Despite their reputation as risky bets, many emerging-market banks--along with their countries' economies in general--fared much better during the last two years than their more "developed" cousins. Even within the developed world, there are dramatic differences between the performance of banks that took on too much risk and those that did not, with some banks having nearly destroyed their businesses and others winning market share as their rivals struggle. We think the significant divergence among international banks during the last two years will extend into the recovery, and we expect to see stark contrasts between the winners and the losers in both the speed and strength of their recoveries.
Brazil
After they reported third-quarter earnings, the three Brazilian banks we
cover--Itau
Unibanco, Banco
Bradesco, and Banco Santander Brasil--all displayed a common theme:
The worst of the crisis may be over in Brazil. Together with Banco do
Brasil, a government-controlled bank, they dominate Brazil's banking
market. Although we think there are some convincing data points to
support this optimism, we doubt that there will be a sharp
recovery--especially with regard to credit quality.
Although nonperforming loans (NPLs) kept climbing across the board, they did so at a slower clip. The pace at which net new NPLs are forming has been constantly declining since early 2009. Hence, we think that in the near term we should start seeing NPL balances actually declining. Another heartening indicator was the fall in early delinquencies--loans overdue between 30 and 60 days. That said, though it is commonplace for banks in emerging markets to have high bad-loan balances that are compensated by fat interest margins, we think NPLs of around 7% or more are no laughing matter. To be sure, even though nonperforming loans may start to trend down, actual loan losses should remain higher than usual for some time, which will pressure banks' bottom line, in our view.
Notwithstanding, Itau's and Bradesco's profitability has shown signs of resilience, with returns on equity staying around 20%. For these two, we think that after a couple of quarters or so, we should start seeing returns creeping back to their former levels of around 25%. The laggard, Santander, still has to cope with higher bad-loan balances and provisions to replenish its reserves which will prevent it from enjoying as speedy a recovery as its competitors. Further, it has by far the fattest equity base, which quells its returns. Nonetheless, even comparing returns on assets, it is way behind.
A significant portion of Brazil's economic recovery--which arguably started in the second quarter--is because of the country's domestic demand, particularly from individuals. In our opinion, a growing middle-income class that consistently calls for more financial products will continue to provide fertile grounds for banks to profitably expand.
Switzerland
The results of Switzerland's largest two banks, UBS
and Credit
Suisse, continued to demonstrate the divergent impact of the
financial crisis. Credit Suisse, which stayed away from accepting
government support, has been profitable every quarter so far in 2009,
even earning a return on equity of around 25% in the third quarter, as
it benefited from its client-focused business model and solid
reputation. So far this year, it has garnered net new asset inflows of
more than CHF 30 billion, demonstrating its clients' faith in its solid
private bank. UBS, on the other hand, has steadily reported losses,
losing some CHF 4 billion thus far in 2009, as it suffered continued
write-downs on its trading assets and a shrinking business. The damage
done to its reputation, both by losses at its investment bank and
numerous scandals at its private bank, shows up in its net new assets.
In sharp contrast to Credit Suisse, UBS has so far shouldered net asset
outflows of more than CHF 90 billion in 2009. We expect the banks'
fortunes in 2010 to be similarly divergent--UBS will struggle to reach
any profitability, in our estimation, while Credit Suisse will likely
report profits near precrisis levels.
Ireland
A sharp fall in credit quality at Bank
of Ireland in the half ended September 30 and at Allied
Irish Banks in the half ended June 30 underscores that these
once-mighty Irish banks are far from out of the woods. Ireland's
dramatic slowdown--real gross domestic product is expected to shrink
7.5% in 2009 and housing prices have fallen 25% since their peak in
early 2007--has hit its banks hard. One, Anglo Irish, was nationalised
entirely in January, and AIB and Bank of Ireland face massive government
bailouts, capital raises, and asset sales. Although there are some small
signs of improvement--Bank of Ireland's loan/deposit ratio fell to 152%
in September from 161% as of March 31, 2009--there's little that can
counterbalance the growing weight of the banks' bad-loan portfolios.
Troubled loans made up 10.6% of Bank of Ireland's portfolio as of
September 30, and the figure is likely to be even higher at AIB when it
next reports detailed results at year-end, given its larger portfolio of
property and construction loans. The future of both banks looks highly
uncertain. The European Union is likely to demand significant asset
sales from both as a consequence of their dependence on state aid, and
the banks are unlikely to ever again consistently post boom-years-sized
profits.
