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Asia's Banks Are Crisis Ready
Asia's banks are hoping that reforms made after the region's 1997-'98 financial crisis will help them surmount the challenges posed by today's global economic meltdown.
It was a spectacle reminiscent of the worst days of the late-1990s Asian financial crisis: Throngs of depositors descended on branches of Bank of East Asia across Hong Kong last September, worried that the lender was short on cash and about to be taken over by the government. Feeding the frenzy were rumors, spread by telephone text messages, claiming that the bank had exposure to troubled insurance giant American International Group and to Lehman Brothers Holdings, which had filed for bankruptcy days before. But unlike the bank runs that devastated South Korea, Malaysia and Indonesia during the regional meltdown a decade earlier, this panic was short-lived.
Within hours the bank, Hong Kongs third-biggest lender, issued a statement denying any funding problems and alleging that "malicious rumors" were to blame for the run. The Hong Kong Monetary Authority, the territorys banking regulator, provided reassurance to panicky customers, publicly proclaiming Bank of East Asia to be sound and injecting $500 million into the interbank market to boost liquidity. Hong Kongs first bank run since 1997 was quashed in less than two days, almost as quickly as it began.
"It looked worse than it was," David Li, the banks chairman, tells Institutional Investor . "There were long queues, but in the end less than 2 percent of deposits were affected." Bank of East Asia recovered that cash and more by years end, he adds.
Lis story is far from unique. Nearly two years into a global credit crisis that has humbled, if not bankrupted, some of the biggest names in finance, Asias banks are holding up better than those of most other regions. The reason? Reforms made after the devastating 199798 financial crisis have left regional lenders, and their customers, stronger and better prepared to face todays economic difficulties. Banks have significantly reduced their balance-sheet leverage over the past decade and have largely avoided the kind of foreign exchange mismatches that pushed many institutions into insolvency in the late 90s and that are plaguing lenders in Eastern Europe today. Asias corporate borrowers are also financially sounder than they were ten years ago and carry less debt.
"Asian banks are certainly a lot better than they were a decade ago," says Hugh Young, Singapore-based head of equities at Aberdeen Asset Management, which oversees about $27 billion in Asian equities. "They have been much more prudent in lending. Many were burned during the Asian financial crisis, and everybody became more cautious and avoided on their own books the toxic investments made by their Western counterparts."
Notwithstanding this relative strength, however, Asian banks like the regions economies are far from immune to the deepening global crisis. Worsening recessions in the U.S., Japan and much of Europe have caused global trade to plummet, spreading hardship to the very foundations of Asias export-led economies. With growth falling sharply and unemployment rising across the region, Asias lenders face new pressures, bankers and analysts say.
The worlds advanced economies will contract by as much as 3.5 percent, on average, this year, with a 2.6 percent decline in the U.S. and a 5.8 percent drop in Japan, according to estimates released by the International Monetary Fund last month. That is expected to cause global trade volumes to shrink by 9 percent this year, the steepest decrease since World War II, according to the World Trade Organization.
Among Asias export-dependent economies, the hardest hit are industrialized countries such as South Korea and Taiwan, which have already slipped into recession. Korean exports dropped by 17.1 percent in February from a year earlier, the fourth straight month of double-digit declines; Taiwans exports plunged 37.2 percent in January and February. Southeast Asian countries, which resisted the global downturn until recently, have seen their growth rates come to a near halt. Even seemingly unstoppable China is feeling the pain: Exports fell by a record 25.7 percent in February. The World Bank recently lowered its growth forecast for the country to 6.5 percent for this year, down from 9.0 percent in 2008.
"Asia is faced with a major external demand shock," says Stephen Roach, chairman of Hong Kongbased Morgan Stanley Asia. For banks, he adds, the challenges are "actually every bit as daunting today as during the Asian financial crisis."
Moodys Investors Service, which rates more than 200 banks across Asia, said at the start of the year that nearly 20 percent carried a negative rating or were being reviewed for possible downgrades, compared with 7 percent a year earlier.
The strength of banking systems varies widely across Asia. Analysts expect banks in Taiwan and South Korea to post losses this year, whereas Hong Kong banks will be somewhat better off because of comparatively stronger financial positions.
