Limited Direct Impact on Asia-Pacific Banks from Subprime Exposure
Fitch Ratings (August 22, 2007)
Fitch Ratings-Hong Kong/Singapore-22 August 2007: Fitch Ratings has reviewed the exposures of most of its rated Asia-Pacific banks to US subprime-backed structured securities and found that direct exposures are low, generally amounting to just a few percent of the investing bank's equity capital.
"Losses on such investments will put a dent in annual earnings but do not pose a systemic risk as they are not a serious threat to the soundness of the banks we have surveyed," commented David Marshall, Managing Director and Head of Fitch's Financial Institutions Group in Asia-Pacific. "Banks in Japan and Australia also sponsor and provide liquidity facilities to conduits but in Fitch's view, the key issue here is the need for them to provide liquidity, rather than adding materially to their subprime exposures," he added. Fitch expects the banks to be able to meet these commitments given the modest size of the conduits relative to the banks' own balance sheets.
Fitch notes that subprime exposures are threatened by both mark to market valuation losses and real, economic losses. Mark to market losses will reflect the sudden drop in market values for these securities, to the extent these can be reliably identified; such charges could be increased or reversed depending on the ultimate level of economic losses on the underlying securities. The extent of these economic losses is not yet clear: 'AAA' and 'AA' rated securities are unlikely to incur losses but those at the lower end of the investment grade spectrum and below are likely to see significant losses.
Given the volatility in credit markets, Fitch acknowledges that there are risks to Asian banks beyond their subprime exposures. They may have to book accounting losses on marking to market other structured products, whose market values may be depressed by poor market sentiment and low liquidity. However, if they continue to hold the securities, these accounting losses should eventually be reversed and the banks should incur significant economic losses only if there is a material change in the default and loss rates on asset classes, other than on securities backed by US subprime mortgage exposures (in particular the more problematic 2006 vintage).
Australia: The banks have published few details but from our discussions with the Australian banks we rate, their potential exposure to the US subprime mortgage market through investments in structured credit instruments such as asset-backed securities (ABS) and collateralised debt obligations (CDOs), are limited, and any subprime element very small. Most of their holdings are of higher rated tranches ('AAA' and 'AA').
Similarly, their exposure through asset-backed commercial paper (ABCP) conduit programmes appears limited, although some banks do provide liquidity back-up facilities for these programmes. The larger banks have sponsored and/or provided liquidity back-up facilities to conduits and could be called up to provide liquidity. We understand that the banks are making preparations in case they are called on to meet these commitments.
While Fitch believes that exposure to the US subprime mortgage market will not produce significant losses for the Australian banks, market conditions for credit have tightened in recent weeks. Australian banks are typically reliant on wholesale funding for a large part of their total funding requirements. The cost of accessing the wholesale market has also increased. If prolonged, the current liquidity crunch could impact the ability of Australian banks to do business through higher funding costs and, potentially, result in difficulty refinancing debt as it matures, particularly commercial paper. The latter is likely to be more of an issue for the smaller institutions; however Fitch has not seen anything to indicate this has occurred substantially in the banking sector thus far and the underlying condition of banks is good, thanks to the buoyant Australian economy .
Japan: The larger banks have disclosed the following information:
* Sumitomo Mitsui Financial Group (SMFG) sold the bulk of its holdings exposed to US subprime mortgages earlier this year, realising a loss of several billion yen. It currently has about JPY100bn (<2% of equity) remaining, mostly in 'AAA' rated securities, but also including some junior tranches.
* Mitsubishi UFJ Financial Group (MUFJ) has YPY280bn in investments with US subprime exposure (3% of equity).
* Mizuho Financial Group has stated that it sold almost all of its US RMBS-related securities in recent months and currently has minimal exposure.
* Aozora has disclosed that its CDO holdings of around JPY50bn include JPY21bn of subprime related CDOs (<3% of equity) and that it has booked losses of around JPY5bn to date mainly reflecting market value declines. Aozora states that its sizeable hedge fund investments are not significantly exposed to the US subprime problem and have continued to perform well.
