A Nervous Bull’s Case
Despite the gloomy scenario in Asian banks, there are compelling value plays in Asian finance that simply cannot be ignored any longer

Asian banks, fund managers and insurance companies experienced collateral damage following the Wall Street credit meltdown and the subsequent repricing of risk across all emerging markets. Moreover, as Asian central banks tightened monetary policy to combat inflation, it was inevitable that speculative bubbles in regional stock exchanges would pop and offshore investors would scramble to limit their exposure and unwind one of the world’s most epic leveraged trades. This was the reason Shanghai’s A share market, Vietnam, India’s Sensex, Hong Kong’s Hang Seng and China Enterprise Index lost 30-50 per cent of their market capitalisation in the past six months. Admittedly, some Asian banks, such as Singapore’s DBS, India’s ICICI Bank, China’s ICBC and Bank of China, admitted to significant CDO exposures. This is a necessary, but not sufficient condition for a rally in Asian banking, as the capital markets must be convinced that there are no more significant CDO/ subprime exposures in the banking closet.

A second condition for any significant rally is hint of a resolution to the credit crisis and the restoration of confidence in the international interbank market. While this scenario is still wishful thinking, the Federal Reserve has responded, in its role as the lender of the last resort, to systematic banking distress and opened its discount window to securities broker/ dealers for the first time since the Great Depression. Accordingly, it engineered the bailout of Bear Stearns via J P Morgan’s takeover bid apart from accepting US$200-billion mortgage backed securities collateral on its balance sheet. But even then, US home prices can still decline at a faster rate, the first consumer recession since 1991 can deepen and wreak havoc on Asian exports, a major global bank, hedge fund or securities firm can go belly up. The bear market in commercial real estate can widen from the US and Europe to Asia.

Between the landmines
However, I believe the Armageddon scenario is mostly priced into the valuation of Asian banking and the Bernanke’s historic moves as the Federal Reserve chief on the Bear Stearns front and the discount window have removed the excessive fear premium that has been haunting the financial markets. The 200 basis points fall in dollar interest rates since September and the credit contraction that forced Western banks to reduce their balance sheet exposure to emerging markets can even mean that the credit crunch will actually benefit the competitive positioning of Asian banks. Landmines exist in bank shares all over the world, particularly in the Gulf, Malaysia, India and China. Yet, there are also compelling value plays in Asian finance that I simply cannot ignore any longer.

Take Chinese banks listed in Hong Kong as an example. The HKCEI was devastated by the bear market in Shanghai, as the Peoples Bank of China (PBOC) tightened interest rates to combat the highest CPI in a decade, Asian hedge funds slashed long exposures, retail speculation in warrants and IPO’s triggered a crash, as valuations rose to stratospheric levels last November. But I believe that the risk/return calculus for Hong Kong listed Chinese shares is a lot more realistic after the 40 per cent plunge in the index. One, index valuations have plunged from 28 to 13 times forward earnings and price/ book value metrics have compressed from a bubble 4X to a reasonable 2.4X now. Moreover, Henry Paulson’s visit to Beijing and the PBOC’s inflation hawkishness means an accelerated pace of Renminbi revaluation, and this is a positive translation gain for Chinese banks, telecom shares and oil companies who dominate the index.

Moreover, Asian hedge funds desperate for performance will have to raise exposure from 40 per cent as long as the indices rally and QDII funds finally begin to trickle into the shell-shocked stock market of the fabled Crown Colony/ SAR on the South China Sea. It is, of course, imperative for investors in Asian banking to use disciplined risk metrics, entry points, even take advantage of juicy risk premia in the listed/ OTC derivative markets.

Some key plays
Take, for instance, Bank of Communications. It trades at a reasonable 16X earnings and 3 times book value, after its 35 per cent fall since New Year, and has no subprime or even dollar exposure. More importantly, it has HSBC as a strategic shareholder. At HK8.50, I will buy Bcom for target over the next 12 months, as Bcom also benefits from rising Renminbi, debt yields, rising net interest margins and rising fee income.

I am also convinced that the victory of the KMT in the Presidential and Legislative Yuan is going to lead to a secular re-rating of the Taiwanese stock market. President Chen’s belligerence was a disaster for Taiwan’s relations with the PRC, whose Politburo raised “the renegade province” rhetoric a few decibel points. President-elect Ma Jing promises to end the cold war with Beijing and this will be a nirvana for Taiwan bank shares, which benefit most from more tourists, more Mainland money in land and buildings and more government spending, apart from more capital flows. While the rising Taiwan dollar and uncertainties in Silicon Valley (tech is 50 per cent of Taiwan’s market cap and earnings) may limit the upside above 10,000 on the Taipei index, local banks can do far better. My play here is Chinatrust Financials at 28 Taiwan dollars for a 35 target.

In India, the New York ADR of ICICI Bank (symbol IBN) has plunged from 74 to 40 now. The $260 million mark to market losses in the CDO book, the inflation hawkishness of the RBI, lower loan book growth, rising NPL in mortgages/vehicles loans and the equity shock (5,000-point fall in Sensex) in the valuation of ICICI Prudential and ICICI Securities has had a devastating impact on banking valuations. Moreover, the international banking subsidiaries of ICICI bank in Canada, Britain, Bahrain, Singapore and the US will face higher funding costs in the interbank market. So, an ideal strategy will be to sell the September 2008 puts on the bank’s ADR. My optimal range for IBN is to buy at 32, sell at 45.

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