Asia banking on expansion(2)

In terms of geography, banks are looking to reach further afield in their home markets and to tap into regional growth, particularly in China.

A recent acquisition in Hong Kong by Oversea-Chinese Banking Corp, Singapore's second-largest bank, underscores this trend but also highlights the dangers of this expansionary drive.

OCBC, which owns Bank of Singapore, announced plans on April 1 to acquire Hong Kong's Wing Hang Bank for HK $129 ($16.63) per share in cash, considerably more than the HK $84 per share that Wing Hang was fetching last September. The deal is worth HK $38.43 billion.

"Singaporean banks have been seeking expansion overseas, mostly in Southeast Asia," says Jonathan Koh, a bank analyst at UOB Kay Hian. Koh is positive about the OCBC deal and points out that the bank has been expanding in Hong Kong and the Chinese mainland since 2008.

OCBC's competitor DBS has also sped up its regional push since 2010. In 2011, Singapore's DBS Bank bought Hong Kong's Dao Heng Bank for HK $45 billion, 3.3 times its book value. That acquisition was not exactly a successful one, ending in a S $2.1 billion ($1.67 billion) write-down to DBS due to its deteriorating credit quality.

DBS is OCBC's biggest rival in Singapore and is now the seventh-largest bank in Hong Kong. OCBC has 16 branches in the Chinese mainland, one in Hong Kong and one in Taiwan.

The OCBC deal with Wing Hang, a solid Hong Kong bank with operations in the Chinese mainland, should give OCBC stronger footing there.

"OCBC Bank has been focusing its operations on capturing capital, trade, investment and people flows associated to China through its close relationship with its customers in the region, both onshore and of shore," says OCBC in a statement.

The impact of the deal on OCBC's bottom line will be almost immediate. For starters, it will increase the profits the bank earns in China from 6 to 16 percent. In large part, this is due to Hong Kong's role as the largest of shore yuan market.

But there are dangers, in particular the exposure to new groups of borrowers with uncertain prospects.

The day after the OCBC Wing Hang deal, rating agencies Fitch Ratings and Moody's expressed doubts. The former put OCBC on "watch negative" and the latter downgraded the Singapore bank.

Standard & Poor's, another rating agency, gave OCBC a "stable" grade and pointed out that the bank could benefit from its strong market position and solid funding profile.

"At this early stage, the deal is credit-negative for OCBC because it needs to raise new capital for this large acquisition, and there is a risk that its capital raising might be delayed or reduced," says Eugene Tarzimanov, a Singapore-based vice-president at Moody's.

"If OCBC successfully completes its financing plan for the acquisition, its creditworthiness should return to pre-acquisition levels. In the longer-term, this acquisition should improve OCBC's geographical diversification and product offering."

Founded in 1937, Wing Hang has 70 branches in Hong Kong, Macao and the Chinese mainland.

On April 8, the International Monetary Fund warned in a report that such exposure includes a series of potential risks.

"While deepening integration suggests that financial linkages will continue to grow, the large exposure requires close monitoring and cooperation with mainland supervisors," the report said.

Part of the problem is concern over bad loans.

"The recent surge in bank lending across most of Asia leaves economies and financial systems at risk," says Matthew Circosta, an economist at Moody's Analytics.

Across Asia, the burden of private debt compared to GDP has grown by between 10 and 20 percent in the last five years. Bad loans officially account for less than 5 percent of all loans across Asia, below the rate that caused problems in the United States and Europe. But that is not the whole story.

"To avoid classifying a loan as bad, many Chinese banks roll over debt or repackage it and sell it … or they extend the deadlines for repayment, explains Circosta. "Unofficial estimates put China's non-performing loan ratio at more than 10 percent."