* Shinsei has disclosed its total exposure to the US residential mortgage market of under USD500 mln (6% of equity); about half is in residential mortgage-backed securities (RMBS), of which the subprime component is "negligible" and half are rated 'AAA'.
* Sumitomo Trust has disclosed JPY26bn (<2% of equity) of investments that may have a US subprime element and Chuo-Mitsui JPY35 bn (<4% of equity). Resona has said that it has none.
In the case of all these banks, any likely losses would be comfortably absorbed by a portion of the bank's annual earnings and none should see its solvency threatened from this factor alone, as the exposures are only a small fraction of the banks' equity. Fitch notes that there are other banking institutions in Japan with overseas investments that may include US mortgage-backed securities but as yet we do not have detailed information from all such institutions, which include regional banks, shinkin and agricultural co-operatives. Fitch will issue further comments as more data becomes available.
The large Japanese banks have sponsored and provided liquidity commitments to a number of conduits; to fulfill these commitments they may need to raise liquidity in yen and dollars, although these banks are unlikely to encounter difficulties raising the necessary liquidity, given the limited size of these commitments versus their balance sheets (up to 5%).
Among the securities firms, Nomura has disclosed end-June 2007 holdings of JPY266bn of RMBS, of which JPY71bn included subprime mortgages. This latter figure is about 8% of Nomura's equity. In the quarter to June 30th, Nomura posted a loss of JPY31bn which included the effects of selling and marking to market RMBS investments that had been a more substantial JPY658bn as of March 31st. Daiwa Securities has stated that it has no such exposures and Nikko Cordial that it has not incurred any losses.
Singapore: The Singaporean banks have been the most transparent in Asia:
*Development Bank of Singapore (DBS) has disclosed US$850 million of CDO/collateralised loan obligation (CLO) exposures including those with ABS exposure of US$188m. This latter amount - not all of which is subprime-related and is rated A or above - amounts to about 1.5% of DBS Group's equity.
*Overseas-Chinese Banking Corporation (OCBC) has disclosed US$430m of CDO holdings, all rated investment grade, including US$181m with ABS exposure. This latter figure is about 2% of OCBC's group equity.
*United Overseas Bank's (UOB's) figures are USD260m and US$60m, i.e. 0.5% of its equity.
The overall CDO exposure of the Singaporean banks of around US$1.5 bln could potentially give rise to losses that would dent annual earnings but would not materially weaken the banks' capital.
Thailand: Siam Commercial Bank (SCB) and Kasikornbank (KBank) reported no exposures to CDOs, while Bangkok Bank (BBL), Krung Thai Bank (KTB) and Bank of Ayudhya (BAY) reported some exposure, mostly to higher rated tranches ('A' and above). The level of exposure ranges up to 6% of equity so that a loss on the portfolio could impact annual earnings but should not threaten solvency. BankThai has more substantial CDO investments including THB1.7bn of US subprime-related (21% of equity) against which it has already taken a THB0.3bn write-down.
Taiwan: According to FSC data, 16 Taiwanese banks have CDO exposures totaling TWD40bn i.e. about USD1.3bn. We do not have full details on their subprime exposures but even the total figure is just over 2% of the banks' aggregate equity. Mega ICBC Bank has the largest exposure of about TWD10bn (7% of equity).
Taiwan's Life insurers have been more active in pursuit of overseas investments due to their need for yield pickup to overcome their chronic negative spread issues. Nonetheless, data to date indicates a rather limited exposure to problematic subprime mortgage assets among life insurers, and most of the exposures are confined to highly rated portions in CDOs. In a worst-case scenario, losses related to subprime exposures are likely to be within 6% of equity even for the more aggressive investors among the life insurance companies.
Korea: Most Korean banks have very small exposures to CDOs with the exception of Woori which has total CDO and mortgage-backed securities (MBS) investments of KRW494bn (<5% of equity) including KRW147bn of subprime-related securities; however, the latter figure is only about 1% of the bank's equity. The exposures of other Korean banks are much lower and for most, the subprime exposure is negligible.
