Expected Loss of 440 Billion Won if H Index Maintains 7000
One-Third Level Compared to Maintaining 6000
As forecasts emerge that the Hong Kong H-Share Index (Hang Seng China Enterprises Index, HSCEI) could rise to the mid-to-high 7000s in the second half of the year, banks that suffered from compensation issues related to equity-linked securities (ELS) are breathing a sigh of relief. If the index surpasses the 7000 mark, the expected losses for the second half of the year would drop to less than half, and there is also anticipation of improved earnings due to the reversal of provisions accumulated in the first quarter.
According to the financial sector on the 16th, the Hong Kong H-Share Index recorded 6761.64 as of the 13th. This represents a 37.2% increase from the year's low of 5001.95. The index had been declining since reaching a peak of 12,106.77 on February 2021, falling to the 5000 level in January this year, but has since rebounded to reach the highest point of the year.
With the Hong Kong H-Share Index reaching the 7000 level, the expected losses for bank investors in Hong Kong ELS for the second half of the year have also sharply decreased. Six major commercial banks (KB Kookmin, Shinhan, Hana, Woori, NH Nonghyup, and SC First Bank) estimated the expected losses for the second half of this year (June to December) based on scenarios of the Hong Kong H-Share Index. If the index remains around 6000, about 600 points lower than the current level, the losses are predicted to reach approximately 1.1966 trillion KRW. However, if the index holds at 6500, losses are expected to be 799.2 billion KRW, and if it surpasses 7000, losses could drop to 441.1 billion KRW, about one-third of the losses at the 6000 level.
Recently, with growing optimism about the Chinese stock market, the upper band of the expected range for the Hong Kong H-Share Index in the second half has risen to the high 7000s. Hana Securities recently raised its forecast range for the Hong Kong H-Share Index in the second half to 6045?7750. This is about 1000 points higher on both the upper and lower ends compared to the previously discussed range of 5000?7000 in the securities industry.
This is because expectations are strengthening that the Chinese economy has bottomed out and is showing signs of recovery. Kim Kyunghwan, a researcher at Hana Securities, explained in a report, "Various factors such as policy, liquidity, earnings, and dividends will drive the rise of the Greater China stock market in the second half. The background includes higher growth expectations this year, a relaxed credit environment, the end of earnings downward revisions, increased policy and economic upside factors, and lower valuations and position weights compared to major countries."
For banks that saw their net profits significantly decline due to large provisions set aside in the first quarter following the pre-compensation resolution for Hong Kong ELS, this trend is welcome. KB Kookmin, Shinhan, and Hana Banks had preemptively recognized provisions of 862 billion KRW, 274 billion KRW, and 179.9 billion KRW, respectively, in the first quarter for Hong Kong ELS pre-compensation. Since each bank set aside provisions based on scenarios below the current stock price level, the higher the Hong Kong H-Share Index rises, the smaller the compensation amount becomes, and the provisions can be reversed, leading to improved earnings.
To reduce the expected losses in the second half due to a decline in the Hong Kong H-Share Index to zero, the index would need to rise to the low-to-mid 8000s, but the industry explains that even reaching the mid-to-high 7000s could significantly reduce the loss scale. A financial sector official said, "To eliminate losses, the Hong Kong H-Share Index would need to rise to 8400?8500, but maintaining the 7000 level alone can have a substantial reduction effect."
The industry expects the Hong Kong H-Share Index and the Chinese stock market to maintain an upward trend for the time being. Kiwoom Securities also noted in a recent report, "The rise in the Hong Kong H-Share Index is attributed to concentrated liquidity inflows, including foreign investors, due to low valuations, economic recovery, and stock market stimulus measures. Although the sharp rise may be burdensome in the short term, considering that the offshore market is still excessively discounted compared to the mainland, further increases are possible. Valuations remain attractive."
However, some caution that the recent rise in the Hong Kong H-Share Index heavily depends on the real estate sector and reflects more 'expectations' than actual economic indicators, suggesting the possibility of further corrections. Other risks include unstable Middle East conditions, the ongoing Russia-Ukraine war, and the potential re-election of former U.S. President Donald Trump in the November U.S. presidential election, which could intensify trade disputes.
Meanwhile, regardless of the rise in the Hong Kong H-Share Index, banks are expected to accelerate voluntary compensation for Hong Kong ELS investors whose contracts have matured. This follows the Financial Supervisory Service's (Dispute Mediation Committee) presentation of compensation ratios for representative Hong Kong ELS dispute cases. The committee decided on compensation rates ranging from a minimum of 30% to a maximum of 65% for representative Hong Kong H-Share Index ELS cases.
Some subscribers are expected to strongly oppose this, demanding full principal compensation. They plan to respond strongly on a 'two-track' basis, including collective lawsuits and contacting the National Assembly's 22nd session Political Affairs Committee. Gil Seongju, chairman of the Hong Kong ELS Victims' Association, told this publication, "Currently, about 600 members have gathered, and we are in contact with law firms. We expect to resolve this by next month." They plan to continue collective actions alongside litigation. Subscribers are also seeking political solutions by contacting members of the Political Affairs Committee as soon as the 22nd National Assembly convenes. Chairman Gil added, "We will pressure for reassessment or recognition of fraudulent sales through the National Assembly."
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