United Kingdom
Across the board, declining credit quality negatively affected the
results of Barclays,
HSBC,
and Royal
Bank of Scotland, and we expect the pattern to continue at Lloyds
Banking Group when it reports later this month. The weak UK
economy--real GDP is expected to decline 4.6% in 2009--is dragging down
all of the banks' results, but there were stark differences between the
banks that have weathered the downturn in fairly good shape and those
that have not. HSBC, buoyed by its exposure to China and emerging
markets, said that pretax profits were strongly ahead of last year's
numbers on a like-for-like basis, though it released few details.
Similarly, Barclays said that profits more than doubled from last year's
numbers, excluding one-time items, as it benefited from strong trading
results. In contrast, Royal Bank of Scotland announced that the
government would take up another £25.5 billion stake in the bank to help
it cope with its rapidly declining credit quality. Shareholder losses
have been almost £3 billion year to date. We expect this divergent
performance to continue in 2010, as HSBC and Barclays report
near-normalised results and RBS and Lloyds report losses.
India
In India, the superiority of HDFC
over ICICI
is as clear as ever, in our view. In part because of much better credit
quality and wider interest margins, the former's returns have stayed at
relatively healthy levels. Not quite 20%, but with returns on equity
around 17%, they compare favourably with those of many other financial
institutions, in our opinion.
ICICI is still losing deposits at an astonishing pace. Although the bank claims it is letting its most expensive deposits run off, we think that if it goes too far, it may have to resort to costlier debt to fund loan growth. So far, in contrast with HDFC, ICICI's loan balances have been quickly declining, but once demand kicks back in earnest, we think margins may contract if the firm's deposit-gathering efforts do not bear fruit.
As with many other emerging markets, signs of amelioration are starting to show mostly through plateauing NPL balances. India's economy is set to grow at an annual clip of between 5% and 6%. Even though this is still a ways from the 9%-10% growth rates it saw during the boom years, we think it is an interesting alternative that stacks up well against other emerging economies' growth rates.
Japan
Despite the return of profitability at both Nomura
Holdings and Mizuho
Financial Group we don't see many signs of progress at these
Japanese banks, which appear doomed to eternally repeat their mistakes.
Once lauded for initially avoiding the subprime contagion, Japanese
banks found themselves also raising dilutive capital as the crisis
continued, and we're not sure that these highly leveraged institutions
are done stabilising their balance sheets. Mitsubishi
UFJ is rumoured to be planning a capital raise of roughly JPY 1
trillion (£6.6 billion), a massive amount by any measure, after raising
a similar figure within the last year. Furthermore, while Goldman
Sachs returned to posting double-digit returns on equity soon after
the financial crisis began to wane, banks like Mizuho returned to only a
modest level of profitability after a multibillion dollar loss in its
last fiscal year. Nomura picked up Lehman Brothers' Asian operations for
a song last year, but it is just beginning to see benefits on the
revenue side, while compensation costs have been taking a toll on
results for some time. The disastrous combination of high leverage and
low core earnings power will continue to take a toll on most of these
institutions for the foreseeable future, in our opinion, and the country
is continuing its long battle with deflation.
Korea
Across the Korea Strait, South Korea's Shinhan
Financial Group saw small improvements in credit statistics, while KB
Financial Group's third-quarter income suffered from increased
provisioning. Both banks benefited from falling interest rates,
improving their net interest margins by lowering rates on deposits and
making loans at higher credit spreads. Although the Bank of Korea was
widely expected to raise rates as the domestic economy improved--the
country's economy grew by 2.9% in the third quarter--the central bank
chose not to do so at its most recent meeting, potentially boosting both
net interest margins and GDP growth in the coming quarters. Although the
South Korean banks have historically shown higher profitability than
their Japanese peers, they've been subject to some of the same
disturbing herding tendencies as their neighbours. For instance, the
country had its own financial crisis only a few years ago as a result of
excessive credit card spending, yet credit cards remain a major focus of
growth efforts at South Korean banks. There is certainly room for growth
compared with the United States, which has a larger number of cards
outstanding per capita, and delinquency rates remain low, but we're
remaining cautious considering the country's recent history.
The winners
The financial crisis provided a graphic demonstration of the differences
between high-quality banks and lesser performers, many of which are now
out of business. However, opportunities have also been created for
surviving institutions. We believe the following banks are
best-positioned to profitably gain market share as the global economy
recovers:
Barclays (UK)--Avoided government rescue, benefiting from Lehman acquisition
HSBC (UK)--Exposure to emerging markets propelling growth and profitability
Bradesco (Brazil)--Conservative lender deeply entrenched in Latin America's largest and brightest economies
Itau Unibanco (Brazil)--Very profitable bank with an appetite for more presence in Latin America
HDFC (India)--Highly profitable bank with good credit quality in a booming economy
Credit Suisse (Switzerland)--Strongest Swiss bank, gaining market share
