In a place "where bank outlets outnumber rice shops", banking stocks naturally become hot picks for local investors. This is exactly the situation in Hong Kong.

Even though the subprime crisis had a tough time for banks last year, most analysts remain optimistic about Hong Kong-listed banks.

Hong Kong banks

Three banks become top picks, each representing a category: Dah Sing Financial (mid-caps), Bank of China Hong Kong (larger banks) and Standard Chartered (international banks). But some remain conservative on HSBC.

This year rate cuts and slowing fee-income growth will be the main themes for Hong Kong banks.

UBS is cautiously optimistic about Hong Kong banks. Despite the rising credit costs, Hong Kong banks' balance sheets remain strong with net subprime exposure of 1 to 7 percent and return of pricing power as key positives, said UBS analyst Sally Ng in a research report.

Ng estimates that under the rate cut cycle, mid-cap Hong Kong banks will outperform large-cap banks as they face less pressure on deposit spread when credit costs increase. The investment bank favors Wing Hang Bank, ICBC (Asia), and BOCHK.

Echoing the UBS view, Merrill Lynch said that lower Hong Kong Inter-bank Offered Rate (HIBOR) will result in lower time deposit rates that would benefit mid-cap banks due to lower funding costs.

In its research report, Merrill Lynch said bigger banks are most exposed to lower HIBOR that will marginally trim earnings on the banks' free funds and yields on HIBOR-based loans while further prime rate cut will squeeze the yield of mortgage and SME loan book. Yet, lower saving rate will be positive for margins of big banks such as HSBC, Hang Seng Bank and BOCHK.

Most analysts remain cautious about HSBC's prospects in 2008 due to the lender's US losses and slowing growth in US and European market despite strong growth in Asia Pacific.

Merrill Lynch reduced HSBC's 2008 earnings forecast by 14 percent this year while JPMorgan cut its target price to HK$110.

Mainland banks

Top players Industrial and Commercial Bank of China and China Construction Bank win the hearts of most analysts because they can well withstand regulatory and external changes. China Merchants Bank also stands out with its high growth and profitability. But there are mixed views on Bank of China.

Despite slowing US economy and the mainland's tightening policies, analysts hold positive views about mainland lenders.

Some banks have already pre-announced the growth of over 100 percent in the first quarter of 2008.

HSBC said in its research report that further upside is possible as the real growth could be higher than pre-announced. Besides, banks' strong fundamentals remain intact, with sustained net income margin and fee growth expected to drive earnings.

It forecasts mainland banks' post-tax profits to grow 25 percent to 53 percent, favoring big banks on distribution strength including ICBC and CCB and Bank of Communications.

JPMorgan, holding a bullish view about mainland banks, believes the latest monetary data still confirms a solid backdrop for revenue momentum, said its analysts including Samuel Chen. As the government will balance inflation with economic growth, annual loan growth is likely to exceed his original forecasts by 1 to 2 percent for many banks.

Meanwhile, Bank of China, which was most affected by US subprime woes, reported earnings higher than the forecast. Goldman Sachs rated BOC's H-shares "neutral" with a target price of HK$3.24.

JP Morgan remains a much higher target price for the bank - HK$4.50. Key risks include unexpected severe asset quality deterioration and further collapse in global credit market but it believes the bank will benefit from foreign exchange lending.

(HK Edition 04/15/2008 page3)