Generating growth

Asia’s banks may have escaped the worst of the US and European turmoil, but they have a different challenge on their hands. As the region’s economies continue to grow, Asia’s lenders need to ensure their growth strategies will allow them to keep up.

Banks in Asia are at somewhat of an impasse: though relatively well capitalised, they still have to figure out how to grow when the economy is slowing, and when acquisitions that had once looked cheap are turning out to be prohibitively expensive or difficult to complete.

However, whatever solution a bank chooses, more capital will likely be necessary.

Lenders in China and South-East Asia, where analysts say banking now holds the most promise, are not yet in dire need of capital. A few factors and trends in the last decade put lenders based there in this fortunate position.

Lessons learned in Asian financial crisis in the late 1990s have helped some regional firms stay away from the toxic credit decisions that banks in Europe and the US are still paying for.

A rich base of deposits from increasingly wealthy customers and double-digit GDP growth have also made sure that banks can expand and lend without punishing repercussions.

However, a slight change in fortunes is forcing the more successful banks to recalibrate their strategies.

China has naturally been one of the main drivers of Asian banking trends, but its economic progress has slackened and, along with it, its banks’ prospects for profits. This month, the National Bureau of Statistics of China reported that third-quarter GDP increased 7.4%, down from the 8.1% and 7.6% recorded in the first and second three months, respectively. China’s GDP grew 10.4% in 2010 and 9.2% in 2011.

One way some bank executives have said they plan to defend against economic contraction at home is to expand abroad. That includes organic expansion with the opening of new branches and – much more challenging – M&A.

Certain banks have been more acquisitive than others.

“Clearly, we’re already seeing that Singapore’s banks have an interest in expansion,” said Jonathan Cornish, head of bank ratings, North Asia, at Fitch. “Japanese firms have been interested in growing their offshore presence. Also, there is always the possibility China may follow suit, but they have been expanding organically, through new branches. We don’t expect to see a lot of M&A in the near future.”

A few deals have been announced or completed over the past year, despite the challenges.

DBS, Singapore’s biggest lender, agreed to buy Indonesia’s Bank Danamon for about Rp66.4trn (US$6.9bn) and acquire a 14% equity stake in Malaysia’s Alliance Financial Group.

Malaysia-based CIMB Investment Bank bought most of the Asia-Pacific cash equities and associated investment banking businesses of Royal Bank of Scotland for £160m (US$255m) this year. The purchase of the Australia and Taiwan businesses is slated for completion in the fourth quarter.

China’s Citic Securities is purchasing Asian brokerage CLSA from France’s Credit Agricole.

Europe not on map

CIMB and Citic have been able to take advantage of the sovereign credit crisis in Europe, as banks based in more troubled countries there have had to realign, if not do away completely with their Asia units.

This may prove fruitful, analysts say, but the new assets need time to be incorporated before the purchases can be deemed successful.

Yet, analysts also do not expect the European credit crisis to yield many other deals for Asia’s most acquisitive lenders. Part of the reason is that European banks do not need the money now as much as they did less than a year ago.

“European banks are under pressure to shed global assets for both capital adequacy and funding reasons, and, so, have talked about asset sales in Asia as a consequence,” said Derek Ovington, a bank analyst at CLSA.

“The process of run-off and divestment was significantly retarded, however, by the ECB’s swap and LTRO programmes, which removed the immediate funding drive for European banks and meant there were no ‘fire sales’ and few large transactions over the past year.”

Closer to home

Although the European crisis may yet create more buying opportunities, Asia’s banks have potential acquisition targets closer to home.

“I don’t expect Asian banks to buy in Europe. It is a fundamentally far less attractive market than their own region,” Ovington said.

Yet, buying in Asia is fraught with its own difficulties. DBS is experiencing this first hand. Some time after the Singapore

bank announced plans to buy Danamon, the Indonesian central bank said it would limit foreign ownership of domestic banks at 40%.

The banking watchdog could still make an exception for DBS. It has said that ownership levels could be higher if the investor is a listed bank with strong financial health, characteristics that seem to fit DBS.

What is more, Temasek owns 29.7% of DBS and 67.4% of Danamon. In effect, the Indonesian bank’s post-merger ownership will not be very different from what it is now.

Other aspiring acquirers could face similar roadblocks.

“Regulation has a huge role in influencing cross-border M&A in Asia, mostly as a block to foreign takeovers of domestic banks,” Ovington said. “DBS has had considerable difficulty and delay simply in replacing Temasek as the controlling shareholder of Danamon.”

DBS, like other Asia banks, needs to raise money. The lender has said it plans to fund the S$6.2bn purchase of Temasek’s stake in the Indonesian firm lender with new shares. In the second phase of the financing, it plans to pay for the Rp21.2trn (US$2.2bn) purchase of the 31.63% stake from minority shareholders with cash on hand and senior debt.

What is more, beyond acquisitions, banks still need to raise capital to keep pace with organic growth. Chinese lenders, slackening GDP growth notwithstanding, are expected to grow the fastest. As a result, they will probably have to raise the most capital.

“Chinese banks are among the least capitalised of the emerging markets countries,” Fitch’s Cornish said. “China may look like it is well capitalised from a Tier 1 point of view, but looking at it as a ratio of equity to assets, their capital bases are quite low. Also, because they are anticipated to grow, they may need more capital.”

Asset quality

In addition, there are other factors that could make new capital a necessity. Investors are concerned that Chinese banks are lending to clients with low credit quality.

“There is some concern that potentially low asset quality at Chinese lenders may eat into capital and profits. So, increases in capital will help the banks,” Cornish said.

However, the fact that most of the big Chinese banks are state owned generally mitigates concerns. In the past, the government has been willing to bail out lenders, and analysts do not see that changing yet.

For now, the country’s institutions are only occasional issuers in the offshore capital markets. Although the debt markets have lately been open for all types of lenders from Asia, banks in the region have generally been loath to join the party, while appetite for big equity placements has been subdued.

Instead, when they have needed to shore up capital reserves, they have tended to retain profits.

“At the moment, Chinese banks are quite content with using profit retention to increase capital,” Cornish said. “Although there are reports about them tapping capital markets, it may prove challenging with the decreased growth prospects at banks and in the Chinese economy. The opportunity to tap the market for common equity, for example, may not be there. Should there be greater certainty next year, they may find it easier to raise money then.”

Still, raising capital is not as much of a challenge for banks in Asia as it is for those in Europe, for example. That is largely because they do not need as much. About 15 years on from the Asian credit crisis, local financial institutions have not felt the need to take on outsized risks. As a result, global banking regulations will be less of a burden.

“Most Asian banks are conservatively regulated and are not materially affected by Basel III as a result,” said CLSA’s Ovington.

“There are some countries – for example., Malaysia, perhaps – where a ‘top-up’ to capital may be required, but no countries are looking at a material short-fall in the near term as incremental capital requirements are likely to be small and benefit from a phase-in.”

To see the digital version of this report, please click here.