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Domestic credit indigestion, but more than 30% losses priced in
Early stage of a new NPL cycle forming
We believe the risks of indigestion related to
domestic credit growth are rising, notably for the
China related (HK, Taiwan, Sing) bank complex as
global cyclical headwinds strengthen, liquidity
conditions tighten and three years of credit
growth excesses season.
An earnings reset…..
Earnings buffers to manage an NPL cycle are
weaker vs. the 2007/8 cycle across the region. We
see HK and Taiwan as most vulnerable to a hard
landing scenario - low pre provision profit
margins reflecting low rate environments, coming
off low credit costs bases and with the highest
levels of excess credit growth to season.
…not a balance sheet threat
We view NPL risks, for now, as earnings, not
balance sheet impairing. This view reflects strong
capital and liquidity positions, listed corporates in
robust health and limited collateral damage from
EU’11 vs. US’08. Higher b/s buffers are offset by
higher regulatory hurdles, but these hurdles could
be lowered again if stresses deepen.
26%-38% loss estimates priced in
Two ways we estimate what’s priced in
(1) Earnings based approach. We estimate a 23%
potential cut to to earnings estimates in the event
of a hard landing, only slightly greater than the 19%
3Q11 fall in MSCI Asia Fin Index. Therefore further
stock price moves down from here will more likely
reflect valuation contagion, not earnings reset.
(2) Single event loss based approach. Assuming the
market prices NPL hits as non recurrent, we
estimate the market has now priced 26%-38% loss
ratio on the most visible sources of NPL risk.
Eight names that screen well
We have force ranked 79 banks on earnings and
balance sheet resilience. A back test of top and
bottom quartile performers shows 94% alpha
generation through the 2008/09 collapse/recovery
cycle. Current entry levels are now more
interesting after a sharp pullback in the
outperformance of top decile names. BCA,
Mandiri, ICBC, CCB, ABC, Kasikorn, BoCHK and
CIMB all rank in the top quartile and are rated Buy
Overview: What’s priced in
Asia banks have fallen 22% on average YTD as the markets price in slower growth in Asia from a prolonged Europe debt crisis and
weaker US macro outlook, and pinpoint more pockets of domestic risks as liquidity conditions remain tight. Our and consensus
earnings projections have not changed much during the course of this year, making the price falls largely a function of valuation
compression to date, in the absence of anchors (reported bankruptcies or rising NPL formation) to reset earnings downward. Recent
stock price moves strike us as closely reminiscent of the pre-Lehman environment in 2008 crisis and associated price falls.
Ultimately, the credit cycle for the Asian markets remained relatively benign through 2009, as liquidity surged through the region,
with both fiscal and monetary loosening easing the pain of corporate revenue headwinds. Excluding the direct US-related marks for
2008, credit costs remain largely an earnings, not a balance sheet issue, with capital raises broadly reflecting capital top-ups not
replacement capital.
That said, while the Asian bank stock prices are in the large part replicating trends of 2008, we see five key differences between now
and 2008.
What’s better
1. Valuations lower but premium higher: Absolute valuations are lower now than entering into the last downturn but the valuation
premium over US/EU banks is higher.
2. Corporate health better: Asia corporate health is better than in 2007, judged by leverage (net debt/equity), interest coverage
(EBITDA/interest) or cash balances. However, the averages can be distortive, it's the tail that matters (see What’s worse)
3. “Problematic” exposure lower: Asia banks have reported lower exposure to GIIPS sovereign debt now than they had US
ABS/RMBS/CDO/SIV exposure back in 2007. Combined GIIPS sovereign debt exposure is US$5bn versus US$1.3tn of US
ABS/RMBS/ABS/CDO/SIV exposure (ex HSBC) in 2007. Combined Europe exposure or claims on Europe of top 17 banks is also
manageable at US$169bn, 1.8% of combined assets with the top exposure at 10% (for Chong Hing bank, cross-border claims on
Europe as % of total assets).
What’s worse
1. Earnings lower, reflecting macro and rates: pre provision return on assets (PPROA – a core measure of operating profitability) of
Asia banks is lower now than in 2007, as: (i) economic growth is slower than in 2007; (ii) interest rates are lower now versus
CYE07, notably for the USD-related markets.
2. Perhaps the single most important difference is that 2011 has been marked by significantly greater domestic credit indigestion
issues, given the excess credit build-up through the China complex (including HK, Singapore and Taiwan-related lending to
mainland China), power-related credit issues in India, and TEPCO-related issues in Japan (albeit now well understood and
perhaps moving off the radar screen).
Reflecting this last issue, and despite the fact that three of the above five differences between now and 2008 point to better (versus
2008) share price performance for Asia banks, valuation multiples for China and Japan banking sectors are now below 2008/1Q09
trough valuations and most of the lower growth Asian markets are well below 10-year mean multiples. Asean banking sector
valuations have remained more resilient relatively speaking, given both the domestic demand insulation and lower risks of lumpy
domestic credit indigestion issues, with credit multipliers typically near or less than 1X through the 2009-1H11 recovery (the
exception being consumer-related lending in Malaysia).
