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Raymond YUEN
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YUEN is a finance professional with over 20 years practical experience in financial accounting, financial management and investment. He is a freelance trainer and grader. He also holds a PhD(Management) with research interest in market crash and Fractal Theory. He served Qualification Program of... More
  • Prediction Of Bank Value By Capital Adequacy Ratio 0 comments
    Mar 22, 2013 5:19 AM

    Abstract

    Basel III is effective on 1 Jan 2013. This is a short research responding to the implementation of Basel III on the possible return of investing in banks listed on the Hong Kong Stock Exchange.

    The results find that with core emphasis of capital adequacy ratio as a prediction of return of banking stocks listed in Hong Kong, the outlook of the banks are with a very diverse difference.

    Body of Paper

    Basel III is effective on 1 Jan 2013. With the implementation of Basel III, a lot of people are worried about the negative impacts on future expansion of banks in the world. The new Basel III main impact on the banks is the capital adequacy requirement. The capital adequacy ratio required for share capital, tier 1 capital and total capital are 3.5%, 4.5% and 8% respectively.

    Assuming capital become a major limitation to growth of banks, the writer conducts a short research on the investment potential of banks based on capital adequacy ratios.

    There are 18 banks listed on the Hong Kong Stock Exchange as at 22 March 2013. The capital adequacy ratios and price earnings ratios of these banks as at 22 March 2013 are set for this short research.

    The assumption is that the price earnings ratios reflect the valuation of the bank with the given capital adequacy ratios. The research regresses the price earnings ratios with the capital adequacy ratios to discover the should-be price earnings ratios of the banks in order to predict the future price earnings ratios revision which could bring in returns or incur in losses.

    Another assumption for estimating the should-be price of the banks is that there is no change in the future earnings of the banks. Otherwise, the price earnings ratio revision would not bring in the expected return or loss.

    The research results are quite convincing with a R square of 0.57 and the beta of capital adequacy ratio is 1.27 with t-statistics of 4.6. This indicates a strong and statistically significant impact of capital adequacy ratios to the price earnings ratios (proxy of future prospect of the banks).

    The results are tabulated below:

    Code Name Actual PE Ratio Predicted PE Ratio Price (HK$) Predicted Price (HK$) Predicted Return (%)
    5 HSBC Holdings 14.60 12.54 83.10 71.36 -14.13
    11 Hang Seng Bank 12.30 9.88 124.30 99.80 -19.71
    23 Bank of East Asia 11.30 10.26 30.90 28.04 -9.24
    302 Wing Hang Bank 13.70 12.03 83.65 73.45 -12.19
    626 Public Financial 11.50 9.11 3.99 3.16 -20.74
    939 China Construct Bank 7.40 9.49 6.21 7.97 28.31
    998 CITIC Bank 5.50 7.72 4.79 6.72 40.38
    1111 Chong Hing Bank 14.00 11.52 17.50 14.40 -17.69
    1288 ABC 8.20 7.21 3.79 3.33 -12.03
    1398 ICBC 7.30 8.86 5.32 6.46 21.39
    1988 Minsheng Bank 8.10 5.95 10.44 7.66 -26.59
    2356 Dah Sing Banking 9.00 11.02 10.28 12.58 22.40
    2388 BOC Hong Kong 13.60 13.55 26.40 26.30 -0.36
    2888 Standard Chartered 13.20 14.18 203.00 218.14 7.46
    3328 Bank of Comm 5.80 7.85 5.87 7.94 35.30
    3618 CQRC Bank 7.50 11.02 4.18 6.14 46.88
    3968 China Merchants Bank 8.10 6.71 16.68 13.81 -17.20
    3988 Bank Of China 6.40 8.61 3.50 4.71 34.50

    Conclusion

    From the research, it seems that some banks are overvalued and some banks are undervalued and the differences in should-be price and current price are huge in some cases.

    Note: The research is done for academic purpose. Anyone invests according to this research findings shall bear the risk by himself.

    The writer owns none of the mentioned stocks.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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