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Banks
Earnings continue to rise on persistent loan growth, despite
growing margin pressure and monetary tightening across Asia,
as well as continued improvement in asset quality
Key themes for 2011 will be the effects of low rates and persistent
economic expansion in Asia
Top picks are CCB, Axis Bank and Bank Mandiri as beneficiaries
of economic growth in Asia and BOC-HK as being well positioned
in the low rate environment
2011 outlook
We remain constructive and generally positive for
the banking sector in Asia in 2011. Whilst there
are headwinds that could affect share price
performance from time to time, we forecast profit
growth of 20%+ y-o-y in 2011 on an EPS basis, in
all markets except Singapore. The most
significant factors to our earnings forecasts are:
Loan growth: As Asian economic growth
continues to be above the global average,
bank lending is expected to remain robust. On
a y-o-y basis, we expect 2011 loan growth to
be slower in nearly all markets; India would
be an exception as the credit expansion cycle
is likely to accelerate into 2011.
Provisions: Most of Asia did not have a
meaningful credit cycle in the recent global
financial crisis. We do not expect a deteriorating
credit cycle in 2011 as Asian economies
continue to expand and credit growth remains
relatively strong. Benign credit costs persist
except where we expect a sharp decline in
provisions in Korea after three rounds of
corporate loan restructuring in and weakening in
project finance loan quality in 2010.
NIM: We expect a mixed story in 2011.
Markets with structurally higher rates (China,
India and Indonesia) will see the greatest
NIM expansion; however selective
competition for new loans and/or funding
likely moderates NIM expansion across the
region. In highly liquid markets like Hong
Kong, we see risks of moderate margin
decline as competition narrows spread.
Next year seems poised to be another year of
volume growth to drive profits. Expectations for
the internationalisation of the RMB in 2010 have
been a bit overzealous, in our view. The true
contribution to earnings may fall short of market
expectations in the near term. We continue to
believe this is a key theme for the medium to long
term; however near-term gains are likely only
incremental and not a material driver of income
growth in 2011.
Systemically important banks & CAR
We believe bank earnings and credit quality
stability will be most affected by two continuing
themes in 2011. First the effects of low rates in
Western markets and the possible knock-on
effects in Asia and reactions by policymakers.
Second will be the continued economic growth in
Asia, and in particular China and India.
Themes for 2011
Effects of low rates
Persistent low rates in the West, coupled with
stronger economic growth in Asia, have created a
wave of capital flows in 2010 that has begun to
raise risks in Asia. From rising property prices to
net inflows in equity markets to inflationary
pressures driven by abundant liquidity, Asian
economies have been thrown new challenges
following the recent financial crisis.
The impacts to banks can be wide depending on the
actions (or inaction) of central banks and monetary
authorities in Asia. To simplify the discussion here
we will focus on three possible implications for
banking systems across the region:
Rising liquidity due to inflows. This so-called ‘hot
money’ risk seems to be alive in Asia and perhaps
has been somewhat exacerbated by appreciating
currencies in Asia and actions by central banks in
the region to raise rates. Left unattended, the
consequences may include asset bubbles, declining
spreads for banks and inflation. We expect the
policy actions to continue into 2011. Central banks
are likely to raise policy rates in all markets except
Hong Kong, due to the USD peg, and there will be
further actions to absorb abundant liquidity. Use of
capital controls likely expands to slow ‘hot money’
and more specific actions on property prices should
be expected. Initially, this sounds negative for
banks. Yet we argue that these measures can be
largely constructive for banks. Loan yield declines
should slow in EM Asia, credit growth may be
somewhat less linked to concerns of asset bubbles
and interbank participants could see upside as
liquidity is withdrawn.
‘Carry trade’ rising in loan books. We have
seen evidence of so-called currency trades
emerging to drive bank lending growth. Perhaps
this is most pronounced in Hong Kong where
RMB deposits have grown 246% from end-2009
which has really accelerated in 2H10. This was at
a time when lending in Hong Kong began to
accelerate from 18% y-o-y in 1H10 to 26% y-o-y
by end-October. As rates remain low on USD
loans and the RMB is set to appreciate c3% y-o-y,
corporate loans have boomed. In essence a
borrower is swapping USD deposits for RMB and
pledging these deposits against a USD loan. After
considering borrowing costs, deposit yield and
RMB appreciation, borrowers could be gaining
c200bps. The demand for this trade is accelerating
loan growth and, in our opinion, is not sustainable
through 2011. Nonetheless, without USD rates
moving higher or RMB appreciation slowing it is
unlikely that these loans will cease.
Improved market turnover from inflows.
Weaker USD, low USD rates and appreciating
currencies in Asia have increased the hunt for
assets in EM Asia. Aside from property we have
seen a significant rise in FII flows in some markets
in Asia, pushing turnover and valuations higher;
namely India and Hong Kong. Additionally Hong
Kong has witnessed an increase in retail brokerage
activities coming from mainland China investors.
We expect these trends to continue pushing market
turnover higher in 2011; especially in markets
where the currency has an appreciation bias and
potential for central bank actions that may increase
the appreciation expectation of the currency. We
also expect the Hong Kong market to see a boost in
turnover from the perspective that USD can be
more easily invested in equities that have
underlying earnings derived from China growth.
Our preferred stock on the theme of lower rates is
BOC-HK. The bank stands in a position to benefit
from the continued lower USD rates, demand
from loans as a byproduct of RMB appreciation
and an expected rise in the turnover of the HKEx.
Rates in Hong Kong will remain low. The banks
are unlikely to raise prime lending rates with no
action expected by the US Fed and HIBOR should
remain low as liquidity remains abundant on the
back of Asian growth and easing measures by the
Fed and the ECB.
