Equity Analysis /

The EM and FM banks best able to cope with weaker loan quality

  • With 2020 global GDP declining 3.0% (IMF), a material hit to bank loan quality seems inevitable

  • Banks are more resilient to NPL formation in Sub-Saharan Africa; in Vietnam and Bangladesh they are more exposed

  • Banking shares in Argentina and Nigeria already price in higher NPLs, those in Saudi Arabia and Ghana don’t

The EM and FM banks best able to cope with weaker loan quality
Rahul Shah
Rahul Shah

Head of Corporate & Thematic Research

Rohit Kumar
Rohit Kumar

Global Financials/Thematics

Tellimer Research
16 April 2020
Published byTellimer Research

2020 global GDP is likely to decline by 3.0%, according to IMF, -2.8% per IIF. The UN estimates 81% of the world’s workers are facing workplace restrictions. In this environment, banks’ loan books face a material deterioration. With the on-the-ground situation evolving rapidly, we employ sensitivity analyses and stress-testing to identify the best-positioned banks.

Asset quality deterioration is likely to be broad-based. In the early stages of the coronavirus outbreak we thought certain sectors (such as oil or tourism) would generate the bulk of new impairments. But the likely depth of this downturn suggests a much broader impact is likely. Weaker borrowers (highly indebted, or with weak cashflows, such as SMEs/ mass-market consumers) will be hit harder, a theme to which we will return.

Regulatory forbearance will muddy the waters. Bank regulators have announced a raft of initiatives, such as interest-free periods, term extensions and subsidies for borrowers; and looser liquidity and capital requirements for banks. These measures should reduce the risk of a snowballing of interconnected NPLs, but may also prevent investors from seeing a true asset quality picture, particularly in non-IFRS9 markets,

Past banking crises saw a median peak NPL ratio of 26%. While the world is currently suffering a growth shock rather than a financial shock, and significant monetary and fiscal policy stimulus has been announced, the size and speed of economic contraction could still push some banking systems into crisis territory, when NPLs can typically triple in volume. In this context, avoiding weaker systems and institutions is paramount.

A 5ppt increase in NPL ratios reduces tier 1 ratios by 260 bps, for our coverage, if fully provided for. Banks in Nigeria and Argentina appear more resilient to capital erosion in this way, those in Vietnam and Bangladesh less so. Applying a macro overlay to these sensitivities could help investors highlight the most/ least exposed banking systems.

Banks in Nigeria have a sizeable safety margin. Assuming a global minimum tier 1 ratio of 12% and full provisions coverage, Nigeria banks could typically withstand a 15ppt increase in NPL ratios. In contrast, banks in Vietnam and Bangladesh are already below this threshold.

Banks in Argentina and Nigeria are already pricing in high NPL formation. Unsurprisingly, most banks in our coverage are trading at sizeable discounts to history. Assuming a return to normal profitability after two years of zero capital generation, banks in Argentina and Nigeria are already pricing in higher NPLs; we think this makes sense given the macro difficulties in both markets. But Saudi banks seem to be pricing in provisions recoveries, which makes less sense given the oil price collapse.

Defensive banks: GUARANTY NL, SAMBA AB, MCBG MP, MBB VN. These names combine a significant capital cushion with share prices that already discount a high level of loan quality deterioration. Note that this analysis does not factor in other relevant risks, such as currency depreciation, capital controls, political instability. 

Figure 1: Hit to bank shareholder's equity for a 5% increase in NPL ratio

Source: Bloomberg, Tellimer Research

Figure 2: Implied NPLs increase priced in by the equity market (y-axis) versus capital buffer against 12% T1 ratio floor (x-axis)

Source: IMF, Tellimer Research