Subprime bark worse than its bite
Listed institutional investors such as insurance companies and commercial banks have seen their stocks pummelled but there is little evidence to support bears' worries.
Fears that Asian financials were the predominant buyers of the riskiest subprime assets are unfounded, according to banking and credit strategists. In a flurry of research reports they have been arguing that the effect on the regionÆs institutional investors including banks and insurers will be manageable and that the sell-off is overdone.
ôFundamentally Asia has quite limited exposure to US subprime,ö says Deborah Schuler, a credit analyst at MoodyÆs, which has so far taken no action on any Asian financials. ôEven if there was a total wipe-out of these CDOs, including those with just a small amount of subprime exposure, we donÆt think it would be a rating issue and not even much of an earnings issue.ö
That message hasnÆt gotten through to investors yet û bears have been knocking chunks off the regionÆs banking and insurance stocks since the subprime panic roiled equity markets in late July. Much of the selling may be influenced by concerns of weak disclosure standards at Asian banks, but sufficient details have now come to light to put those fears to rest.
After talking to financials across the region Tracy Yu, a Citi banking strategist, reports that Taiwanese insurers and Singaporean banks hold the biggest portfolios of subprime-related collateralised debt obligations (CDOs).
According to that report, Shin Kong Financial has $360 million of such products in its investment portfolio, which may help to explain why it has been one of the worst-performing financial stocks in the region during the past month û the insurerÆs share price is down almost 19% from its July peak of 23.2. Taiwanese rival Cathay Financial is suffering from similar sentiment even though it claims to own just $55 million of CDOs with some subprime exposure û its share price is down close to 17% from a recent peak of 93.8 on July 24. In Singapore, DBS has $187 million in subprime CDOs and its share price has dropped more than 12% since mid-July.
It now seems that the problems are not nearly as bad as all that. Even if these institutions suffered a 20% loss across their entire portfolio of CDOs û not just the subprime ones û they would still be relatively unscathed. Shin Kong would take a hit equivalent to 7% of its investment portfolio, Cathay 1.5% and DBS 2%.
The losses elsewhere in Asia will be even smaller. Korean banks were the first in the region to disclose their exposure to toxic subprime investments, with Woori the worst-affected. It has $125 million of subprime CDOs û a relatively small position on a book valued at more than $13 billion.
Hong Kong and Chinese banks and insurers have little exposure, says Yu, and most of it is triple-A rated, capital guaranteed and classed as available-for-sale or hold-to-maturity, which means that unrealised losses will not appear in banksÆ income statements.
Financials in other markets have minimal or even zero exposure. Indian banks and insurers, for example, have no subprime investments thanks to rules that prevent them from investing local funds offshore. Indonesian banks are domestically focused and most have been scaling back their international presence.
In Malaysia, Maybank reportedly has some subprime exposure through $60 million of credit-linked notes but no other financials are thought to be affected at all. The story is similar in Thailand. Krung Thai Bank has $160 million of synthetic CDOs referenced to corporate credit but no direct subprime exposure. JPMorgan reports that Bank Thai has a $50 million CDO investment backed by home loans, but the other Thai banks appear to be unaffected.
ôThe subprime bark is worse than its bite,ö says JPMorganÆs Andrea Cheng in a report published on Tuesday. ôThe volatility of ABX and iTraxx Crossover relative to their underlying reference securities should give credit investors a good measure of the gap between valuation losses and likely realized losses.ö
ThatÆs bad news for any institutions or funds that use these indices to put a market price on their CDOs because the valuations they end up with as a result do not reflect the risk of default on the underlying assets.
This problem was neatly demonstrated by UOB in its first-half results announcement on Tuesday, which included details of a S$48 million provision it has had to make to cover the falling value of its CDO portfolio.
Such losses should be a short-term blip so long as there are no actual defaults in the portfolio. ôWe believe the entire mark-to-market losses will eventually be written back,ö says Yu at Citi. ôSector fundamentals remain stable.ö
Widening credit spreads will have other consequences for banks, beyond the cost of setting aside cash for tumbling investment valuations. Higher borrowing costs will also hurt lending business and the bearish mood in equity markets wonÆt help fee income from asset management and brokerage units. But the scale of the damage should be relatively small and certainly not as bad as equity investors are predicting.
Indeed, Cheng says more expensive debt may even be a good thing. ôFrom a long-term fundamental analysis perspective we view a repricing of risk as a credit positive as it should remove some of the irrationality that was developing as a result of a 55-month run of ever-tighter spreads,ö says Cheng.
