ASEAN banks' bad debt woes set to push valuations even lower

* Investors cautious on ASEAN banks as bad debts climb

* Rising NPLs, credit costs weigh on returns, valuations

* NPLs still below alarming levels, banks' coverage ratios healthy

By Nichola Saminather

SINGAPORE, Nov 26 (Reuters) - Stocks of Southeast Asian banks are at their lowest valuations since the global financial crisis, but analysts don't expect investors to jump back in for some time, fearing a further increase in non-performing loans (NPLs).

Most investors expect bad loans will continue to rise through the first half of next year as regional economies struggle, weighed down by weak export demand, falling commodity prices and China's slowdown.

That is pressuring returns and valuations, which are at six-year lows in Indonesia, Thailand, Malaysia and Singapore.

"We haven't seen the worst in banks' earnings yet in ASEAN, said Kum Soek Ching, head of Southeast Asia research at Credit Suisse Private Banking and Wealth Management in Singapore.

"Non-performing loans are a reflection of the growth and cashflow challenges that corporations are going through."

Shares of Thai, Malaysian and Singaporean banks have all underperformed their broader country benchmarks. Indonesian lenders were the exception, thanks to a raft of fiscal reforms announced in September.

Five of the 10 worst performers in October in Invesco's ASEAN fund were banks, including Malayan Bank, Bank Rakyat Indonesia and Singapore's Oversea-China Banking Corp.

The top 10 holdings of United Overseas Bank Asset Management's Asian financials fund included only two Southeast Asian banks as of Oct. 31, Singapore-based DBS Holdings and UOB.

"We have a cautious view on ASEAN banks due to the overall economic slowdown in the region," said Jolene Seetoh, director for Asia ex-Japan equities at the firm in Singapore.

"While credit costs may remain high as ASEAN banks continue to set aside higher provisions and restructure their loans, they should peak next year and gradually decline as economic growth stabilises," she said.

When "stressed" credit costs peak they could drive returns on equity lower and shrink price-to-book ratios by as much as 26 percent, making that the time to buy, Citi analyst Robert Kong wrote in a Nov. 11 report.

BAD DEBT CHALLENGES

To be sure, sour loans are still well below alarming levels with Malaysia's NPL ratio at 1.6 percent, Indonesia's at 2.4 percent, and Thailand's at 2.78 percent, according to AmResearch, PT Bahana and central bank data. Investors expect them to peak below 4 percent across the region.

However, many banks are also seeing more delinquent and restructured loans that could become bad debts.

A surge in provisions by Indonesian lenders this year linked to the troubled mining sector led to the first combined profit decline in almost a decade for its 10 biggest banks.

PT Bank Mandiri, the nation's largest lender by assets, is trading at 1.6 times forward book value, a 28 percent discount to its five-year median, according to Starmine. PT Bank Negara Indonesia, is at 1.4, a 16 percent discount.

Two of Thailand's three biggest lenders, Krung Thai Bank and Siam Commercial Bank, saw third-quarter profits plunge after NPLs surged, largely in connection with one steelmaker. Krung Thai is at 0.9 times forward book value, 28 percent below its five-year median, and Siam is at 1.3, a 32 percent discount.

In Malaysia, banks have recorded five straight months of impaired-loan increases, according to an AmResearch report.

Their loan loss cover was at 98.1 percent in September, indicating that not all newly impaired loans are provided for, analyst Rachel Huang wrote in the report.

Malaysian banks are "most at risk of earnings disappointment," Credit Suisse's Kum said.

Despite rising NPL ratios, particularly at OCBC and UOB, which are more exposed to the Malaysian and Indonesian resources sectors than rival DBS, Singaporean banks are among the region's most defensive, thanks to stronger balance sheets, Kum said.

(Reporting By Nichola Saminather; Editing by Nachum Kaplan & Kim Coghill)