Chinas big state-owned banks enter the crisis in much better shape after reporting rising profits and declining nonperforming loans. Industrial & Commercial Bank of China, the worlds biggest lender by market value, posted a 36 percent gain in 2008 net income, to 110.8 billion yuan ($16.2 billion); the banks NPLs fell to 2.29 percent of all loans, from 2.74 percent a year earlier. Such strong performance may not last, however, as state banks ramp up lending to offset shrinking interest rate margins and to meet new loan targets set by Beijings economic stimulus program. Premier Wen Jiabao last month exhorted banks to increase lending to boost the economy. "The government wants to propel growth, avoid unemployment and prevent companies from failing," says May Yan, a Hong Kongbased analyst at Nomura International.
Banks face much greater difficulties in Japan, where institutions such as Nomura Holdings and Mitsubishi UFJ Financial Group swung into the red in 2008. So-called demand shock is severe in Japan, where the economy shrank at a 12.1 percent annual rate in the quarter ended in December, the most in 35 years, as export orders retreated at an unprecedented pace. In February, Japanese exports plunged a record 49.4 percent from a year earlier, following a 46.3 percent drop in January. Big manufacturers such as Nissan Motor Co., Panasonic, Sony Corp. and Toyota Motor Co., which are facing steep losses, are closing plants and laying off more than 50,000 workers in aggregate.
For the banks, announcements by such blue-chip companies are no small matter. Falling corporate profits continue to hammer stock prices, which lost more than 40 percent of their value in 2008. Those declines, in turn, have eroded capital positions at Japanese lenders. Tier-1 capital at Japanese banks stood at 7.7 percent of assets at the end of March 2008, well above the minimum 4 percent requirement under the Basel II capital rules, but stocks made up about 50 percent of that capital, according to Fitch Ratings. With Tokyos Nikkei index having declined by 31 percent over the past year, bank capital has been seriously depleted.
Banks in South Korea, Asias fourth-biggest economy, are particularly vulnerable. At the start of the year, Moodys had more Korean banks on negative outlooks or under review for possible downgrade than banks of any other Asian country. Thats because these banks rely on international markets to fund lending. "Korea is one of the few banking systems in Asia where domestic deposits are insufficient to fund loans," says Deborah Schuler, group credit officer for Moodys in Singapore.
Loan-to-deposit ratios at Korean banks range from 130 percent to more than 300 percent. Korean banks rely on wholesale markets for about 44 percent of their funding, including 10 to 12 percent from international markets. Concerns about South Koreas ability to refinance that debt have put pressure on the won, which fell more than 25 percent against the dollar last year, more than any other Asian currency.
The South Korean government has responded rapidly, putting in place a 20 trillion won ($14.3 billion) fund to pump fresh capital into banks through the purchase of subordinated bonds and hybrid debt. Separately, the government is preparing a 40 trillion won fund, to be capitalized by Korea Asset Management Corp., the countrys distressed-asset manager, to buy bad loans from financial firms and toxic assets from troubled companies.
"Korea is in a difficult position, but at least the government is putting in policy to make sure things dont spin out of control," says Brian Hunsaker, a regional bank analyst with Fox-Pitt, Kelton (Asia) in Hong Kong.
Most Asian governments have the wherewithal to support their banks, thanks to the big buildup of foreign exchange reserves over the past decade, another key legacy of the Asian crisis. Such reserves stood at $3.16 trillion at the end of 2008, up from $620 billion in 1999, according to statistics compiled from the Asian Development Bank.
Asian lenders have avoided borrowing mismatches lately. Those mismatches, whereby banks borrowed in hard currencies overseas to lend in their domestic markets, were a major contributor to the crisis in the late 1990s. "The region has learned its lessons well from the crisis of a decade ago," ADB president Haruhiko Kuroda said in a recent speech. "Bank balance sheets are typically stronger," he noted, because of "postcrisis restructuring" and improvements in "oversight and risk management practices."
As a result of these changes, most of Asias lenders are entering the current crisis better capitalized and more capable of meeting challenges than they were a decade ago. "Theres a lot less stress in the banking system today than what you had in 1996 and 1997," says Markus Rosgen, chief Asia strategist at Citigroup in Hong Kong.
