BUY OR SELL-Small Hong Kong banks: M&A hype or reality?

(For more Reuters BUY OR SELL stories, click [BUYSELL/])

* Small HK bank shares beat the blue-chip index .HSI in Q2

* Bullish view sees banks in potential M&As

* Bearish call is based on uncertain US financial mkts

By Alison Leung and Parvathy Ullatil

HONG KONG, July 6 (Reuters) - Small Hong Kong banks have become investor favourites over the past quarter, rising on hopes they will be acquired by Chinese banks eager to gain a foothold in the territory as they gear up to expand abroad.

The enthusiasm for them hasn't waned even after China's ICBC (1398.HK) (601398.SS) late last month denied rumours it was in talks to buy Wing Hang Bank (0302.HK) [ID:nHKG316414]. Wing Hang and other banks such as Dah Sing Banking Group (2356.HK) and Chong Hing Bank (1111.HK) are still viewed as potential targets.

But with some predicting a broad market pullback after the blue-chip index saw its best quarterly gain of 35 percent in more than 15 years, can M&A hopes keep the small banks' rally going?

EYED BY CHINA, TAIWAN

Definitely, says Ivan Li, an analyst at Kim Eng Securities. Not only are China banks and insurers potential buyers but also Taiwan banks, who are eyeing a springboard into China, as all three potential target banks have units on the mainland, Li said.

"The story is still there, we always believed that local banks are attractive M&A targets," Li said, adding their valuations were not rich despite the recent run-up.

Wing Hang, the fifth-largest Hong Kong lender, jumped 83 percent in the second quarter and had a price-to-book valuation of 1.8 while Dah Sing and Chong Hing, which both trade below 1 price-to-book, soared 79 percent and 52 percent, respectively. That compared with bigger rival Hang Seng Bank's (0011.HK) 40 percent gain.

JP Morgan upgraded Wing Hang to 'overweight' from 'neutral' and lifted its 12-month price target 50 percent to HK$90 last month.

"From a purely economic point of view, Chinese banks, which are at higher valuations, could look at buying these Hong Kong banks, which are comparatively cheaper, as that would ultimately be valuation-accretive for the Chinese lender," said Andrew Gillan, investment director at Aberdeen Asset Management, which owns 6.99 percent of Wing Hang and 2.69 percent of Dah Sing.

NOT ISOLATED

Some disagree.