In our APAC Banking Sector Study, published last September, we assessed the outlook for banks in Australia, China, Korea, Japan and India, noting that accommodative government policy, coupled with less stringent regulation, has provided banks in the region with adequate time to absorb the potential shock of COVID-19. Following that study, clients have asked us about our views on banks in key markets in Southeast Asia, such as Indonesia, the Philippines and Thailand. While we view the credit quality of banks in these countries as stable, we favour investing in the major systemically-important banks and higher up in the capital structure. A rise in nonperforming loans (NPLs) is likely across all three countries, but net interest margins (NIMs) and capital ratios of the major banks remain healthy enough to absorb those losses.
Indonesia: Constructive view on major banks, particularly state-owned
Indonesia should enjoy a strong economic recovery in 2021. In 2020, the Indonesian economy slumped into its first recession since the 1998 Asian Financial Crisis and full-year GDP was down by 2.1%, contracting for the first time in more than two decades. However, the shock was relatively moderate compared with other Southeast Asian countries and we estimate that 2021 GDP growth will be around 5%.
We have a constructive view on the credit outlook for major Indonesian banks this year, the four largest of which represent around 55% of market share. Our preference is for state-owned banks due to their strong fundamentals and potential sovereign support. Indonesian banks have been trading at slightly wider spreads than peers in Southeast Asia, offering modestly attractive valuations.
Despite some concern that NIMs are likely to be compressed and credit costs may increase, profitability and the capital position of major Indonesian banks remain high. We expect major banks will be able to absorb the impact of COVID-19 and the potential losses from restructuring loans (accounting for around 20% of total loans). However, we are wary of the risk of micro lending and small commercial loans. While part of the risk of microfinancing is shared by the government, these borrowers have limited business track records and we will be closely monitoring default levels.
Philippines: NPLs to pick up but loan growth and NIMs should ease pressure
Overall, we believe that the credit quality of Philippine banks remains stable. Similar to Indonesia, we are more constructive on the major banks considering their systemic importance, strong capital positions and conservative loan portfolios.
We estimate that reported NPL ratios will pick up this year to around 6% following the expiry of the pandemic -related debt moratorium in December 2020. However, the proposed Financial Institution Strategic Transfer Act should allow banks to divest their NPLs and place them in a better position for recovery in 2021. Early NPL divestiture will allow banks to free up their lending capacity and we forecast high single digit loan growth in 2021, compared with the 0.7% decrease seen in 2020. NIMs are under pressure due to the central bank cutting rates from 4% in December 2019 to 2% by November 2020, but are still high enough (3.5%+) to absorb incurred credit costs.
Thailand: Systemic risk is low but economy likely to lag other Southeast Asian countries
The Bank of Thailand is projecting a 6.6% GDP decrease in 2020 and 3.2% GDP growth in 2021, slower than other Southeast Asian countries. Due to the country’s higher reliance on the external economy (tourist receipts represented 11.5% of 2019 GDP), we expect a slower recovery for Thailand compared with other Southeast Asia regions.
Thailand’s financial system is resilient, in our view. While the economic environment is challenging, Thai banks maintain high capital provisions and decent NIMs to absorb increased credit costs. Before the COVID-19 outbreak, the country’s economy was very stable and Thai banks accumulated their capital steadily to common equity tier 1 (CET1) capital ratios of 12.9%-17.1% as of year-end 2020. However, considering the external dependence of the economy, the recovery for Thailand’s banks is likely to be slower than regional peers, and current tight spreads are not particularly attractive when considering risk vs. reward.
We favour investing in the major systemically-important banks in Southeast Asia rather than second tier banks. We do not expect any systemic shock, but the profit recovery for smaller banks is likely to be slower, in our view, and the current tight spread difference of 20-30 basis points between the major banks and other banks in the region does not provide sufficient compensation.
For more on our outlook for Asia this year, please read “Asia Market Outlook 2021: Attractive Opportunities As Economies Rebound.”