HSBC has a vast wealth of experience across many different product lines and time zones. In March 2007, it was the first to “bring out its dead” with regard to the American sub-prime crisis. At that early stage, the rest of Wall Street was still in denial. Now it seems the writing is on the wall again.
On 5 November HSBC stated that growth in its Asian heartland would slow down – not because of a lack of opportunity, but because of overly low pricing. Too many banks are offering huge loans to questionable customers without sufficient attention to credit quality. The upshot could be another deluge of painful asset write-downs. Only this time, they would originate from the East, not the West.
So what does this mean for Industrial and Commercial Bank of China (ICBC), the world’s biggest and most profitable finance house,with a market cap of $280bn? At the moment it’s making hay. The loan book of $1trn is ballooning at between 15% and 20% per year, while bad debt provisions have dropped to record low levels of 1.15% at the end of the third quarter of 2010, down from 3.79% in 2006.
Don’t be fooled, though. These favourable conditions will not last forever, particularly if there is a repeat of the 1998 Asian Crisis. Back then, credit losses rocketed to three to four times existing levels. Chinese consumers are far more parsimonious than their Western cousins, but even so, current non-performing loan (NPL) levels are unsustainable. At some point the domestic economy is going to decelerate and this natural brake will trigger a slew of losses from over-extended corporations and home-owners.
Turkey of the week: ICBC (HK:1398), rated OVERWEIGHT by JP Morgan
While it’s impossible to be too precise on the scale of the fallout, the impact could be huge. Chinese GDP growth falling from 10% today to, say, 6% could trigger default rates of 2.5%, 4.5%, and 3.0% over a three-year period. At first glance this might not sound too bearish, but it would create write-downs of $100bn. That would wipe out ICBC’s entire tier 1 regulatory capital. That wouldn’t be the end of it, though. If the dividend was cancelled, and other parts of the group met their targets, I estimate the bank’s tier 1 ratio would halve from 9.4% now to about 4.5%. That would mean another $40bn to $50bn of fresh capital having to be raised via a dilutive rights issue.
So I would rate the business on a 1.4 times net assets multiple. That generates an intrinsic worth of approximately ¥3.2 or HK$5.3. As a result, I would steer well clear of this stock. I would also avoid Asian ETFs and/or other overseas funds buying up Chinese banking stocks. Finally, and for the same reasons, I wouldn’t look favourably on rivals such as Standard Chartered (LSE: STAN) either.
Recommendation: SELL at HK$6.17