Persistent economic growth in Asia
Across the region, economic growth has posted
solid rebounds in 2010. Recent PMI data and
monthly GDP data suggest these trends will
continue into 2011. We expect Asia ex Japan
growth to slow from 8.8% in 2010e to 7.6% in
2011e. Whilst somewhat slower, we expect China
and India to expand faster and to be key drivers of
overall Asian growth. PMI readings continue to
show expansion in Asia and consumption has
remained steady as a buffer from near-term fallout
from somewhat slower Western growth in 2011.
Continued economic growth should sustain the
demand for credit with the most pronounced
demands in China, India and Indonesia.
Specifically in these markets, we expect system
loans to expand in 2011 by 14% in China, 21% in
India and 23% in Indonesia.
The key risk to watch on the growth front is
inflation. Central banks in Asia have started to
address inflationary concerns with rate hikes and
efforts to absorb abundant liquidity to guard
against misallocation of capital that could further
fuel inflation. As mentioned earlier in this section,
our economists forecast policy rate hikes across
our coverage sectors except Hong Kong in 2011.
In general terms, these rates hikes should be
positive for bank earnings and coupled with
robust loan growth in the higher economic growth
markets, we expect NIMs and operating income to
expand on volume and higher yields.
There is not a single bank that will give an
investor maximum exposure to all high-growth
economies in Asia. Thus we have three preferred
plays on Asia’s continued economic growth:
China Construction Bank (CCB) in China, Axis
Bank in India, and Bank Mandiri in Indonesia.
Valuation and risks
BOC-HK (2388 HK, OW, HKD26.7,
TP HKD30.80)
BOC-HK sits in a unique position. In our view,
this is the best bank on RMB internationalisation;
but this is not really a theme for 2011. Instead we
see BOC-HK well positioned take advantage of
higher loan growth on low-cost liquidity flowing
into Hong Kong and the fee-related services from
a more buoyant market in Hong Kong.
Valuation
We value BOC-HK at 2.8x our 2011e book value
using a simple Gordon growth methodology. Based
on our 2011e book, we derive a target price of
HKD30.80, implying a 20% potential return
inclusive of dividends. BOC-HK is currently trading
on 16x 2011e earnings and 2.4x 2011e book.
Risks
Key risks to our call are: 1) significant changes in
economic and monetary conditions; 2) China
policies that could affect RMB internationalisation
and/or expansion of Chinese enterprises outward
from China; and 3) sharply lower turnover or poor
sentiment in the Hong Kong equity market.
China Construction Bank
(939 HK/610939 CH, OW(V),
HKD7.01/RMB4.63,
TP HKD10.20/RMB8.50)
While CCB would not be the only Chinese bank
to benefit from persistent growth in China, we see
a few advantages including somewhat slower loan
growth in the lending boom of 2009-10 than
peers, a longer duration loan book to enhance
yield from rate hikes, the largest consumer loan
book in China and diversified fee income. Given
policy risks and expectations of further monetary
tightening, investors should consider that the
Chinese banks are likely to underperform in the
near term. Long-term investors may use this time
to build positions, whereas shorter-term investors
may wish to wait until we are closer to policy or
earnings catalysts in 1Q/1H11.
Valuation
We value CCB at 2.6x our 2011e book which is
derived using a simple Gordon growth model.
Based on our 2011e book, we derive target prices of
HKD10.20/RMB8.50 for the H- and A-shares
respectively, implying a 50% potential return for the
H-shares. CCB’s H-shares are currently trading on
8.3x our 2011e earnings and 1.8x our 2011e book.
Risks
Key downside risks to our call are: 1) draconian
policies that significantly impact the growth and
profitability of the bank; 2) rise in provisions due
to higher minimum thresholds or deterioration in
asset quality; 3) significant asymmetric rate hikes
that would narrow lending spreads for Chinese
banks; and 4) measures to cool China’s economy
that result in more significant and persistent
slowing of the economy.
Axis Bank (AXSB IN, OW, INR1329,
TP INR1900)
Axis Bank is one of the banks well positioned to
benefit from continued growth in India. The
relatively high CASA deposit base (42%) should
provide a buffer to protect or modestly expand
margins in a growth cycle with more limited
liquidity.
Valuation
We value Axis Bank at 3.6x our end-FY12e book
using a weighted average combination of PE, PB
and economic profit model methodologies. This
approach derives a target price of INR1900,
which implies a 40% potential return inclusive of
dividends. Axis Bank is currently trading on 18x
our 2011e earnings and 3x our 2011e book.
Risks
Key risks to our call include: 1) slower than
expected loan growth; 2) deterioration of asset
quality; 3) rising funding costs on the back of
tighter liquidity in the market; and 4) slowing
growth in India and/or policy moves on the back
of rising inflation.
Bank Mandiri (BMR IJ, OW,
IDR6,400, TP IDR8,655)
Bank Mandiri is well positioned to benefit from
the underlying growth potential. A relatively low
loan-deposit ratio (72%) plus sticky, low-cost
deposits provide the bank with a buffer to avoid
funding cost pressures relative to peers. We
believe the bank is positioned better than peers to
accelerate earnings growth in the context of
broader economic growth of Indonesia.
Valuation
We value BMRI at 3.6x our 2011e book using a
simple Gordon growth model. Based on our
2011e book, we derive a target price of IDR8,655,
implying a 35% potential return inclusive of
dividends. Bank Mandiri is currently trading on
13x our 2011e earnings and 3.35x our 2011 book.
Risks
Key risks to our call are: 1) short-term share
overhang from upcoming 1Q11 rights issue;
2) slowing loan growth perhaps from slowing
economic growth; 3) deteriorating asset quality;
and 4) falling interest rates.
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