HONG KONG-LISTED mainland banks are already looking expensive on conventional measures of valuation, but they could still have more upside if they mirror the rapid earnings growth of their Indian counterparts, the head of Citigroup Inc.’s Asian bank research department said last week.

Mainland banking shares, however, may fall sharply if there is evidence of a rise in nonperforming loans, Citigroup’s Tracy Yu said.

“You have risk and reward, and the market will always struggle between growth and asset quality risks,” said Yu, who was speaking ahead of the Hong Kong debut Friday of Industrial and Commercial Bank of China (ICBC), the mainland’s biggest bank by assets.

“If the markets were to price in growth similar to the Indian banks, there should be quite some upside for the mainland banks,” she said, sketching out a bullish scenario, which isn’t her formal view.

Some investors view mainland banks listed in Hong Kong as overvalued, after surging share prices took some of them above three times their book value per share.

Investors have piled into the mainland banks believing they are good proxies for the booming mainland economy, which grew 10.7 percent in the nine months to September.

HSBC Holdings, one of the world’s biggest banks by assets with a solid track record of earnings growth, trades at only 2.1 times book value. HSBC finished Friday unchanged at HK$147.10 (US$18.88), and has risen 18.2 percent in the year to date.

Bank of Communications Co. ended at HK$5.93 Friday, a touch lower from its all-time high of HK$5.98 reached Thursday. The Shanghai-based bank’s share price has more than doubled since its IPO in June last year. China Merchants Bank Co. closed at HK$12.14 Friday and is up 43 percent from its September IPO price, trading 3.2 times Citigroup’s estimated 2006 book value.

But price-to-book valuations for mainland banks could be pushed much higher if they can keep up a sizzling pace of earnings growth in line with the robust economy, Yu said.

“The rationale behind this very high price to book is essentially the CAGR (compound annual earnings) growth. If you have a CAGR growth of 25 percent to 30 percent per year, you would double the book value within three to four years.”

Yu cited the stellar earnings performance of Indian banks between 2001 and 2005 as an example. The earnings trend would have justified a valuation of about 3.8 times book value for the State Bank of India in 2001, 5.4 times book value for ICICI Bank Ltd., and as much as 13 times book value for HDFC Bank Ltd., said Yu.

HDFC alone was able to grow earnings per share at a 26.7 percent annual rate from 2001-2005.

For mainland banks to maintain strong earnings growth, they would have to keep a lid on nonperforming loans, Yu said.

(SD-Agencies)