APAC Banking Sector Study: Identifying the Most Resilient Countries

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At an aggregate level, banks in Japan, Korea and China fared better in our stress test than those in India and Australia.

The banking sector has transitioned from being at the epicentre of the 2008 global financial crisis to being part of the potential solution following the COVID-19 outbreak.  We believe that the impact of COVID-19 on banks has been moderate in most APAC countries because of the supportive stance of governments and financial institutions, along with relatively better initial conditions. Accommodative government policy, coupled with less stringent regulation, has provided banks with adequate time to absorb the potential shock. Despite that, the spreads for APAC financial institutions are wider than their US peers, largely for technical reasons.

This study assesses how banks across Asia Pacific have been affected by COVID-19 and how they performed in our stress test analysis. Based on this analysis, discussed below, we conclude that Japan, China and Korea may offer attractive investment opportunities with the potential for excess return and defence. On the other hand, we maintain a cautious approach towards Australian and Indian banks considering the risks of rising nonperforming loans (NPLs) related to structural issues and the ongoing pandemic.

PIMCO’s Regional Bank Stress Test

Our stress test scenario assessed the current financial strength of banks in the region by analysing how they might perform in a severe global financial crisis, such as the one in 2008-2009 or the Asia crisis in 1997. As discussed above, so far Asia has avoided such a scenario. Our analysis suggests that in this scenario, we should expect major Asia Pacific banks to suffer an average loss of 50-200 basis points (bps) on their common equity tier 1 (CET1) capital—the core capital banks are required to hold to absorb unexpected losses.

It is worth noting that even in our risk case scenario, all regions retained at least high single digit CET1 ratios, so we believe the risk of capital impairment is remote. We saw a slightly smaller negative impact on banks in Japan, Korea and China in the stress test, but Australian and Indian banks underperformed their regional peers. This is not because Japan, Korea and China are immune from the impact of COVID-19, but rather because we expect widespread use of forbearance (reducing payment amounts) and payment holidays to delay the recognition of potential losses.

Banks’ net interest margins (NIMs) are under pressure. However, Japanese banks have been experiencing pressure on NIMs for decades and offsetting the impact by diversifying their revenue sources. Korean banks are also pursuing revenue diversification and 1H results demonstrate that they are making good progress. Chinese banks’ earnings are likely to decline this year, but they maintain relatively higher NIMs and return on equity (ROE) that may offer an adequate cushion to absorb losses from NPL write-offs.

We expect Australian and Indian banks may see negative net income in our stressed scenario, while Japanese, Korean and Chinese banks should be less affected. We believe that the divergence mainly stems from different initial conditions. While NPLs in Japan, China, and Korea remain near historical lows, NPLs in Australia and India were increasing even before the COVID-19-outbreak. Authorities in India and Australia have cut interest rates, extended debt repayment moratoriums and offered fiscal stimulus packages. However, we do not view these measures as sufficient to adequately offset the negative asset quality impact from COVID-19, as well as existing structural issues. When banks report large negative net income, the risk that banks skip paying their coupons on their additional tier 1 (AT1) capital is expected to rise because it may trigger capital distribution constraints.

Investment implications

With COVID-19 leading to unprecedented disruption for the global economy, we are taking a cautious approach, focusing on carefully selecting securities as uncertainty over the economic recovery remains high. Overall, we have a constructive view on Japanese, Chinese, and Korean banks. Despite the COVID-19 outbreak, banks in these countries have maintained low NPLs and delinquency ratios, thanks to better initial conditions and strong government support. While credit spreads have come down since the March 2020 peak, we believe these financial institutions still offer attractive valuations compared with their US peers due to the absence of (or modest, if any) large scale corporate bond purchase programmes by their central banks. Bonds issued by these banks are less correlated to global indexes and remained resilient during the market turmoil in March. We believe that banks in these countries offer attractive investment opportunities for those who seek additional yield along with defensive attributes.

Read Key Highlights for Each Market in PIMCO’s full study.

 

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Takanori Miyoshi, Credit Research Analyst
Taosha Wang, Credit Research Analyst
Dorris Chen, Credit Research Analyst
Annisa Lee, Head of Asia-Pacific Credit Research

Disclosures

All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counter-party capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Investing in foreign-denominated and/or -domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets.

Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work in all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Outlook and strategies are subject to change without notice.

Forecasts, estimates and certain information contained herein are based upon proprietary research and should not be interpreted as investment advice, as an offer or solicitation, nor as the purchase or sale of any financial instrument. Forecasts and estimates have certain inherent limitations, and unlike an actual performance record, do not reflect actual trading, liquidity constraints, fees, and/or other costs. In addition, references to future results should not be construed as an estimate or promise of results that a client portfolio may achieve.

Stress testing involves asset or portfolio modeling techniques that attempt to simulate possible performance outcomes using historical data and/or hypothetical performance modeling events.  These methodologies can include among other things, use of historical data modeling, various factor or market change assumptions, different valuation models and subjective judgments.

This material contains the current opinions of the manager but not necessarily those of PIMCO, and such opinions are subject to change without notice.  This material is distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

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