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Domestic credit indigestion, but more than 30% losses priced in
Early stage of a new NPL cycle forming
We believe the risks of indigestion related to
domestic credit growth are rising, notably for the
China related (HK, Taiwan, Sing) bank complex as
global cyclical headwinds strengthen, liquidity
conditions tighten and three years of credit
growth excesses season.
An earnings reset…..
Earnings buffers to manage an NPL cycle are
weaker vs. the 2007/8 cycle across the region. We
see HK and Taiwan as most vulnerable to a hard
landing scenario - low pre provision profit
margins reflecting low rate environments, coming
off low credit costs bases and with the highest
levels of excess credit growth to season.
…not a balance sheet threat
We view NPL risks, for now, as earnings, not
balance sheet impairing. This view reflects strong
capital and liquidity positions, listed corporates in
robust health and limited collateral damage from
EU’11 vs. US’08. Higher b/s buffers are offset by
higher regulatory hurdles, but these hurdles could
be lowered again if stresses deepen.
26%-38% loss estimates priced in
Two ways we estimate what’s priced in
(1) Earnings based approach. We estimate a 23%
potential cut to to earnings estimates in the event
of a hard landing, only slightly greater than the 19%
3Q11 fall in MSCI Asia Fin Index. Therefore further
stock price moves down from here will more likely
reflect valuation contagion, not earnings reset.
(2) Single event loss based approach. Assuming the
market prices NPL hits as non recurrent, we
estimate the market has now priced 26%-38% loss
ratio on the most visible sources of NPL risk.
Eight names that screen well
We have force ranked 79 banks on earnings and
balance sheet resilience. A back test of top and
bottom quartile performers shows 94% alpha
generation through the 2008/09 collapse/recovery
cycle. Current entry levels are now more
interesting after a sharp pullback in the
outperformance of top decile names. BCA,
Mandiri, ICBC, CCB, ABC, Kasikorn, BoCHK and
CIMB all rank in the top quartile and are rated Buy
Overview: What’s priced in
Asia banks have fallen 22% on average YTD as the markets price in slower growth in Asia from a prolonged Europe debt crisis and
weaker US macro outlook, and pinpoint more pockets of domestic risks as liquidity conditions remain tight. Our and consensus
earnings projections have not changed much during the course of this year, making the price falls largely a function of valuation
compression to date, in the absence of anchors (reported bankruptcies or rising NPL formation) to reset earnings downward. Recent
stock price moves strike us as closely reminiscent of the pre-Lehman environment in 2008 crisis and associated price falls.
Ultimately, the credit cycle for the Asian markets remained relatively benign through 2009, as liquidity surged through the region,
with both fiscal and monetary loosening easing the pain of corporate revenue headwinds. Excluding the direct US-related marks for
2008, credit costs remain largely an earnings, not a balance sheet issue, with capital raises broadly reflecting capital top-ups not
replacement capital.
That said, while the Asian bank stock prices are in the large part replicating trends of 2008, we see five key differences between now
and 2008.
What’s better
1. Valuations lower but premium higher: Absolute valuations are lower now than entering into the last downturn but the valuation
premium over US/EU banks is higher.
2. Corporate health better: Asia corporate health is better than in 2007, judged by leverage (net debt/equity), interest coverage
(EBITDA/interest) or cash balances. However, the averages can be distortive, it's the tail that matters (see What’s worse)
3. “Problematic” exposure lower: Asia banks have reported lower exposure to GIIPS sovereign debt now than they had US
ABS/RMBS/CDO/SIV exposure back in 2007. Combined GIIPS sovereign debt exposure is US$5bn versus US$1.3tn of US
ABS/RMBS/ABS/CDO/SIV exposure (ex HSBC) in 2007. Combined Europe exposure or claims on Europe of top 17 banks is also
manageable at US$169bn, 1.8% of combined assets with the top exposure at 10% (for Chong Hing bank, cross-border claims on
Europe as % of total assets).
What’s worse
1. Earnings lower, reflecting macro and rates: pre provision return on assets (PPROA – a core measure of operating profitability) of
Asia banks is lower now than in 2007, as: (i) economic growth is slower than in 2007; (ii) interest rates are lower now versus
CYE07, notably for the USD-related markets.
2. Perhaps the single most important difference is that 2011 has been marked by significantly greater domestic credit indigestion
issues, given the excess credit build-up through the China complex (including HK, Singapore and Taiwan-related lending to
mainland China), power-related credit issues in India, and TEPCO-related issues in Japan (albeit now well understood and
perhaps moving off the radar screen).
Reflecting this last issue, and despite the fact that three of the above five differences between now and 2008 point to better (versus
2008) share price performance for Asia banks, valuation multiples for China and Japan banking sectors are now below 2008/1Q09
trough valuations and most of the lower growth Asian markets are well below 10-year mean multiples. Asean banking sector
valuations have remained more resilient relatively speaking, given both the domestic demand insulation and lower risks of lumpy
domestic credit indigestion issues, with credit multipliers typically near or less than 1X through the 2009-1H11 recovery (the
exception being consumer-related lending in Malaysia).
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