Why Asian banks?
Why Asian banks?
The Asian banking sector is becoming more attractive to the wider stock market, with asset quality a consideration
Invesco believes the attractions of the Asian banking sector are improving relative to the wider stock market. Consensus is more concerned about asset quality than necessary. Ample capital at many banks means that there may be scope for share buybacks, special dividends and accretive mergers and acquisitions. We believe that:
- Korean banks’ valuation multiples do not reflect their strong fundamentals
- Indian banks are addressing non-performing loans on their balance sheets
- Chinese banks’ asset quality risks are fully priced in
Our investment thesis on Asian banks is largely based on our view that the risk of asset quality problems has been overstated and some banks can afford to be less conservative in their balance sheet management. The Asian banks average tier 1 ratio is high by international standards at approximately 14.7% and, at some point, we believe the banks may allow this ratio to fall in order to boost shareholder returns through engaging in share buybacks, special dividends and mergers and acquisitions.
Since the start of this year, we have been more favourable to the Asian banking sector across our portfolios. Firstly, we believe that banking systems which have seen less extreme loan growth in recent years, such as in Korea, have relatively good asset quality and balance sheet strength which is not reflected in their valuation multiples. Secondly, banks that have been proactive in recognising bad assets, as in India, will gradually improve asset quality and will become well-placed to deliver value to shareholders, in our opinion. Thirdly, we have identified attractive investment opportunities among the large Chinese banks based on the view that the quality of their balance sheets is better than they are perceived by the market.
Korean banks’ valuation multiples do not reflect the potential inherent in their balance sheets
Since the global financial crisis, financial regulators have focused on increasing banks’ capital ratios. However, we believe a point has been reached where regulators can afford to be less aggressive in enforcing high capital ratios, creating the potential for balance sheet capital to be used to increase shareholder returns. In particular, the Korean banks’ ratios are now strong enough, in our view. Specifically, our investment case for key holdings in Korean banks is based on potential, given strong balance sheets and management maintaining or improving return-on- equity (ROE). We believe this is not reflected in many price/book ratios. Another reason includes banks with historically low valuations which, in our view, seem attractive given solid asset quality and the scope for shareholder returns to be boosted by a higher dividend payouts.
Indian banks are addressing their high levels of non-performing loans on their balance sheets
In India, a key obstacle to loan growth has been the high level of bad debt on banks’ balance sheets evidenced by their stress loan ratios of approximately 12%. Banks, encouraged by the Reserve Bank of India (RBI), have begun to finally come clean on their non performing corporate loans and we believe this process is nearer the end than the beginning. One of India’s largest private banks has been hurt by India’s bad debt cycle with more than 14% of its loan book impaired in some form. However, we believe that it has the necessary capital -solid tier 1 capital ratio of 14.2% - and high–pre-provisioning profitability to earn its way out of its problems without recourse to new equity. It is trading on a 1.4x price/book ratio which we believe is attractive for a bank that, in our opinion, may achieve an attractive ROE as its business recovers.
Asset quality of Chinese banks is better than the market is factoring into valuations
Our investment thesis for the big four Chinese banks is based on the view that the quality of their book value is not as bad as the market is assuming. In our opinion, the outlook for non-performing loans is getting better as the government’s actions to end overcapacity in industries such as steel, aluminium and cement, are ensuring that loss making companies are either being eliminated, or experiencing an increase in profitability. It is in these sectors where a large amount of bad debts reside. We have a higher exposure to some Chinese banks as a result.
To summarise, we believe that asset quality is better than the market believes and banks may be in a position to boost shareholder returns through share buybacks, special dividends and accretive mergers and acquisitions. In our view, attractive investment opportunities can be found in this sector.
The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.
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