Guess which bank will suffer big-time from 20% decline in home prices

This bank's earnings will decline 15%.

According to Bernstein Research, given its lower profit margins, we forecast BEA will be more negatively impacted from falling house prices even though the bank has lower exposure to HK retail. 

Bernstein Research noted that in general, the banks reported relatively benign retail mortgage impairments over  the 2002-03 period despite the weak housing and rising unemployment environment.

"We forecast that BEA's earnings would decline 15% in a scenario where HK housing prices fell 20%, sharper than the 11% decline at BOC(HK) and 7% decline at Hang Seng Bank," says Bernstein Research.

Here's more:

The recent housing boom - Hong Kong house prices have risen ~120% in the past five years and look set for a correction in the near-to-medium term.

Given the prudential measures taken by the HKMA in the last few years, we expect that the fallout on mortgages will be contained. We see the biggest risks in Hong Kong from unsecured and SME books which we think will account for a bulk of the rise in impairments (more than 100bps rise in impairments over loans).

More importantly, we see risk weightings across asset classes increasing sharply to the tune of 20-25% further denting current HK banks' profitability.

Going into this cycle where are the risks? In the last few years we have seen rapid systemic loangrowth in Hong Kong which we believe masks the underlying impairment trend in the back book.

Within asset classes, we are less worried about mortgages than we are about unsecured and SME. Risks on the mortgage book seem contained given the prudential measures adopted by the HKMA in the last 4 years and also given that the average loan to value on new residential mortgages remains below its historical long term average.

On the other hand SMEs and unsecured books tend to account for a bulk of impairments during a downturn. These will be hit by unemployment if developer activity comes sharply  down - a trend for which we are already seeing early signs.

Another important factor going into this cycle is risk weightings. Anecdotal evidence from most HK banks suggests mortgage risk weightings are in the 5-10% range. With the regulator (HKMA) already enforcing a floor of 15% on new mortgages, in a stressed scenario, we could easily see a 20-25% increase in RWAs across the banks' retail books.

While the banks have increased pricing on mortgages (+25bps) in response to these measures, these increases in pricing will be largely offset by increase in impairments as well.