Forget Aussie banks; HSBC is a better bet!
The Bank Levy is a new threat and given all the other challenges faced by the big four banks, analysts are finding it hard to be bullish, despite the recent pullback in their share price.
With the outlook for the global economy looking more optimistic and signs of reflation, UBS analyst Jon Mott reckons Asia’s banks are a better bet than the Aussie lenders - particularly the Hong Kong banks.
Everyone knows the challenges facing Aussie banking majors: high household debt; macro-prudential tightening; house prices in bubble territory; near-record low bad debt charges; higher capital demands; and the risk that the bank levy will rise.
“In future years when the Federal Budget is under pressure, we believe there will be a large temptation to ‘raid the cookie jar’ and increase taxes on the banks," he said.
“This may effectively put a cap on the growth prospects of the banks. The more they succeed, the more likely they are to face higher taxes.”
Although Mott has some residual concerns with the outlook for Asia’s bad loan cycle, he reckons banks there now appear to be either through or within touching distance of the peak in many regions, especially in Indonesia and India.
The analyst likes the Hong Kong banking sector partly because of the strong underlying tailwinds from further increases in US interest rates but more crucially because the market has gotten the story wrong.
“While much discussion of the rate impact on the Hong Kong banks focuses on whether asset yields or funding costs are more sensitive to rate rises, we believe the conclusions are right for the wrong reason," he said.
“Our analysis of rate cycles in Hong Kong over the last 22 years shows real upside lies in the return banks make on their 'free funds’, not the spread.”
By breaking out this return on 'free funds’ - which is capital and demand deposits - out of the net interest margin, Mott estimates the rate rises implied from the current Hong Kong yield curve will deliver the domestic Hong Kong banks a 12 basis point tailwind on net interest margins.
This is roughly equivalent to HK$5.3 billion net earnings or 9.1 per cent for 2019 forecasts or a 110 basis point uplift to sector return-on-tangible-equity, which is currently 13.9 per cent.
Further, the analyst argued that current Hong Kong bank share prices reflect just three rate rises over the next three years.
“There is little doubt that rate rises carry the obvious risk of adding balance sheet stress to a very leveraged Hong Kong private sector. However, our analysis of the interest rate burden of 1,300 Hong Kong corporates, seven industry sectors and the Hong Kong mortgage books does not present the case for a near-term crisis.”
UBS prefers domestic Hong Kong banks like Bank of China over their global Hong Kong bank peers. That said, the house prefers HSBC relative to Singapore and Australian banks.
According to Mott, while HSBC’s 2017 first quarter update showed positive trends on loan growth and margin expansion, HSBC's capital generation is the real story.
The 14.3 per cent common equity tier one capital ratio delivered at the first quarter leaves HSBC standing with US$10 billion of capital above the top of its own 12-13 per cent target capital range.
“Although this is hardly revolutionary at 6 per cent of market cap, it is a reminder that HSBC's 10 per cent RoTE implies too much capital generation to be absorbed by our 4 per cent loan growth forecasts – so either lending will be more rapid, or capital returns higher.”
In terms of capital management, Mott said HSBC will likely launch a US$5 billion share buyback this year and US$4 billion buyback in 2018.