Hong Kong: Fitch's survey of most of the banks it covers in Hong Kong suggests negligible credit exposure to the US subprime mortgage crisis. No bank surveyed has direct credit exposure to US subprime mortgages through CDOs or asset backed paper. A number of these banks have reported small exposure to subprime securities through their investments in structured investment vehicles (SIV), although the SIV portfolios contain predominantly 'AAA' and 'AA' rated paper, and the banks do not expect any notable credit losses from their SIV portfolios. Among the local banks, Bank of East Asia has proportionately the largest holdings of CDOs (USD600m, i.e. 20% of equity) but states that these do not include any US subprime exposures.
China: Subprime-related losses may be material in dollar terms, but are not considered so when taken in relation to capital for most Chinese banks. The banks with the largest holdings of foreign securities are the Big 5 banks, among which only Bank of Communications thus far has provided any clarity regarding exposure, stating that it has no direct exposure to US mortgage-related securities, prime or subprime. Bank of China (BOC), Industrial & Commercial Bank of China (ICBC), and China Construction Bank (CCB) have stated that they will disclose exposure amounts during their release of interim financials this week and next. Of these three, BOC, with its more than USD130bn in foreign currency securities (as of end'06), is expected to be most exposed and its management has already admitted that millions of dollars of losses are anticipated. However, for a bank with an equity capital of USD54bn, the overall impact should be small.
CCB and ICBC, with total foreign currency securities holdings of USD42bn and USD28bn at end'06, respectively, are also likely to have some exposure, but strengthened earnings and the recent substantial capital raising by both banks should provide ample cushion to absorb any losses. The final of the Big 5 banks, Agricultural Bank of China (ABC), has stated that it does hold subprime-related MBS and CDOs, but has not publicly disclosed the exact amount. ABC's thin profits and equity base provide less cushion to absorb subprime losses, though at this point such losses appear relatively small.
China Merchants Bank, Shenzhen Development Bank, and Bank of Shanghai have stated they have no direct exposure to US subprime, but other smaller banks have revealed very little information regarding their portfolios. On the whole, the holdings of foreign securities at these banks are quite small, and any potential losses arising from subprime exposures are expected to be manageable.
Philippines: The Philippine central bank has stated that Philippine banks in aggregate hold USD180m of CDOs (about 2% of system equity), and Rizal Commercial Banking Corp (RCBC) has disclosed that it holds USD60m (16% of equity). However, we understand that all are backed by corporate debt and not by mortgages.
Malaysia: Maybank, Public Bank, CIMB, Hong Leong Bank, RHB and Affin have reported no direct exposures. Maybank holds investment papers (credit linked notes) issued by US financial institutions that may have subprime exposures but the amount is modest at USD60m (1%f equity).
Indonesia: The banks report no significant exposures. A few have small investments in commercial paper issued by ABCP conduits through their New York branches but the amounts are small at 0.2% of assets.
India: Indian banks have not disclosed details of subprime related investments. A few Indian banks with international activities may have some exposures but we would not expect these to be material relative to their capital, given that Indian banks have experienced strong demand for mortgage finance in their domestic market. Therefore they have not had to look overseas for investment opportunities, in contrast to financial institutions in Japan, Taiwan, Singapore and Hong Kong where weak economic conditions led them to look overseas for more attractive investment opportunities.
Contacts: David Marshall, Peter Tebbutt, Hong Kong, 852 2263 9963; Ambreesh Srivastava, Lai-Peng Tan, Singapore, +65 6336 6801; Reiko Toritani, Tokyo, +81 3288 2673; Akiko Kudo, Tokyo, +81 3288 2686; John Miles, Tim Roche, Brisbane, +617 3222 8600; Jonathan Lee, Taipei, +8862 2514 7164.
Media Relations: Lisa Lim, Singapore, Tel: +65 6238 7301; Chinatsu Ozaki, Tokyo, Tel: +813 3288 2679; Shivani Sundralingam, Singapore, Tel: + 65 6336 0095.
101 Finsbury Pavement, London, EC2A 1RS