February 18, 2017 2:30 am JST

Bank of East Asia's China ops see first-ever loss

Net profit slid 33% as bad debts rise on mainland

JOYCE HO, Nikkei staff writer

From left, Bank of East Asia executives Adrian David Li Man-kiu, David Li Kwok-po and Brian David Li Man-bun discuss 2016 financial results on Feb. 17. (Photo by Joyce Ho)

HONG KONG -- Bank of East Asia reported a 33% slide in net profit for 2016 as mounting bad debts on the Hong Kong company's mainland book took a heavy toll, driving the first net loss for the bank's China arm since its formation in early 2007.

A second consecutive year of deteriorating performance led to net profit of 3.72 billion Hong Kong dollars ($480 million), or HK$1.21 per share -- a seven-year low. The biggest drag came from impairment losses on loans and advances, which rose more than 70%. But despite the improvement in the second half of the year, full-year net interest income and non-interest income fell 7% and 4.7%, respectively. The China arm delivered a net loss of HK$461 million.

Dividends per share dropped 36.4% from a year ago to 56 Hong Kong cents, even though the bank had raised its payout ratio to 46.7%. The bank's Hong Kong-listed shares closed 4.06% lower Friday at HK$33.10, though the price remains 11.45% higher for the year.

Mainland woes

Asset quality was particularly worrying for Bank of East Asia's mainland arm, as 2.87% of these loans were nonperforming, up 24 basis points from a year ago and above the group's average at 1.49%. Credit costs likewise shot up to 2.56% for the mainland operation, compared with 0.95% for the group.

"Disposal of the impaired loans caused short-term pain," the company said in its annual review.

"Mainland policymakers continued their efforts to rebalance the economy through supply-side structural reforms," the company said. "However, adjustments are proceeding slowly against a backdrop of weak external demand, excess industrial capacity and lackluster investment sentiment."

Year-on-year declines were amplified as income was translated from the depreciating yuan to the Hong Kong dollar, which is pegged to the U.S. dollar, the bank said.

But the group remained confident in its bets on the mainland. "We still believe in the China market, which has a huge potential," Brian David Li Man-bun, the bank's deputy chief executive, told reporters Friday. "China will continue to be a highly important market for the group."

Some benefits of a stronghold in mainland China are not readily apparent on the onshore book, Brian Li said. "Our franchise in the mainland is still very strong," he said. "That has driven a lot of cross-border business, or referrals to Hong Kong as well as overseas branches."

The deputy chief executive expects a turnaround for the bank this year.

His father David Li Kwok-po, chairman and chief executive of the bank, gave a similar view at briefing. "We are confident that we have already taken most of the bad news on board, and that the credit cycle has bottomed out," he said.

Yet the bank has grown a lot more cautious about extending credit to customers in mainland China, Taiwan and Macau, which altogether saw a 6.7% decline in loan growth from a year ago. In contrast, gross advances in Hong Kong and overseas markets increased 5.1% and 7.9%, respectively.

The company expected this more prudent approach to credit risks would dovetail with its plan, unveiled in August, to reduce costs by HK$700 million over three years. The bank said it had achieved 40% of that target in 2016.

Battle for control

But some investors are wary about the bank's future. "Cost-cutting doesn't really mean too much unless you can support a certain level of revenue growth post-cost-cutting," said an institutional shareholder who requested anonymity. The investor also raised concerns over the bank's tendency to issue new shares, which might dilute shareholders' interests. The bank's return on average equity shed 2.51 percentage points to 4.1% last year.

Bank of East Asia is the larger of the two remaining family-owned lenders in Hong Kong. David Li, the third generation running the business founded by his family in 1918, is fighting a long battle against New York-based Elliott Management, which has pressed for a sale of the bank since last February after the hedge fund management firm built a 6.84% stake.

Placing new shares with two strategic stakeholders -- Tokyo-based Sumitomo Mitsui Financial Group and Spanish lender Criteria Caixa -- was seen as a move by David Li to strengthen his control over the inherited business, notwithstanding the Hong Kong bank's need to shore up its capital for meeting regulatory requirements. The two partners currently have a combined interest of 30.86%.

The third-largest shareholder, Guoco Group, an affiliate of Malaysia's Hong Leong Financial Group, has a track record of profiting from bank-related trade sales. Guoco in 2001 sold its 71.3% stake in Hong Kong lender Dao Heng Bank to Singapore's DBS Bank for HK$41.92 billion, or 3.3 times Dao Heng's book value.

Meanwhile, David Li also was embroiled in a corruption scandal involving former Hong Kong Chief Executive Donald Tsang, who was found guilty on one account of misconduct in public office Friday.

If David Li were removed as chief executive, support from the two strategic partners might be in question, said the shareholder who asked not to be identified, noting that David Li was crucial in cementing the ties between the two foreign lenders. David Li, whose term is set to expire in March 2018, said an extension would be up to the board. "I have no authority to decide," he said.

Despite the bank's lackluster performance, its shares have steadily gained since Elliot's intervention, which had fueled expectations of a sale of the bank. Various asset managers have cut their position in Bank of East Asia lately, including BlackRock Institutional Trust, State Street Global Advisors Asia and Hang Seng Investment Management. Nine of 11 analysts polled by Reuters recommended a "sell."

Sumitomo Mitsui Financial Group, Inc.

Japan

Market(Ticker): TKS(8316)
Sector:
Industry:
Finance
Major Banks
Market cap(USD): 54,581M
Shares: 1,414.44M
Asia300

Bank of East Asia Ltd.

Hong Kong

Market(Ticker): HKG(23)
Sector:
Industry:
Finance
Regional Banks
Market cap(USD): 11,920.5M
Shares: 2,725.56M
Asia300

Hong Leong Financial Group Bhd.

Malaysia

Market(Ticker): KLS(1082)
Sector:
Industry:
Finance
Finance/Rental/Leasing
Market cap(USD): 4,668.79M
Shares: 1,147.52M

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