So who did buy all the subprime junk? Cheng says that an informal survey of JPMorganÆs structured credit team revealed Australian funds as the regionÆs biggest buyers of the risky mezzanine CDOs, but even those investments are thought to be mostly at the double- or single-A level.
ôFundamentally Asia has quite limited exposure to US subprime,ö says Deborah Schuler, a credit analyst at MoodyÆs, which has so far taken no action on any Asian financials. ôEven if there was a total wipe-out of these CDOs, including those with just a small amount of subprime exposure, we donÆt think it would be a rating issue and not even much of an earnings issue.ö
That message hasnÆt gotten through to investors yet û bears have been knocking chunks off the regionÆs banking and insurance stocks since the subprime panic roiled equity markets in late July. Much of the selling may be influenced by concerns of weak disclosure standards at Asian banks, but sufficient details have now come to light to put those fears to rest.
After talking to financials across the region Tracy Yu, a Citi banking strategist, reports that Taiwanese insurers and Singaporean banks hold the biggest portfolios of subprime-related collateralised debt obligations (CDOs).
According to that report, Shin Kong Financial has $360 million of such products in its investment portfolio, which may help to explain why it has been one of the worst-performing financial stocks in the region during the past month û the insurerÆs share price is down almost 19% from its July peak of 23.2. Taiwanese rival Cathay Financial is suffering from similar sentiment even though it claims to own just $55 million of CDOs with some subprime exposure û its share price is down close to 17% from a recent peak of 93.8 on July 24. In Singapore, DBS has $187 million in subprime CDOs and its share price has dropped more than 12% since mid-July.
It now seems that the problems are not nearly as bad as all that. Even if these institutions suffered a 20% loss across their entire portfolio of CDOs û not just the subprime ones û they would still be relatively unscathed. Shin Kong would take a hit equivalent to 7% of its investment portfolio, Cathay 1.5% and DBS 2%.
The losses elsewhere in Asia will be even smaller. Korean banks were the first in the region to disclose their exposure to toxic subprime investments, with Woori the worst-affected. It has $125 million of subprime CDOs û a relatively small position on a book valued at more than $13 billion.
Hong Kong and Chinese banks and insurers have little exposure, says Yu, and most of it is triple-A rated, capital guaranteed and classed as available-for-sale or hold-to-maturity, which means that unrealised losses will not appear in banksÆ income statements.
Financials in other markets have minimal or even zero exposure. Indian banks and insurers, for example, have no subprime investments thanks to rules that prevent them from investing local funds offshore. Indonesian banks are domestically focused and most have been scaling back their international presence.
In Malaysia, Maybank reportedly has some subprime exposure through $60 million of credit-linked notes but no other financials are thought to be affected at all. The story is similar in Thailand. Krung Thai Bank has $160 million of synthetic CDOs referenced to corporate credit but no direct subprime exposure. JPMorgan reports that Bank Thai has a $50 million CDO investment backed by home loans, but the other Thai banks appear to be unaffected.
ôThe subprime bark is worse than its bite,ö says JPMorganÆs Andrea Cheng in a report published on Tuesday. ôThe volatility of ABX and iTraxx Crossover relative to their underlying reference securities should give credit investors a good measure of the gap between valuation losses and likely realized losses.ö
ThatÆs bad news for any institutions or funds that use these indices to put a market price on their CDOs because the valuations they end up with as a result do not reflect the risk of default on the underlying assets.
This problem was neatly demonstrated by UOB in its first-half results announcement on Tuesday, which included details of a S$48 million provision it has had to make to cover the falling value of its CDO portfolio.
Such losses should be a short-term blip so long as there are no actual defaults in the portfolio. ôWe believe the entire mark-to-market losses will eventually be written back,ö says Yu at Citi. ôSector fundamentals remain stable.ö
Widening credit spreads will have other consequences for banks, beyond the cost of setting aside cash for tumbling investment valuations. Higher borrowing costs will also hurt lending business and the bearish mood in equity markets wonÆt help fee income from asset management and brokerage units. But the scale of the damage should be relatively small and certainly not as bad as equity investors are predicting.
Indeed, Cheng says more expensive debt may even be a good thing. ôFrom a long-term fundamental analysis perspective we view a repricing of risk as a credit positive as it should remove some of the irrationality that was developing as a result of a 55-month run of ever-tighter spreads,ö says Cheng.
So who did buy all the subprime junk? Cheng says that an informal survey of JPMorganÆs structured credit team revealed Australian funds as the regionÆs biggest buyers of the risky mezzanine CDOs, but even those investments are thought to be mostly at the double- or single-A level.
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