* China shares headed for 21 pct drop in August
* HK shares set for first monthly drop in six months
* A-H share premium gap at lowest since Jan 2009
* Chine Merchants Bank shrs drop on new fund-raising target
(Updates to midday)
By Parvathy Ullatil & Claire Zhang
HONG KONG/SHANGHAI, Aug 31 (Reuters) - China shares sank 5.4 percent by midday on Monday, with the index heading for its biggest monthly loss in 10 months, after corporate earnings failed to keep up with stock price gains and new share issues were poised to saturate the market.
Hong Kong stocks followed suit, giving up 1.9 percent as it heads for its first monthly loss since March.
China Merchants Bank <3968.HK> skidded 3.6 percent to HK$16.82 after the country's sixth-largest lender raised its maximum fund-raising target for a planned rights issue by 22 percent to 18 billion-22 billion yuan ($2.6-3.2 billion), due to a likely tightening of banks' capital adequacy rules.
Its Shanghai stock <600036.SS> gave up 4.9 percent.
China's banking regulator issued draft rules this month that would bar banks from using subordinated and hybrid bonds sold to other lenders as part of their capital base, as the government reins in rapid lending growth amid fears that the surge could fuel asset bubbles and cause a sharp increase in bad loans.
The stock was the worst performer among Chinese banks on Monday after the lender announced a 37.6 percent slide in its first-half profit on account of a sharp contraction in its net interest margins and a rise in its credit cost during the period.
A-H PREMIUM GAP AT LOWEST SINCE JAN
By 0425 GMT the benchmark Hang Seng Index <.HSI> 374.69 lower at 19,723.93.
The gauge is set to drop 4 percent in August, paring its yearly gain to 37 percent while the premium gap <.HSCAHPI> between yuan-denominated A-shares and their Hong Kong-listed counterparts dropped to a 17 percent gain, its lowest since January this year.
Analysts predict a volatile September for the markets with the main index loosely supported at 19,462 points, its 50-day moving average.
"There is still the hope that the Chinese market will stabilise before Oct 1, the mainland's 60th anniversary. But if the Hang Seng doesn't claw its way back above 20,000 points in the next day or two then there is less chance of stability in the rest of the month," said Linus Yip, strategist with First Shanghai Securities.
The China Enterprises Index <.HSCE>, which represents top locally listed mainland Chinese stocks, was down 1.9 percent at 11,214.06.
China Southern Airlines <1055.HK> tanked 4.3 percent to HK$2.43 after it said its net profit fell 97 percent in the first half of 2009, reflecting the impact of the outbreak of Influenza A H1N1 and intensified market competition, in addition to the global economic slowdown.
BYD Co <1211.HK> bucked the downtrend to rise 3.3 percent after its first-half profit rose 98 percent, reflecting expanded market share for its handset components and assembly businesses despite a shrinking handset industry. Its automobile business also achieved solid growth, with turnover surging 133 percent.
BIGGEST MONTHLY DROP SINCE OCT 08
The Shanghai Composite Index <.SSEC> ended the morning at 2,706.960 points, putting it on track to post a 21 percent loss for the month after recording seven consecutive monthly gains. It is down 22 percent from this year's high.
Losing Shanghai A shares outnumbered gainers by 894 to 45 while turnover for Shanghai A shares dropped to 70.2 billion yuan from Friday morning's 73.3 billion yuan.
Oil refiners were hit hard for a third day as state-regulated domestic fuel prices remained unchanged despite surging global crude oil prices, disappointing market expectations of a fuel price hike.
Shanghai-listed A shares of top refiner Sinopec Corp <600028.SS> slid 9.5 percent at 11.20 yuan by midday.
Analysts saw no fresh news on Monday morning to trigger the slide but noted lingering pressure from a multitude of factors, including worries about declining liquidity in the market, too many new shares flowing in and weakening investor sentiment.
The index sagged below its 125-day moving average, now at 2,755 points, which is viewed by most Chinese investors and analysts as a watershed between a bear and a bull market. It was the first break through the closely watched chart line since early February.
"Shorts and longs may still fight for control of tha (125-day moving average) level in coming days, but the market will in any event remain sluggish in the first half of September as investors await August economic data," said senior stock analyst Qian Xiangjing at CITIC-Kington Securities in Hangzhou.
A convincing breach of the key moving average, which analysts said still requires a few days to confirm, would put the index's next support at 2,500, a more psychological level than technical one.
That would suggest a market more driven by investor sentiment than fundamentals.
Analysts said slowing lending should have no major impact on the economy, partly because Chinese companies are turning much of the short-term discounted bill financing they received in the first half-year into long-term investment in the second half.
Metallurgical Corp of China's Shanghai A-share initial public offering, which aims to raise about 16.85 billion yuan ($2.47 billion), will start book-building on Tuesday and take subscriptions next week. [ID:nSHA362276].
China's Baosteel <600019.SS>, the world's third-largest steelmaker, plungd 7.1 percent to 6.41 yuan after saying its first-half net profit dropped 93 percent. [ID:nSHA368837]
(Editing by Edmund Klamann and Ken Wills)