Hong Kong banks this year should not count on stock market windfall they had received in 2007, as recession fears in the United States and the subprime crisis are expected to cool investment sentiments worldwide.

Industry analysts said the record-breaking income from stock-related services is unlikely to happen again, but on the bright side many agreed that the worst of the US bad debt crisis had passed for local lenders.

"There will be further writedowns for sure, but many banks had already made provisions for 50 percent to 80 percent of their high risk CDO and SIV assets," Credit Suisse vice-president for banking research Jay Luong said, "so the worst is behind us."

Luong said the crux of the CDO problem lies in the global liquidity crunch, rather than the deterioration in asset quality. Therefore, if credit market conditions improve, banks can expect the value of their CDO profile to regain some loss grounds.

Core business healthy

Although the subprime crisis unleashed a torrent of bad debts eating into the profits of local banks, the fundamentals of Hong Kong's banking sector remain healthy, according to economists.

"The control of Hong Kong Monetary Authority (HKMA) on the banking sector is better than the US Federal Reserve. Besides, Hong Kong banks are more conservative in lending versus the US banks," said Timothy Lo, managing director of CIC Investor Services - a subsidiary of the French Credit Industriel et Commercial.

Hong Kong banks have weathered numerous upheavals like the 1997 Asian financial crisis and have learned to maintain a capital adequacy ratio higher than 8 percent - the international benchmark. This means that banks are richer in cash and are less leveraged on lending than its US counterparts.

"Also, Hong Kong's exposure to subprime-related securities is small comparatively," Tony Tong, banking analyst of China Everbright said. "Put those writedowns aside, earnings are actually pretty strong."

However, Tong admits that it was a stroke of luck that the stock market was doing incredibly well in the first half last year, which stopped the hemorrhaging in some smaller lenders' profit books.

Tough times ahead

With further monetary tightening policy on the mainland looming on the horizons, the successive interest rate cuts in the US and American recession woes, 2008 will be a year marked with challenges for lenders.

"This year the probability of a slowing economy in the US, coupled with a slowdown in the mainland's economic growth, will make business tough for banks," Luong said. He expects banks' earnings to experience a more slackened mid to high single digit growth rather than the high double digit growth seen in 2007.

Several investment banks also maintained a "cautiously optimistic" outlook for Hong Kong's bank plays in 2008. UBS sees the strong fundamentals behind the balance sheets of local lender, after subprime exposure, and the "return of pricing power" for loans as key positives.

Yet, the Swiss investment bank said the narrowing of deposit spread in this year caused by the possibility of declining interest rates, will likely to put more pressure on banks with a large capital pool. UBS tipped mid-cap banks like Wing Hang, ICBC (Asia) and BOCHK as good buys.

Goldman Sachs, on the other hand, held a more pessimistic views by downgrading Hong Kong banking stocks to cautious from attractive. It reiterated concerns over further write-downs for CDO and SIV exposures, pressures on net interest margins and net fee income as major downside factors for the sector in 2008.

(HK Edition 04/15/2008 page3)