The level of nonperforming loans, one of the best indicators of banking health, shows how the industry is holding up despite mounting economic pressures. Bad loans spiked during the regional crisis a decade ago, with South Koreas NPLs rising to 10.1 percent of all loans, Malaysias peaking at about 20 percent, Thailands hitting an estimated 50 percent and Indonesias soaring to a whopping 58 percent.
Although NPL ratios are set to rise now, they start from historically low levels and are not expected to reach anything like the highs of a decade ago. South Koreas NPL ratio, which touched a record low of 0.71 percent last June, is expected to increase to 3.6 percent by the end of this year, Fitch Ratings predicts. The NPL ratio of Singapore banks is likely to hit 3.5 to 4 percent this year, up from 1 percent in September but well down from 7.7 percent as recently as 2002, the agency forecasts. Similarly, it sees Taiwans NPL ratio reaching 3 percent this year, up from 1.6 percent in November but down from 8 percent in 2002.
"Economies will suffer, and some economies will go into recession," says David Marshall, head of Fitch Ratings financial institutions group for the Asia-Pacific region. "But dont expect the NPLs of previous years."
Unlike several Asian countries, Thailand didnt consolidate dud assets in a so-called bad bank a decade ago, so NPLs remain relatively elevated, at about 8 percent of all loans; Fitch predicts the ratio will rise to 11 percent by year-end. The agency forecasts that Indonesias NPL ratio could reach 6 percent this year, from 3.9 in September.
A big reason for the relatively modest growth of bank NPLs is the robust health of Asian corporate balance sheets. Companies are the least leveraged that theyve been in the past ten years, with debt-to-equity ratios in the region standing at about 25 percent, compared with 82 percent at the outset of the Asian crisis in 1997, according to estimates by Citigroup. "The problem ten years ago was, you had an unusually indebted corporate sector, utilizing no market discipline, where everybody had access to debt regardless of business or profitability," says Fox-Pitt, Keltons Hunsaker.
Asias banks have improved lending quality in recent years by centralizing credit authority and tightening controls. And they have made big strides in computerizing their operations, helping to squeeze out fraud and establish consistent and transparent lending procedures overseen by the central offices.
Kookmin Bank, South Koreas biggest lender, invested more than 1 trillion won between 2005 and 2007 to computerize accounting records that had been maintained manually, to integrate centralized customer relationship systems and to prepare the bank to comply with the Basel II global capital rules.
Among potential problem areas, retail lending exposure at most Asian banks is not that much of a worry, analysts say. Although banks have expanded products like credit cards and mortgages, those areas remain proportionately far smaller than at institutions in the U.S. and Europe. Commercial real estate is a growing concern, though. Weakening demand for office space and sinking prices are putting pressure on developers and will likely lead to a rise in nonperforming loans.
Office and residential pricing and investment have been hit across the region, according to CB Richard Ellis Group, a commercial real estate services firm. Prime office rents dropped by 20.9 percent in the fourth quarter of 2008 from the previous three-month period in Hong Kong, by 19.9 percent in Singapore and by 8.7 percent in Shanghai. Declines in luxury residential capital values were recorded in seven of the ten markets tracked by the property firm, led by Hong Kong, with a 31.4 percent quarter-on-quarter decline.
Asian banks did have direct losses to subprime investments, but they were only a fraction of the more than $700 billion in write-downs and credit losses that global institutions have announced over the past year and a half. According to the Asian Development Bank, Asias direct bank subprime losses stood at about 3 percent of the total, including $7.4 billion at Japans Mizuho Financial Group and $4.3 billion at Nomura.
Notably, Asian direct losses from Lehman Brothers and other failed U.S. financial firms have been limited.
Commercial banks and finance companies in Taiwan, one of the places with the greatest ties to Lehman, had exposure of about $1.2 billion to the firm; Mega Financial Holding Co. alone had a position of $200 million. South Korean financial institutions had a combined exposure of $1.34 billion to Lehman and Merrill Lynch & Co., while banks in the Philippines and Thailand had collective exposures to Lehman of $386 million and $124 million, respectively.
