Why BOC is top pick among Hong Kong banks

Has strongest capital adequacy ratio (12.3% Tier 1) vs peers, an attractive 5.2% dividend yield and CNH asset deployment growth potential.

Margins were negatively affected by high offshore RMB (CNH) funding costs in 2H12, but we see CNH margins improving in FY13 as deposit competition has eased so far this year.

FY12 results above Street but below our expectations: BOCHK reported net profit of HK$20,930mn, +2% y/y (+16% y/y excluding Lehman writebacks), 2% above Bloomberg consensus but 3% below our forecasts. The main difference vs our forecast in 2H12 was 1) net interest income (-4% h/h); 2) fee income (-7% h/h) especially in loan and insurance commission; and 3) credit cost which rose to 20bps (1H: 3bps). Our FY13-14E profit estimates are largely unchanged.

Lower margin but improving deployment of CNH: BOCHK maintained its dominant 23% market share with HK$175bn of CNH deposits, despite fierce competition in 2H. CNH funding deployment improved substantially. CNH loans nearly tripled to HK$47bn and CNH LDR rose to 27% (from 17% in 1H).

Overall margin declined by 8bps h/h to 1.56% in 2H, led by higher RMB funding cost (RMB deposits account for 19% of total) and drove group deposit costs 8bps higher h/h. Moreover, debt securities yield declined as excess liquidity (post-QE3) was deployed into short duration securities. Management sees stable margins in 2013 (1.60%) due to corporate loan pricing competition.

Strong capital position and dividend upside potential: Dividend payout ratio rose slightly to 62.6% (HK$1.238/share, from 61.5% in 2011), within the target range of 60-70%. Considering capital needs for strategic investments, management may consider payment of a special dividend in future. Management guides for a slightly positive impact on reported CAR from the transition to Basel III, which will be disclosed during the 1H13 results announcement.