Taiwan financials: CDP exposures may be understated; remain defensive/selective
Domestic "bond fund" issue in 2004-06 may have lead to some high-risk CDO purchases
- Since mid-2004, some of Taiwan's local ITCs have been going through a "bond fund" crisis...
- ...as inverse-floating notes suffered losses in the rate-hike environment which then triggered redemption risk
- The FSC asked ITCs/key shareholders at that time to step up and bear the loss for bond fund investors.
- In order to mitigate the loss, some FHCs chose to arrange CBOs...
- ...mixing those money-losing inverse floating notes with high-yield CDOs, and selling them to other financial institutions (FIs).
- To ensure they could price these CBOs at attractive terms, CBO arrangers would include some equity/junior tranche CDOs
- In some cases, arrangers also provided principal guarantees to the FI buyers
- For instance, Mega Bank disclosed it had arranged two CDOs (NT$18bn in total) under such circumstances in 2005-06.
Banks/FHCs might be understating their CDO exposures as a result of the bundled currency swap
- The CBO arrangers would sometimes bundle a currency swap with the CBOs to hedge the currency risk and increase their appeal to potential buyers
- These buyers may then put these currency-risk-free securities within their less-investor-scrutinized NT$ investment portfolio...
- ...despite the underlying (and now sharply rising) credit risk that resided with such overseas CDO exposures
- When evaluating/disclosing the extent of their US sub-prime exposure, some FHCs would only look at their FX investment portfolios
- This could potentially lead to an under-stated CDO exposure figure.
Implications: go defensive; avoid those with huge bond fund balance in the past
- We are currently checking with each FHC/bank under our coverage to see if they have such exposure in their NT$ investment portfolio.
- Meanwhile, we suggest investors avoid those FHCs that had huge bond fund balance on their ITC subsidiaries back then (e.g., Fubon FHC).
- We identify SinoPac FHC (2890.TW, Neutral) as a more defensive play, given its modest CDO exposure, and below ex-growth valuation.
- Key risks are unexpected proprietary trading loss and asset quality deterioration
China banks: Latest rate hike modestly positive for 2008E NIMs; still key to watch CPI trend
Backdrop
PBOC raised loan and time deposits rates by 27 bps, effective September 15th, while leaving demand deposit rates unchanged.
We see two positives
- It shows a more decisive PBO move to curb accelerating CPI inflation
- We estimate it could be modestly (+2bp to +9bp) positive for banks’ 2008 NIM (especially for smaller banks with high L/D ratio and demand deposits)
- …in turn an earnings buffer for any subsequent tightening measures, e.g. more data-dependent rate hikes, loan growth curbs
- We believe by allowing for better NIMs, PBOC is hoping for banks to be more cooperative in curbing excessive loan growth (17% YoY in August)
- However, it remains to be seen if inflation/overheating risks are now under control, before we could turn outright positive on China banks
Key questions in our mind:
- 1. Whether inflation may continue to accelerate, as we believe:
- Note this rate hike was largely expected and therefore may not be effective in reducing CPI/asset inflation expectations
- 1-year real deposit rates after interest tax of 3.7% still far lower than 6.5% CPI in August
- Overall monetary condition (e.g. loan growth at 17% yoy in August) still far from neutral
- 2. Whether A-shares/property markets continue to surge before/during the 17th National Congress of the Chinese Communist Party in mid-October
- This rate hike left demand deposits rates unchanged and did not raise long-term deposit rates more than short-term deposits rates
- This may therefore not attract much liquidity from A-shares markets back to the banking system
- We do not rule out the possibility of more heavy-handed tightening after the party meeting in October if potential A-share/asset “bubble” continues to build up
Source of opportunity
- We retain a neutral stance on China banks at present, and would be more positive if CPI/PPI inflation materially slows.
- Given the valuation gap and potential QDII expansion, we are more positive on H-share banks than A-shares.
- We prefer CMB (3968.HK, Buy; one of the highest beneficiary of this rate hike) and ICBC (1398.HK, Buy).
- CCB (939.HK, Neutral) is our next-best pick, given its high profitability and A-share floating as a near-term catalyst, and as this rate hike slightly benefits CCB’s 08E NIM 1bp to 2bp more than ICBC’s.
- We keep Neutral rating for CCB on valuation reasons, as its market cap (including 9bn new Ashares) is just 4% below ICBC’s (vs. 1H07 assets 36% below ICBC’s)
India financials: Loan pricing - will it remain stable?
What’s new?
- Several company/ press releases since start of September noting that banks and finance companies have cut or are considering a cut in mortgage lending rates as well as other retail loan products.
What do we think of the reduction in lending rates?
- The decision (or talks) by lenders to cut lending rates comes as a bit of an against-the-grind surprise
- ... as liquidity elsewhere in the world dries up, market rates rise, bank pricing power improves
- We believe that the motive to cut lending rates on a selective basis is
- 1) to deploy excess liquidity in the better-yielding assets; or
- 2) to gain market share in a chosen segment (especially mortgage).
- This potential action may however, in our view, result in
- 1) asset liability mismatches if excess short-term liquidity is deployed into L/T assets, e.g., mortgages
- 2) lower sector profitability, with deposit rates now showing any corresponding signs of decline.
- The trade-off of growth over profitability would be unfavorable for banks, particularly public sector banks given their low profitability.
Does it change our positive stance on the Indian financial sector?
- Stable loan pricing environment is one of the key driver to our positive stance on the sector.
- Despite the announced rate cuts, we continue to maintain our positive stance as.....
- .....we expect continued benign macro environment, strong demand for loans, and restoration of a stable pricing environment.
- We attribute low probability to the prospect of further cuts in lending spreads to:
- 1) our expectation of system pick-up in credit growth in 2HFY2008;
- 2) its adverse implications on the profitability of the banks.
Our top picks
- Our top pick are Axis Bank (AXBK.BO, Buy) and HDFC (HDFC.BO, Buy)
- We also maintain our Buy ratings on ICICIB (ICBK.BO) and IOB (IOB.BO)
Key risk to our positive sector stance
- A slowdown in economic activity
- Further tightening of monetary policy (in our view, current macro conditions do not warrant further action in 2007)
- Significant deterioration in asset quality (we assume a benign environment for credit quality base-case)
- Deterioration in loan pricing environment.
US macro (-ve) and MEW: Was Q2 the last hurrah for debt?
Backdrop: excerpts from our US economics research team reading on the latest US debt metrics
Asia banks read-across: still focused on impact of falling US mortgage equity withdrawal, combined with subprime/credit markets unwinds, on the US economy and its pass-through impacts to various parts of Asia and its banking sectors.
- The Fed’s flow of funds report for the second quarter provides evidence of a substantial shift underway in borrowing patterns even before the latest blow-up in credit markets
- Corporate sector borrowing continues to pick up, with borrowing requirements now at 1.7% of GDP
- The profligate household sector maintained a steady pace of debt accumulation
- ...while the federal government actually paid down debt in the second quarter
- Third-quarter data are likely to show sharp deceleration in borrowing as tighter credit standards took hold
- Mortgage borrowing looks poised for an especially heavy hit, and as a result we have revised down our forecasts for mortgage equity withdrawal (MEW)
- We now expect total MEW to fall to just over $200 billion in 2008, from our previous forecast of roughly $300 billion and a 2006 level of $830 billion
