Investors advised to steer clear of BOC Hong Kong
Brokers wait for explanations from the bank's management over questions of problem loans to property tycoon
With the taint of scandal again lurking over BOC Hong Kong (Holdings), brokers are reassessing their calls on the bank's shares and advising investors to steer clear of the stock until management provides clarity on the involvement of the bank's former chief executive in problem loans made to a Shanghai property tycoon.
Late last month, BOC Hong Hong, the listed unit of Bank of China, announced a sudden management reshuffle that sent chief executive Liu Jinbao back to Beijing, replacing him with He Guang-bei. His sudden departure was then linked to an investigation into shady loans made during Mr Liu's tenure at the bank's Shanghai branch. Authorities are investigating Chau Ching-ngai, the chairman of Shanghai Land Holdings, and more than $2 billion in questionable loans the bank made to the Shanghai property tycoon.
The Independent Commission Against Corruption arrested a former BOC Hong Kong executive for alleged involvement in the case.
Since rumours of the investigation first surfaced, BOC Hong Kong shares have dropped about 3 per cent to yesterday's $7.95 close amid mounting concern about the bank's credibility and its ability to assess risk.
'This investigation raises the issue of credibility, which is a much bigger issue than the actual loss itself,' said a banking analyst at a US brokerage. 'The bank needs to achieve better risk management. This has been its goal. If investors see a chink in their armour, it tests their credibility. It's not the loss per se, it's what's behind the loss.'
With few verifiable details on the size of the loans or the potential to recoup the funds, analysts said it is not possible to assess the financial impact on the bank.
Kevin Chan, banking analyst at Nomura Securities, downgraded the stock to neutral from buy this week and cut the brokerage's long-term fair-value estimate to $9.00 from $10.10.
'Based on the information we have, the financial impact on BOC seems quite limited,' he said.
Even BOC's biggest fans recognise the allegations and investigations as a blow to the bank's credibility, while the bank's detractors herald the scandal as validation of their previous concerns.
HSBC banking analyst Alan Chua said HSBC did not change its rating on BOC Hong Kong 'because it couldn't get any worse'.
This is not the first time the Bank of China has become embroiled in scandal. Last year before its IPO, US securities authorities slapped the bank with a record US$20 million fine.
Dominic Chan, banking analyst at CLSA, said the latest scandal comes as no surprise given the bank's track record at assessing credit risk.
'BOC Hong Kong has an 8 per cent NPL [non-performing loan] ratio, which is way above the industry average of 3.5 per cent. Management said they would bring it below 7 per cent by the end of 2003 but it would be difficult to achieve given the new developments and also the impact of Sars.'
Mr Chan said he had always had an underperform rating on the share, citing concerns about the bank's exposure to Hong Kong's deflated property sector.
'The bank has a huge pool of property investments valued at about HK$20 billion. This means any 10 per cent decline in office property values, cuts its pre-provision profit by 12 per cent,' he said.
However, the bank has maintained some fans.
Nomura's Mr Chan said he did not downgrade the stock to sell, despite the wave of bad publicity because the bank remains an attractive dividend play and longer term the management shuffle may be positive.
'It's a lesson to learn for the company. They can learn from this mistake and it could further improve corporate governance,' he said. 'We see the controversy as a short-term setback. BOC Hong Kong's long-term potential in capitalising growth opportunities in renminbi clearing remains intact, in view of proposals calling for closer co-operation between the mainland and Hong Kong. [But] until respective authorities offer clarification, the stock is unlikely to outperform the market.'
Because the new management participated in the bank's pre-IPO restructuring, its target to raise return on equity to 15 per cent this year from 12.5 per cent in 2002 and 6.5 per cent in 2001, should remain intact, Mr Chan said.
Still, focusing on targets may prove difficult if management is distracted by scandal.
John Wadle, regional banking analyst at UBS Warburg, one of the sponsors of the bank's listing, cut his BOC Hong Kong share price target to $7.50 from $9.80 this week amid concern about unanswered questions.
'We do not think management gave sufficiently satisfactory answers to questions raised at the AGM to prevent a drop in confidence by the investment community and perhaps its customers. We believe these possible outcomes could, in the short term, translate to a lower share price for the stock and possibly, in the medium term, an impact on business to the group.'
Merrill Lynch, which maintains a buy recommendation on the stock, warned that if the bank needs to write-off the $2 billion of bad loans, that would slice 20 per cent off its forecast $8.15 billion in 2003 net profit.
But Merrill said even after a 20 per cent profit reduction, the shares offer 11 per cent return on equity, meaning its ROE over price-to-book at 7.3 times forecast 2003 earnings remains higher than the Hong Kong banking sector average.
