Continued dives in major emerging market currencies including the Ringgit, Lira and Real continues. Of these three, all had investment grade ratings before Brazil’s was cut by Standard & Poor’s from BBB- to BB+. The first move on Brazil’s sovereign ratings could be indicative of cuts to other low investment grade ratings and even some higher ones. Of those watched by MENASEA investors at risk besides Turkey and Malaysia include China, South Africa, Indonesia Thailand, Saudi Arabia including Bahrain and Oman. The question to come is whether the market respond indicating the ratings contain new information or whether the loss of investment-grade ratings was already baked into credit markets.
Will Turkey’s Participation Banking industry sustain its growth momentum?
The participation banking industry in Turkey has shown reasonable growth in the past decade. Currently there are five players constituting the participation banking sector, with Ziraat being the fifth one which started its operations earlier this year as Turkey’s first state-owned participation bank. It is also the first window connected to a conventional bank. The share of participation banking in the banking sector rose from 2.4% in March 2006 to 5.5% as of this year (Total assets are currently worth $41.3 bn).
Although these banks have approximately 6% share of the total banking sector, it has a lot of potential to increase its share. Comparing participation sector with the Turkish banking sector as a whole we see that participation banks’ bank capital to asset ratio and the NPL ratios are slightly higher than the rest of the banks. This could be indicative of higher risk to a fall in asset prices which would make participation banks worse off than their conventional counterparts. Counteracting this theory are data on the sector showing most of the rise in NPLs is due to problems at Bank Asya which is not necessarily indicative of the sector as a whole due to the political struggle that engulfed it beginning in 2014. Given the political uncertainty surrounding the inconclusive election and planned second election scheduled for November 1 have dealt Turkey a set back for its economy, This could further constrain borrower’s ability to pay and lead to a rise in the current low level of NPL/gross loans ratio (2.8 % for banking sector as a whole). Currently the rate of non-performing loans (NPLs) is also low for participation banks at just 4.55% (weighted by total assets) but this number is significantly affected by Bank Asya. Excluding Asya, Turkey’s participation banks had just 2.28% NPL, lower than the banking system as a whole.
We further look at potential risks for the participation banking industry which may be an early warning indicator that participation industry may be at risk of not sustaining its growth. The coverage ratio, which is loan loss reserves divided by NPLs, shows a slight decline as compared to previous years, indicating that the participation banks have provisioned less for their bad debt and might not be in a position to take future loan losses without more adverse effect on their profitability. The rate of NPLs is low despite monetary policy remaining tight (rates have not risen despite a weakening economy) which would increase the short-term interest rate causing borrowers to face higher costs or more limited access to refinance their outstanding loans. Secondly, the banking sector’s heavy reliance on foreign exchange financing makes it more vulnerable to the continued weakness of the lira. FX risk is less acute for participation banks who have been issuing more lira denominated sukuk as well as not having as much foreign exchange denominated financing.
However, they are not insulated either as banking sector weakness caused by the 21% depreciation in the lira year-to-date would spill over into the real economy. Many of their customers may also have foreign-exchange denominated conventional loans that may pressure their ability to repay even lira-denominated loans. This affects their overall risk exposure indirectly if not directly but, in contrast to earlier periods of political uncertainty, Turkish banks (both conventional and participation bank) are better capitalized to absorb a shocks. They may take a hit on their profitability driven by increasing provisioning and write-offs of bad debts if the political and economic situation spirals into crisis.
Differences Can Be Deceiving
By Kurt Lieberman, CEO, Magni Global
When analysts and investors assess investment opportunities, they frequently look for numbers and other information that compare the opportunities and identify the differences. The resulting insights become the basis for estimating future valuations and hence potential investment performance of the opportunities. Perhaps surprisingly, these “apparent” differences can be less important than unseen similarities. By understanding the unseen, analysts and investors can make better investment decisions, particularly when investing in international equities.
A comparison of Malaysia and Singapore provides an interesting example of such an approach. From many perspectives the countries are different. Malaysia is a much larger, while Singapore has a much higher per capita GDP. Malaysia is mostly Muslim, while Singapore contains many religions. For investors, Malaysia is part of the emerging markets, while Singapore is part of the developed markets.
Despite the many differences, over an extended period the two countries have performed relatively similarly (see chart on the right). Performance over shorter periods are frequently impacted by various “crosswinds” with countries tending to revert to underlying value over the longer term.
The similarity in long-term performance could be explained by non-traditional factors that have been shown in whitepapers and other articles to be drivers of portfolio performance. Multiple studies have shown the importance of governance in equity portfolios. Yet, governance is tough to measure at a company level given varying reporting requirements and a lack of standard frameworks to assess company-supplied governance information. Since companies tend to follow the legal, regulatory, and reporting requirements of the country where they are listed, governance can and should be measured at a country level. The legal, regulatory, and economic infrastructure of countries is usually unseen by traditional investment analysis and, similar to an iceberg, forms the important investment information below the surface. From this perspective, Malaysia and Singapore have relatively similar corporate governance environments.
Magni has developed a process for researching and assessing the legal, regulatory, and economic infrastructures of countries. The process uses Magni’s Sustainable Wealth Creation (SWC) principles which are based on well-accepted economic concepts. Countries who receive high scores according to the SWC are required to have more than strong intent and/or rules; there must be evidence that the companies within the country adopt the intended behavior. SWC address three very important questions.
- Do financial statements accurately reflect a company’s position?
- Do shareholders have protections and adequate controls?
- Can company leadership make decisions confidently?
To convert principles into an objective, repeatable process, SWC is divided into twelve Economic Standards. The Economic Standards are further divided into 280 Qualitative Sovereign Factors. Countries are scored based on their declared intentions plus their actual level of adherence.
Currently Singapore ranks 27th among the 46 countries in the combination of the developed markets and the emerging markets. Malaysia ranks 32nd. Singapore is one of the lower ranked countries in the developed markets, while Malaysia ranks ahead of more than half of the countries in the emerging markets. While both have improved their absolute scores over the years, Singapore has maintained a modestly higher score for the entire period. Singapore’s somewhat higher ranking is driven by better integrity in their markets, better regulation of financial services, and slightly better laws and regulations related to legal entities and shareholder property rights. Even though Malaysia is part of the emerging markets, it has some advantages over its neighbor in the developed markets, including better transparency regarding government policies and better operation of its payment systems.
Malaysia is one of a couple of countries in the emerging markets who have an environment for corporate governance that rivals some countries in the developed markets. More important than their market classification and more important than their financial or demographic statistics, the key to understanding a country is its legal, regulatory, and economic infrastructure.
Recently the emerging markets have been hit hard. The recent rapid decline in Chinese equity markets has led to concerns about all countries in the emerging markets (e.g., some sort of contagion). By assessing the less visible information found under the waterline, countries can be compared and such a process can help determine which countries are better positioned following the current Chinese-induced dislocation.
Magni analysis is based on the premise that Countries Matter™ based on what is “below the waterline”. They have made a white paper titled “Country Selection – An Important Addition to Responsible Investing” available for download at www.magniglobal.com