Hang Seng Bank Earnings: We Lower Our Fair Value Estimate by 8% but Still See Shares As Attractive

We lower our fair value estimate for Hang Seng Bank 00011, or Hang Seng Bank, to HKD 136 from HKD 148 after its interim 2023 earnings, still about 23% upside from the current share price and indicating that we view the shares as attractive at present. We value Hang Seng Bank at a price/book ratio of 1.63 times and assume midcycle return on equity of 12.5%. This equates to a midcycle price/earnings ratio of 13 times, and a midcycle dividend yield of 5.4% on our assumption that Hang Seng Bank maintains a 70% payout ratio.

Earnings were weaker in the first half of 2023 than we forecast going into the year mainly because Hang Seng Bank’s loan book shrank 4%. This was due in part, we believe, to the bank’s efforts to derisk its mainland China corporate loan portfolio, which had led to elevated credit costs in 2022, and as loan demand was weaker than expected in Hong Kong amid a relatively muted recovery from the effects of China’s pandemic lockdowns a year ago. Some borrowers are also opting to borrow onshore in renminbi rather than borrowing in Hong Kong dollars or U.S. dollars due to the lower interest rates available onshore. In response to this lack of loan demand, Hang Seng Bank allowed its deposits to shrink 8% from their end-2022 level by not raising deposit rates aggressively to capture rate-sensitive customers (given that the bank has ample liquidity and sticky deposits), which improved its ratio of current account and savings deposits, or CASA, to total deposits to 61% from 59%. This helped protect net interest margins, particularly in the spring when Hibor was well below U.S. dollar short-term rates. Most recently, Hibor has mostly caught up to Libor (which is still rising itself), boding well for net interest margins in the second half even if loan volumes continue to disappoint. Results otherwise were decent, with cost/income ratio improving to below 36% and credit costs improving due to the bank’s derisking efforts.