Although Asian banks have avoided many of the troubles of their counterparts in Europe and the U.S., problems like the brief run at Bank of East Asia suggest that confidence can be shaken easily. BEA officials declined to comment on the telephone text messages that reportedly cited exposure to AIG and Lehman because the matter is under police investigation, but the bank has reported a loss of HK$492.7 million ($63.6 million) on its exposure to those two companies.
In the aftermath of the September panic, BEA decided to sell off its entire portfolio of collateralized debt obligations, booking a one-time loss of HK$3.5 billion, which represented less than 1 percent of consolidated assets. The move contributed to a 97.5 percent decline in 2008 aftertax profits, to HK$104 million from HK$4.22 billion a year earlier. "We decided to make a clean break of it," says bank chairman Li. "We didnt want people to speculate how the CDOs would affect our balance sheet." Even after the move the banks capital adequacy ratio stands at 13.8 percent.
In addition to write-downs, the global crisis has prompted Asian financial institutions to raise capital to bolster their ability to weather an increase in nonperforming loans.
"Its necessary," says Nana Otsuki, a bank analyst at UBS in Tokyo, because falling stock markets are weakening banks regulatory capital. Stock market losses in Asia ex-Japan reached $9.625 trillion last year, an amount equivalent to 109 percent of the regions gross domestic product, the Asian Development Bank estimates.
Japans three biggest banks announced that they would raise nearly ¥1.7 trillion ($17.4 billion) through the sale of stock and bonds, in large part to pay for U.S. expansion. Mitsubishi UFJ, which forked over $9 billion for a 21 percent stake in Morgan Stanley in October, raised ¥790 billion by selling common and preferred shares late last year. Mizuho Financial, which invested $1.2 billion in Merrill Lynch in January 2008, raised ¥355 billion in December and then sold an additional $850 million in preferred securities in February. Nomura, which bought Lehman Brothers Asian and European operations in September after the U.S. investment bank collapsed, raised ¥410 billion by selling bonds.
More help may come from the Japanese government, which in December announced an emergency stimulus package of ¥10 trillion in government spending, plus ¥13 trillion that is to be used to stabilize the financial system, including troubled banks.
In South Korea, Kookmin Bank secured 1.9 trillion won by issuing subordinated bonds, including 400 billion won to its parent, KB Financial Group, after the government advised domestic banks to lift their capital ratios to 12 percent. Woori Finance Holdings Co. and Hana Financial Group said they would buy a combined 1.7 trillion won of equity and debt from their banking units. In Malaysia, CIMB Bank raised 1 billion ringgit ($276 million) of tier-1 capital from a private placement after the bank obtained central bank approval to raise 4 billion ringgit.
In December, Singapores DBS Group raised 4.0 billion Singapore dollars ($2.7 billion) through a rights offering, increasing its tier-1 capital ratio to 9.9 percent, from 7.8 percent. A month earlier the bank announced it was shedding 900 jobs, or 6 percent of its workforce.
To address the wider economic crisis, Asian governments are also implementing what HSBC Holdings regional economists Frederic Neumann and Robert Prior-Wandesforde call an unprecedented stimulus effort. Such spending programs across the region may amount to $800 billion, led by Chinas 4 trillion yuan effort.
South Korea plans to spend 17.7 trillion won on stimulus measures, including cash handouts, infrastructure development and job creation, in addition to the 60 trillion won already committed to inject capital into banks and buy up bad assets. The government has also announced measures to prevent a currency crisis, including a plan to guarantee as much as $100 billion of the external debt incurred by Korean banks between October 20, 2008, and June 30, 2009.
Other Asian governments have announced similarly bold economic packages that combine government outlays and tax reductions. In Japan those measures could reach $200 billion, or 4 percent of GDP. A program of comparable scale is being implemented in Taiwan, while Malaysia says it will spend $16 billion to jump-start its economy.
"After the growth shock of falling exports, the powerful forces of recovery are being marshaled," says HSBCs Neumann.
It remains to be seen whether these programs are bold enough to forestall the kinds of business failures that would dramatically damage bank balance sheets. "The scenarios are getting scarier," says Citigroups Rosgen. "The danger is that we have a much more severe slowdown than we currently forecast or anybody is forecasting. If this is another Great Depression, then all bets are off."