Monday, August 1, 2011 12 comments ++[ CLICK TO COMMENT ]++

Is this the beginning of a credit correction in emerging markets?

I ran across an interesting article from Bloomberg describing the weakening of credit conditions in some key emerging markets. Although too early to say if this portends to any serious calamity, it does feel, at least to me, like the HSBC sub-prime earnings warning from 2007 (of course, when HSBC warned in early 2007, it was widely ignored by many, including me :( ).

I hate to quote so much but this could be an important story. Bloomberg reports,

Brazil’s financial shares have lost more this year than counterparts in crisis-stricken Europe as consumer defaults hit a 12-month high in June and borrowing costs climbed to 46 percent. Bank stocks in China are trading at lower valuations than global emerging-market indexes for the first time since 2006. The country faces a financial crisis with bad debt that may jump to 30 percent of total loans, Fitch Ratings said.

In India, the cost of insuring banks against default has climbed to the highest level in a year. Loan-loss provisions at State Bank of India (SBIN), the nation’s largest lender, rose 77 percent in the first three months of 2011, while net income fell 99 percent.

“People are beginning to smell the credit cycle turning,” Michael Shaoul, chairman of Marketfield Asset Management and chief executive officer of New York-based brokerage Oscar Gruss & Son, said in an interview. “Credit cycles have tremendous momentum, and whenever they turn you want to pay attention,” said Shaoul, who recommends selling high-yield bonds in emerging markets and betting on further losses in bank shares.
One of the problems in emerging markets is that their credit growth has been massive. People complain about the debt growth in USA but the emerging markets are in a different league. It isn't uncommon to see debt expand 30% per year in those countries. Those countries do tend to have high GDP growth but even then, the debt growth is far larger. For example, China, like other emerging markets, has seen debt expand around 30% per year yet its nominal GDP growth is probably no better than 16% (say, liberal estimates of 10% real GDP + 6% inflation).

Chinese lenders expanded credit at a record pace in 2009 and 2010, making more than 17.5 trillion yuan ($2.7 trillion) of new loans as the government moved to offset a collapse in exports during the global recession. The surge in loans exceeded credit expansions in the U.S. before its financial crisis, in Japan before its stock and property bubbles collapsed in 1990 and in South Korea before the Asian financial crisis of the late 1990s, according to Fitch.

Brazil’s annual credit-growth rate accelerated to as high as 34 percent in September 2008, the fastest since at least 1995, before moderating. The pace has picked up again, exceeding 19 percent for 11 months through June, central bank data show.
The market is starting to take notice but banks are reporting deteriorating conditions:
Investors are cutting their estimates for the value of Chinese bank assets. The MSCI China Financials Index’s price-to- book ratio, a measure of share prices relative to net assets, tumbled to 1.8 on July 29, the lowest level since February 2009, from 2.8 two years ago, according to monthly data compiled by Bloomberg. The ratio for Chinese lenders slipped below that of the MSCI Emerging Markets Index on June 21 for the first time since January 2006, data compiled by Bloomberg show.

Industrial & Commercial Bank of China (601398) Ltd., the world’s largest lender by market value, slumped 8.2 percent from the end of March through July 29 even after saying bad loans dropped almost 4 percent in the first quarter. The stock gained 1 percent today.

Credit-default swaps on Bank of China Ltd. (3988), the nation’s third-largest lender by assets, jumped to 153 basis points from 106 on March 31, according to data compiled by Bloomberg and CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in privately negotiated markets.


Brazil’s biggest lender, Itau Unibanco Holding SA (ITUB4), raised its default-rate forecast for 2011 to between 4.5 percent and 4.6 percent on July 11. The Sao Paulo-based bank had forecast a rate of 4.2 percent to 4.5 percent. Itau’s shares have tumbled 21 percent this year, helping to drag down the MSCI Brazil Financials Index by 19 percent in local currency terms. That compares with a 12 percent retreat in Europe’s Stoxx 600 Banks Index and a 7.3 percent drop in the S&P 500 Financials Index. (S5FINL)

Credit Suisse Group AG lowered its rating of Itau on July 26 to “neutral” from “outperform” and cut its earnings forecasts for Brazilian banks by an average of 4 percent this year on concern that higher provisioning costs will crimp industry profits. Itau shares slipped 0.1 percent today.

Brazilians’ debt burdens are rising after the central bank lifted its benchmark interest rate five times this year to the highest level since March 2009. The average interest rate on consumer loans was 46.1 percent in June, up from 40.6 percent in December, according to the central bank. The average rate on company loans increased to 30.8 percent from 27.9 percent.

Loan payments by Brazilian consumers climbed to 26 percent of disposable income in March, up from 24 percent a year earlier. The rising costs of debt signals Brazil’s consumers are “overstretched,” Neil Shearing, a senior emerging-markets economist at Capital Economics in London, wrote in a July 12 report.

In India, debt ratings for companies are deteriorating at the fastest pace since 2009 as slower economic growth and 11 interest-rate increases by the central bank since March 2010 heighten the risk of defaults. ICRA Ltd., the local unit of Moody’s, lowered rankings for 34 borrowers last quarter, according to data compiled by Bloomberg.
Indian lenders’ nonperforming assets may rise 25 percent in the year ending March 31, 2012, to 2.92 percent, the central bank said on June 14 after conducting stress tests.
The cost of insuring State Bank of India’s bonds against non-payment with five-year credit-default swaps increased as much as 48 basis points this year to 208 on July 18, the highest since July 2010, according to CMA. Swaps for ICICI Bank Ltd., the second-biggest Indian lender, jumped by as much as 54 basis points to a 12-month high of 253 on July 19.

“Whenever you have a period of high growth and the macroeconomic picture changes, there will always be an issue” with credit quality, said Sampath Kumar, an analyst at brokerage India Infoline Ltd. in Mumbai.

Lenders in other emerging economies are also showing signs of stress. Bank of Moscow needed the biggest bailout in Russian history last month after racking up at least 150 billion rubles ($5.4 billion) of unsecured bad loans. The $14 billion rescue of the country’s fifth-largest bank signaled Russian lenders’ health may be “substantially worse” than most investors judge, Carroll Colley, a director at New York-based research firm Eurasia Group, wrote in a July 8 report.

Russian lenders accounting for 51 percent of the banking system’s assets failed central bank stress tests this year. Losses in the stress scenario may amount to 5.2 percent of gross domestic product, Bank Rossii said in an April report.
As Bloomberg reports below, the multinational banks are starting to get hit:
Souring loans in emerging markets could affect global banks. Banco Santander SA (SAN) shares sank 3.2 percent on July 27 after Spain’s biggest lender reported a 32 percent surge in loan-loss provisions in Brazil, an increase that surprised investors, according to Daragh Quinn, an analyst at Nomura International in Madrid.

Citigroup, the third-largest U.S. bank, gets more than half of its profit from emerging markets, CEO Vikram Pandit, 54, said in March. Consumer lending in Asia jumped 41 percent in the two years through June to $66.7 billion, as deposits rose 27.7 percent. In India, Pandit’s native country, the bank boosted lending to corporate clients by 33 percent in the year ended March 31. Loans to small and medium enterprises jumped 35 percent, according to a company statement.

While second-quarter revenue from its consumer bank’s Latin American and Asian units rose a combined 13 percent to $4.46 billion, profit fell 14 percent.
I didn't know Citigroup got half its profits from emerging markets. Citigroup shares have been under pressure all year and I wonder if some of that is due to the weakening emerging market situation.

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