What is driving the performance of Asian financial stocks this year? Profitability, growth or sheer resilience?
More than anything it is growth. People forget that Asian financials are domestic stocks. The driver of their growth is the domestic consumer. So if you look at Asian economies, exports have been weaker than domestic consumption. Being focused on the area of the economy that is doing relatively well has helped keep loan growth strong and revenues at a reasonable level.
Globally, we are beginning to see some movement of perceptions towards banks and that generally positive tone globally has also helped the sector do better than the market.
Within your fund you are overweight Indian banks. Why is that?
I am always positive on Indian banks because India has the most diverse financial sector.
It has the state banks, the private banks and a lot of consumer finance businesses.
I think managements are good, particularly in the private sector. It is also very profitable. ROEs are high at between 18% and 22%, compared to a global standard (although not as high as Indonesia). We have done well because we have positioned ourselves in more specialised consumer finance plays like Bajaj Finance and D1 Housing.
We also own the major stocks like HDFC Corporation and HDFC Bank. Axis Bank is another stock that people were a bit negative about six months ago, but we have recently been increasing our positions there. So it is a combination of a profitable sector with good growth and good management.
Remember as well that the private banks can cherry pick business from the state banks.
You see a divergent trend in problem loans with the state banks’ NPLs rising and the private sector being quite stable. What about China and Chinese banks?
China is so state controlled in terms of the financial sector that it is difficult to use our approach. Fundamentally we take the view that financials are different from other sectors. Banks are risk businesses: you write business today and you don’t know the profitability of that business until year three, four or five. We create portfolios and decide on stock selection based on the balance sheets rather than the income statement. We look at funding structures, and the quality of loan books. Over the long term, the reason this fund has done so well is that we miss the blow ups. And that’s how you make money in the long run in financials.
How do you assess the potential risk of those blow-ups?
You assess the credit culture within the bank. If they consistently write dud loans, what is the long-term performance, over 10 or 12 years? In the mortgage business you check loan-to-value ratios.
How about recent moves to dampen property prices in Hong Kong and Singapore? Is that a risk to the banks?
The mortgage business is fundamentally about unemployment. The reality is that the quality of the loan book is closely linked to trends in unemployment. You can go through periods — as the UK is doing now — where you can have negative equity but as long as people are employed they continue to service the loans. Hong Kong is a good example of that. If you go back to the last property crash, the level of NPLs coming out of Hong Kong mortgages was remarkably low.
For me the biggest worry in Asia is that in the last few years we have had a step change in interest rates [being consistently low]. A lot of people have started borrowing for the first time in emerging Asia. So what happens when interest rates start to rise? We haven’t been through a cycle of rising interest rates with lots of new borrowers. On balance I am quite sanguine about it. I don’t think rates will rise dramatically as they did in the 1980s and 1990s. The regulators and the banks have also been quite cautious about how they have lent, because of what has been going on in the West.
Is that true even of the consumer finance companies?
You have to look at the aggregate level of gearing of the consumer and it remains very low. Cyclically it is too early for us to expect that sort of asset quality crunch. But NPLs across the board are incredibly benign.
There have been a lot of Asian bank block trades and spin offs of positions held by third parties.
What is your approach to those deals and investment opportunities?
It is usually an opportunity for us because the market sells off. Generally they are undervalued as they are pricing the deals to go. I am not a great fan of banks having minority stakes in some bit of a business just because they want to be in a country. Some have them for historical reasons. When the banks or insurance companies were originally listed they wanted to have big names to help the initial IPO. But long term, capital requirements have changed and it is now onerous to hold stakes in the financial companies.
From my perspective, this pull back of European banks from Asia is a real plus. You really see it. There has been a collapse in the European bank presence in things like syndicated lending and trade finance. This reinforces the view that the local banks will gain. When we started the fund 15 years ago, there was a big difference in IT systems and management between the local banks and HSBC, Standard Chartered and Citi. All that has now disappeared.
Banking with HSBC in Thailand is no longer a better experience than banking with Siam Commercial Bank. And time and time again in emerging markets, when there is a bit of a problem, all the Western banks rush out the door and the local guys remember that.
There has been the emergence of what people are calling the superregionals, especially in Southeast Asia: UOB, CIMB, DBS. Do you buy into that story and can those banks thrive in new markets?
I think it is difficult. Taking the Singaporean banks, they have grown up in a structured, well-regulated environment.
If you translate that into an Indonesian context you will find that you will not grow very much. The parameters you set are quite strict.
So is the Danamon purchase by DBS a mistake?
I don't think it's a mistake, but I wonder whether DBS is a bank that will be good at growing what is essentially a car finance business. At its core, Danamon is Adira Finance — a hugely successful car finance business. It is very well run but culturally it is quite difficult going from being a very successful commercial bank to being a successful consumer finance bank. It's a different business. It has better margins but you have to take more risk.
Collections are more important and it becomes more automated. It is much less about relationships. The guys who will do well are the Malaysians. Although with CIMB, historically Niaga was focused on the mortgage business and BCA, the strongest bank in Indonesia, has decided to focus on that segment. BCA, has without question, the best funding structure in Indonesia and that is what mortgages are all about, as you are not going to get long-term, wholesale funding in Indonesia. BCA has that huge pool of deposits.
How about North Asia?
The risk-adjusted returns in Hong Kong are okay. Taiwan and Korea are both incredibly cheap. Historically the returns have not been great and I am not sure what the catalyst will be. In Taiwan it will probably be consolidation. Korean banks are very cheap even against European banks. It is telling you that investors think that the sector is on the verge of some sort of crisis. US banks aren't growing much and they trade on much higher valuations.
Is this due to worries about related-party lending and nasty surprises in the past?
I think that's it. Also the regulator and the politicians have often been quite interventionist in the past. A lot of us think there are better places to invest, although it is true that they are very cheap.
The dilemma for anyone investing in Asian financials is that we have all done very well investing in Southeast Asia and in India, and so we are all underweight North Asia. Because I am always structurally underweight Chinese banks, it is difficult to shift the fund up into Taiwan or Korea.
This article first appeared in the December/January edition of FinanceAsia magazine
