BEA digs itself into a real estate hole

A tough road lies ahead for the young, new CEOs of Bank of East Asia (0023).

Ivan Tong

Monday, June 17, 2019

A tough road lies ahead for the young, new CEOs of Bank of East Asia (0023).

Chief Executive Carrie Lam Cheng Yuet-ngor has suspended the controversial extradition bill for now in a bid to ease emotions on the street, but as protests continue, the fate of Hong Kong stock market this week is very much up in the air.

BEA's stock in particular, which fell over 9 percent last Friday, faces a tough test.

The sharp fall in the local bank's shares resulted from a profit warning it issued last week, due to problems over its loan assets in the mainland.

It's profit downgrade shows that the cracks in the mainland's real estate-driven economy are becoming more and more apparent.

And since mainland loans account for a large chunk of BEA's business, there could be more non-performing loans that emerge in the future.

Since its launch back in 1918, BEA only has issued a few profit warnings.

One of these was back in 2008, when the bank's earnings were inevitably affected by the global financial crisis.

The latest high-profile warning announced last Thursday was due to a downgrade of four legacy loan assets in China with a nominal value of about HK$6.2 billion, involving commercial property loans in tier-three cities several years ago.

The bank estimated a post-tax impairment loss of between HK$2.5 billion and HK$3 billion because of the downgrade.

On Friday, BEA's share price slumped with many investment houses posting negative outlooks for the bank.

The profit warning comes just weeks before chairman and chief executive David Li Kwok-po steps down on July 1.

His two sons, Adrian David Li Man-kiu and Brian David Li Man-bun, take over the reins as co-chief executives next month with David Li taking on the role of executive chairman.

In addition, another veteran, senior adviser Joseph Pang Yuk-wing, retires at the end of this month.

From a strategy viewpoint, the bank probably revealed the loan problem before David Li's departure to ease the burden on the incoming CEOs as they embark on their new journey.

But the problem is that mid-sized banks with a high proportion of mainland loans will be impacted much more by the deterioration in loan asset quality than large commercial banks, amid the Sino-US trade war and an increasing downside risk to the mainland's economy.

BEA, which was taken off the blue-chip Hang Seng Index last year, saw its shares once sink by as much as 9.5 percent last Friday, which was the biggest decline since 2008, closing at HK$21.95, the lowest since February 2016.

There is not much data available on just how serious is the problem of commercial loans and residential loans in the mainland.

The non-performing loan figures disclosed by state-owned banks are not necessarily accurate but they are backed by the government and this is why these large banks are too big to fail but less robust.

At the opening ceremony of the Lujiazui Forum in Shanghai last week, Guo Shuqing, the chairman of the China Banking and Insurance Regulatory Commission, warned about the "over-financialization" of the mainland property industry and high household debt ratio.

He said some citizens had invested half of their funds into real estate, but history has shown that people have always paid the price of being too heavily invested in the property market.

I suspect the "over-financialization" problem he spoke about refers to a housing bubble - similar to the Japanese asset price bubble in the early 1990s - though he did not make it too obvious.

According to my observations there are serious oversupply problems in commercial properties, especially office buildings and hotels, in some tier-three and tier-four mainland cities, and the red-hot residential property market is now showing signs of cooling down.

If there is a sharp downturn in the property market - which is supported by banks' leverage - then the banks, of course, and China's economy, will be severely tested.

Ivan Tong is Editor in Chief of The Standard