Published: December 01, 2008
The extent of globalisation and the interdependence of the global financial markets are more evident today than ever before. One could have never imagined the impact of risky home loans in the US on the global equity markets and on the balance sheets of investment banks which invested in these risky assets in the secondary market.
When the first signs of trouble started surfacing early this year, the jury was divided on the resultant impact on Asia.
With capital troubles hitting the likes of Northern Rock, the demise of Lehman Brothers, Bear Sterns and Merrill Lynch being taken over etc., these underlying mortgage-backed assets were deemed worthless. Writing these off had huge capital implications for anybody holding them. The world markets watched in horror as banks such as Washington Mutual, and even countries such as Iceland, went bankrupt or were taken over.
When the first signs of trouble started surfacing, the jury was divided on the resulting impact on Asia. There were strong proponents of the ‘Asia de-coupled’ theory and some economic pundits indeed argued that the Asian economies were less reliant on the west, based on domestic demand coupled with strong growth in intra-Asia trade, resulting in Asia being insulated from the credit crisis in the US.
This theory has since been amply disproved. Asset prices in Asia are on a southward spiral as investors become risk-averse and move to safer instruments such as cash deposits or need the liquidity to service their working capital requirements as banks tighten credit lines. Most Asian stock indices have fallen 30-40% from their January 2008 levels and Asian exports seem to be slowing down as demand for Asian goods softens.
In 2007 and early 2008, with buoyant stock markets in most Asian economies and the flow of FDI into Asia, liquidity was in ample supply in countries such as India, China, Singapore etc. Indeed the central bank in China was concerned about the economy overheating and raised interest rates to curb inflation and to slow down the lending portfolio of the local banks. In countries such as Singapore and India, property prices in some segments grew more than 100% and related rental yields sky rocketed. Rising commodity prices added further fuel as costs of construction escalated. In Singapore, fearing a property asset bubble, the government put a stop to deferred payment schemes for mortgages in October 2007. [[[PAGE]]]
In the US, the US Fed and its chairman Mr. Bernanke referred to inflationary pressures on the US economy and left Fed rates intact in August 2008.What happened next is one for the history books. Since the fall of the big investment banks, such as Lehman and Merrill Lynch, investor sentiment has worsened and capital adequacy of most banks is in question. The London Inter Bank Offer Rate (Libor) market was operating at a premium above Fed Rates and credit became a scarce commodity. Institutional investors started pulling out of their Asian investments to safer havens, sending Asian stock markets plummeting. In the property sector, demand for new home sales has moderated or fallen in property hot spots such as Singapore, Mumbai etc. This, coupled with job losses and economic slowdown in the US, meant reduced demand for Asian goods.
According to IE Singapore, Singapore’s NODX (Non-Oil domestic Exports) decreased by 5.7% in September 2008 (24% decrease to the U.S.) , following a 14 % decline the previous month. This was attributed to lower electronic and non-electronic NODX.
In October, Singapore declared it was in a technical recession, i.e two consecutive quarters of negative GDP growth. According to a recent DTZ property segment report from Singapore, prices of luxury condominiums have fallen by up to 26% compared to the same period last year.
With a global slowdown, most Asian economies are poised to grow at a much slower rate than in 2007/08 and have revised their GDP forecasts for 2009. This will also have a depreciating effect on their local currencies as Asian central banks are set to further cut domestic interest rates to maintain economic momentum.
The slowdown in export orders and protracted US economic slowdown is hitting the order books of Asian exporters. With the recent drop in commodity prices, small and mid-cap corporates will experience profit erosion and balance sheet stress related to the higher cost of borrowing, falling commodity prices and a slowdown in their sales momentum. One can expect consolidation in some industries, such as commodity traders, as well as corporate defaults in the small and mid-cap segments as some of these companies start experiencing payment delays from their buyers i.e. extended working capital cycle, higher cost of borrowing, and a slowdown in sales. This holds true even for the financial services industry, given the margin pressures coupled with reduced flexibility in the balance sheet.
From an investment perspective, corporate treasurers will move from risky asset classes to lower return but safer cash deposits, most of which have been guaranteed by central banks in Asia.
Raising capital to support their longer term growth will be another dilemma facing these corporate treasurers in the current environment. With current asset prices, any share issuance for raising capital would be undervalued, thus further diluting the stock price, whilst raising debt will be a challenge given current investor sentiments, except for highly-rated entities. As costly as it may be, leveraging longer term debt facilities may be the only option available to some of these firms.
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Never before has prudent risk management and capital controls been more important for banks, and Basel-II and its capital adequacy mantras have a greater role. Banks are pricing counterparty risk higher, raising liability balances and keeping an eye on their loan asset portfolios for signs of stress. The temptation for banks might be to charge an excessive premium for risk. But this opportunistic gamble would be myopic. In times such as this, it is critical to go ‘back to basics’ of relationship pricing and working with the industry to help tide over the current economic turmoil. The relationships built during this period will be the most valuable during the boom cycle that will follow the current period.
The slowdown in export orders and protracted US economic slowdown has started to finally hit the order books of Asian exporters.
Cash management revenues, on the other hand, have taken a tumble as float revenues drop with the falling interest rates. There will be increasing interest margin compression in the short term as banks vie with each other to attract USD liabilities.
Banks will have to look at consolidating their corporate client portfolios and balance their risk-based revenues (trade finance, loans) with non-credit-based aspects of their client business e.g. cash management operating accounts and liabilities. In other words, deepening relationships with existing clients, whilst keeping an eye on their capital ratios, will be the theme in the current environment rather than new client acquisition.
On the retail side, with the projected increase in unemployment and dampening property prices, banks will need to watch their retail mortgage and credit card portfolios. This will be especially true for the un-secured lending portfolios such as credit cards versus collateral-backed mortgages even though the start of the crisis was with mortgage defaults.
The markets are in turmoil. While the initiatives by the various central banks and governments have provided some measure of stability, no-one can tell when a return to normality will take place. In the short term, the only certainty is more uncertainty.
Corporates and banks will be ever more prudent in reviewing their assets and risk within their portfolios. Layoffs will be inevitable in the finance, property and manufacturing sectors as demand slows and companies strengthen their balance sheet. This will prompt most central banks to increase money supply, by making cheaper credit available, by reducing borrowing rates.
As the market eventually starts its recovery, hopefully sooner than later, there will indeed be a new “old” challenge to face – that of low interest rates, inflation, ample liquidity for investment and, presumably, renewed investor sentiment and vigour. As this recovery begins, and hopefully commodity prices remain stable, companies start re-hiring and central banks start tightening money supply, we will then re-enter a contained bull cycle, one that we hope will continue for a long time.
References:
http://www.contrarianprofits.com/articles/asian-exports-continue-to-surge-despite-us-slowdown/2371
http://www.property-report.com/em_top_stories.php?id=2002&date=281008
http://www.iesingapore.gov.sg
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