Asian Bank Research
& Consultancy Services
Asian Bank Research,
Without the Noise
Banks - Credit Cost Delta
With another USD1tr package in the US the risk remains that economic malaise will not be as dire as initially expected by the Fed or others. During 2Q20 many US banks – as well as banks globally – have seen substantially lower credit costs compared with 1Q20. What matters more is the trajectory during coming quarters and especially as recovery, re-opening takes holds for most all countries. To better understand where many banks are positioned going into 2H20 we look at total credit costs during 1H20 compared with FY19. For banks where credit costs are several times higher, holding all else equal we can expect that perhaps ‘too much’ has been done and 2H20 can see considerable drop off in
provisioning. Of the major US banks, none compare with Wells Fargo (WFC).
Banks - Ultimate Leverage
The leverage that banks have to re-opening, recovery of economies is exaggerated. This is especially when interest rates are low. In a period where margins may be 3%, credit costs of 75bps are not unwieldly. In a period where margins are closer to 2%, the same credit costs are profit-destructive. Then there are credit costs directly. During 1Q20 most all banks globally took extraordinary charges, forecasting out the dire days of that time.
It became clear during 2Q20 that those forecasts were too pessimistic, that this crisis is not like others, and for many banks, credit costs came down substantially. And 2H20 credit metrics are likely to be far more positive than 1H20 credit metrics. Provision costs could come down substantially in coming quarters, but while still remaining higher than average. Against frail margins, from low interest rates, re-pricing of the ‘back book’ this means the delta in credit costs is more powerful than normal to profit. And banks benefit from improved credit metrics across all lending, consumer and corporate, as recovery takes hold, as spending, investment, confidence improves.
With structurally low equity/assets, banks’ delta in returns on equity can be exaggerated into recovery. What makes banks especially interesting now is the approximate USD95 trillion of deposits in banking systems globally.
ASIA - Benign bad loan trends belie surging impairment costs
Many banks in Asia are seeing surging credit costs and despite more meagre growth in bad loans. This is also occurring with banks that have seen little in the way of new lending, including Japan. It is no longer enough to focus on bad loan formation when forecasting, understanding provision expenses.
Some may argue that this is due to new accounting regulation IFRS 9, which requires banks to take total expected credit losses (ECL) over the life of a bad loan.
Chailease is a proven, profitable leasing alternative to banks. It is a Taiwan-based multi-sector lease financing company, operating in Taiwan, China and Asean countries primarily.The company has a rich history of lease financing, beginning in 1977, with a
proven track record of investing in specialized subsidiaries. The best evidence of the company’s ability to well manage its growing business is its rising ROA from 2.3% to 3.8%, from 2011 through the twelve months to 3Q18. Where Chailease impresses more is with ROE where it ranks 2nd highest in the region at 25.0%.
This compares with a far lower average ROE of 9.7% for peers. Where a ROE can be inflated from leverage, meaning a low level of equity compared with assets, it isimportant to understand the components. The reality is that Chailease is incredibly under-leveraged compared with its regional peers and despite this, it maintains the 2nd higher ROE. The company’s equity/asset ratio in the latest full year was 17.1% compared with 27.8% on average for the companies in our sample with populated data.
CHINA: Grit Beyond The Mainstream
The tapestry of China bank malaise typically threads its way through corporate indebtedness, weak financial metrics and slowing economic growth. We doubt there are many non-believers regarding risks facing corporate China and China’s banks. What may be less clear is how growth in city commercial bank NPLs is soaring, compared with more mainstream commercial banks, or that the distribution of NPLs is worsening toward more loss and doubtful loans.
HONG KONG - Heart Of Trade War Where Negative Delta Can Surprise
With all eyes on the negative risk to China’s banks from US-China trade war, there may be an even greater negative delta with Hong Kong’s banks. This is because HK’s banks have almost no NPLs and
almost no credit costs. HK’s banks are also tangential to the US-ChIna trade war so perhaps not an obvious loser.
But the reality is banks in HK have substantial trade loans, income from these loans and from trade-related services. This is in addition to risks from deteriorating credit quality.
It is easy to be lulled into a false sense of confidence with HSBC Holdings (HSBC). This is especially the case when looking at headline figures for impaired loans. Its reported problem loans are down dramatically over the past several quarters.
And yet despite this, its credit costs as a percentage of loans are driving higher. Figures were at a record low of 7bps in 1Q18 and rose to 35bps by 4Q18. The figure is now well higher than any quarter over the previous two years. We though would argue that the surge in credit costs is more due to deteriorating credit metrics. And this is where we believe the market is not adequately focussed.
HSBC is less able to afford credit costs. The much-touted boon in margins following rising interest rates hardly came through. The company’s net interest income/assets ratio rose an underwhelming 8bps from its trough in 3Q16 to 4Q18.
INDIA: No Signs of Relief
There have been many false dawns in India during the current economic malaise. The most obvious was when the government announced a recapitalization of banks. Others include election promises or revamping of debt resolution procedures. But it should be clearer now that without a fundamental reduction in debt, or a change in loan underwriting standards or a meaningful, sustainable resumption of top line growth, bank credit metrics are only likely to weaken.
SINGAPORE: Loan Migration, a Quiet Decay
Singapore banks have revealed a sharp decline in their pass loans over the past two months. It is not something that most normally look at, but it is telling. The pace of decline is sharp and nearly on par with bank experience during late 2015. In 3Q19 the total level of pass loans compared with total loans is lower than most quarters since 1Q09.