) while post-tax returns on average equity and post-tax returns on average assets stood at 4.5% and 0.5% respectively. In the near term, MARC views the bank’s profitability measures will be weighed down by weakening asset quality, a narrowing NIM and slower loan growth.

MARC notes that BEA has maintained a healthy capital position with common equity tier 1 (CET1) capital, tier 1 capital and total capital ratios standing at 12.1%, 13.5% and 17.4% as at end-2016 respectively. Although the capital ratios have improved from the previous year, they remain below the industry average of 16.0%, 16.9% and 19.6% respectively as at end-September 2016. Its capital quality has remained fairly strong with CET1 capital comprising 69.5% of the total capital base. In addition to internal capital generation, the capital base was supported by continued issuance of new shares in lieu of dividend payments. In 2016, dividends amounting to HK$1,663 million were reinvested via issuance of new shares. Subsequently, the bank has also declared a second interim dividend of HK$757 million to be paid on March 30, 2017, in cash with an option to reinvest in new shares. The increase in capital base partly offsets the impact from the phasing out of non-Basel III compliant instruments, which constituted 11.3% of the total capital base as at end-2016 (2015: 13.5%).

BEA’s loan-to-deposit ratio increased to 80.4% as at end-2016 (2015: 76.4%) due to a contraction in customer deposits. Current and savings deposits grew moderately but was offset by the contraction in fixed deposits during the year. However, the bank maintained a healthy liquidity position during 2016 with an average liquidity coverage ratio of 137.2% for the fourth quarter of 2016 (fourth quarter of 2015: 151.2%), which was well above the statutory limit of 70.0% for 2016. The statutory limit will increase progressively to 100.0% by 2019.

The rating outlook reflects MARC’s expectation that BEA will maintain asset quality metrics and profitability measures that are commensurate with the rating band. The stable outlook also assumes no significant deterioration in the macroeconomic conditions of China and Hong Kong over the next 12 to 18 months.

Contacts: Norehan Ikhlas, +603-2082 2257/ norehan@marc.com.my; Sharidan Salleh, +603-2082 2254/ sharidan@marc.com.my

March 8, 2017