Mainland squeeze

Bank of East Asia feels weight of its China drive

China has never been an easy market for foreign banks, but those that fought their way into the People's Republic are now feeling the pain. Hong Kong-based Bank of East Asia has the second-biggest branch network on the mainland of any overseas lender except HSBC. But the aggressive expansion of recent years is proving a drag as the outlook for China sours.

The $9.5-billion lender has had a foothold in China since 1920 and remained there through World War Two and the Cultural Revolution. But its growth spurt started in 2007 when it established a wholly-owned local subsidiary. It now has 129 branches and sub-branches. In the first half, China accounted for 38 per cent of operating income.

As economic activity in China has slowed, bad loans have shot up. The ratio of impaired loans at its mainland business more than doubled to 2.65 per cent in the six months to the end of June. Bank of East Asia has responded by tightening its lending criteria and is now talking about rationalising its network. That could further drag down the eight per cent return on equity that the bank generates which is already below the wider sector's 11 per cent, according to Eikon.

Shares of Bank of East Asia have slumped 12.8 per cent so far this year. That's almost twice the decline suffered by the local benchmark Hang Seng index. After a recent wave of takeovers the only other independent bank in the former British territory is Dah Sing: its shares are up 21 per cent over the same period.

US activist investor Elliott seems undeterred, however. The fund has lifted its stake in Bank of East Asia from 2.5 per cent to over six per cent while mounting a legal challenge against the lender's decision to sell stock to Japan's Sumitomo Mitsui Banking Corp. That sale further entrenches the founding Li family, which owns around 7.8 per cent of Bank of East Asia.

Elliott's stake building suggests there is value to unlock. But that may only hold true if Bank of East Asia can keep bad loans at its large China business in check.