Guess which Hong Kong banks will be badly hit by lower commercial property prices

Analyst predicts a 10% fall in prices.

According to Barclays Research, BOCHK, HSB and WHB's book values are more affected by falling commercial property prices; Barclays estimates every 10% decline in property prices would result in a 4%, 2.9% and 2.7% lower FY14E book value, respectively.

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In terms of earnings, BEA and BOCHK appear more vulnerable; we estimate every 10% decline in property prices would result in 5.4% and 5.7% lower FY14E PTP (vs 3.6-4.2% for their local peers), mainly in relation to investment property exposure.

Commercial A-grade office prices in Hong Kong declined 3% between June and August 2013 (vs a +11% CAGR over 1H08-1H13), and Hong Kong property analyst Paul Louie expects them to decline 20% by 2015E.

Hang Seng Bank (UW), BOCHK (OW) and Wing Hang Bank (EW), which record premises they own at market value, could be affected by potential downward property revaluations, in our opinion.

HSB, BOCHK and WHB more susceptible to potential downward property revaluations: BOCHK, HSB and WHB use the fair value method to account for their own premises (ie, revalued at the end of each reporting period to market value), resulting in large property revaluation reserves, equivalent to 13-21% of 1H13 book value.

Our property analyst Paul Louie expects office prices to fall 20% by 2015E, and we believe the Hong Kong banks may be susceptible to downward property revaluations, although there may be a time lag for rising property yields to feed into valuer models.

In addition to premises, Hong Kong banks are exposed to investment properties (held for rent or capital appreciation, rather than for own use), which are all recorded at fair value.

Adjusting P/B multiples for property revaluation reserves: If property valuation reserves are excluded, we estimate adjusted P/B 2014E would be higher at 2.5x for HSB (vs 2.2x unadjusted), 2x for BOCHK (vs 1.6x), and 1.8x for WHB (vs 1.6x). BEA, DSBG and DSF's adjusted P/Bs are not materially different, as they account for premises mostly at cost and are more defensive against a potential downturn in commercial property prices, in our view.

DSBG, DSF and BOCHK our top picks: In our view, DBSG and DSF (both OW) are defensively positioned for potential property price declines and are inexpensively valued at 0.9-1.1x 2014E P/B.