China exposure a double edged sword for Hong Kong banks

Hong Kong banks' mainland exposure has been a strong growth driver for income but has also been a drag on their valuation, say some experts.

"It is a double-edged sword," said Joseph Chan, a Shanghai-based partner at Sidley Austin. "The growth potential on the mainland remains an attraction for Hong Kong banks ... but the China exposure also seems to weigh down valuations."

Concerns over the quality of their mainland assets are among factors that have deterred potential suitors from bidding aggressively for Hong Kong banks.

In the latest industry deal, Guangzhou-backed Yue Xiu paid a price-book ratio of 2.08 to acquire 75 per cent of Chong Hing Bank. In comparison, China Merchants Bank in 2009 acquired Wing Lung Bank in a deal that put the price-book ratio at 2.9.

The city's largest family-controlled bank, Bank of East Asia, will only consider selling if it is offered a price-book ratio of 3 to 4, according to chairman and chief executive David Li Kwok-po.

The five largest mainland banks are trading at an average price-equity ratio of 4.82, from 5.47 six months ago.

Mainland bank valuations priced in possible credit losses and the impact of regulatory changes on margins in the event of interest rate liberalisation, said Matthew Phillips, a partner and financial services markets leader at PwC Hong Kong and China.