Bank of East Asia, Hong Kong's fifth-largest lender by assets, posted higher first-half earnings but warned that the quality of its assets on the mainland was deteriorating and the spread was narrowing between the bank's cost of funds and its loan income.
The bank, which generates about 40 per cent of its business from the mainland, said net profit rose 10.2 per cent to HK$2.99 billion on the back of improved non-interest income and several one-time gains from the sale of some assets and the revaluation of certain property.
While the bank continues to benefit from its expansion on the mainland, analysts say 'the China story' seems to be losing some of its magic.
BEA China's net interest margin, a measure of lending profitability, narrowed 18 basis points to 2.27 per cent compared with the same period last year, because of higher funding costs driven by tighter liquidity on the mainland.
'Margins on the mainland are likely to contract further in the coming months due to interest rate liberalisation,' said chairman and chief executive David Li Kwok-po, who is expected to remain in his position until at least March 2015.
Non-performing loans on the mainland rose 11 basis points to 0.17 per cent compared with the same period last year, because of credit quality deterioration, particularly in Zhejiang province.
Deputy chief executive Brian Li Man-bun said he did not see the asset quality deterioration as a system-wide problem because the bank's bad debts were concentrated in only a few regions and remained below the average of BEA's peers on the mainland.
'We are cautious on BEA's asset quality given the high exposure to China,' Patrick Pong, an analyst at Mirae Asset Securities, wrote in a research note.
The bank continues to face capital constraint issues, and its capital levels remain the lowest among Hong Kong lenders. BEA's capital adequacy ratio, which measures capital against risk-weighted assets, fell 50 basis points to 13.2 per cent in the latest half.
BEA China achieved moderate loan growth of 5.2 per cent and deposit growth of 2.9 per cent in the first half compared with the end of last year. At the end of June, the bank had 24 branches and 83 sub-branches on the mainland.
'The bank's core business appears to be losing steam as capital constrains growth,' said Adam Chan, an analyst at CCB International, who added that the bank's preferred strategy continued to be generating capital through disposal of non-core assets, which is not sustainable and makes earnings volatile.
In Hong Kong, lending profitability stabilised after the bank experienced a tough squeeze in its net interest margin last year.
BEA would focus on corporate banking, yuan trade business and high-yield lending in Hong Kong, said Adrian Li Man-kiu, deputy chief executive responsible for Hong Kong. He added that Hong Kong's mortgage business was still in decline. The bank is the fifth-largest new mortgage issuer in Hong Kong.