Like the deep roots of a mighty oak amid a ferocious storm, the strong capital reserves of Singapore’s banks should stabilise their credit position despite a harrowing 2Q20. PhillipCapital research analyst Tay Wee Kuang has therefore maintained his “neutral” call on the Singapore banking sector. Recovery in business, he says, will benefit non-interest income as banks are likely to be past troughs in income levels. 

Local banks reported sharp declines in net interest margin (NIM) in 2Q20 with double digit declines in base points across the board y-o-y. The quarterly average NIM of 1.57% across all banks is approximately 10 base points than the previous quarterly low of 1.65% in 2013 despite similar interest rates. 

“The sharp decline was exacerbated by huge deposit inflows experienced during the quarter as well as a lagged repricing of deposits. As such, we are expecting NIM to recover slightly in subsequent quarters with repricing in deposits and liquidity outflow,” writes Tay in a broker’s report issued on August 24. 

UOB saw the sharpest NIM drop, falling 33 base points from 1.71 in 1Q2020 to 1.48 in 2Q2020. On the other hand, OCBC saw its NIM fall the least. It lost 19 base points from 1.76 in 1Q2020 to 1.6 in 2Q2020. 

On the bright side, August has seen lending rates stabilising, potentially easing some of the downward pressures on NIMs going forward. While the 3-month SIBOR (Singapore interbank offered rate) fell 10 base points below 1H20 lows to 0.41% from 0.53%, it has recovered from a low of 0.15% in 1H20 to 0.21% currently. These are comparable to quarterly lows observed in 2013, where 3-month SIBOR stood at 0.37%. 

Unfortunately, loan growths turned negative in June for the first time since 2016, with a 0.98% reduction y-o-y. Consumer loans fell sharply by 3.44% y-o-y as Singapore exits from the circuit breaker measures in April and May. While there was weakness across the board, credit card loans are slowly recovering, growing by 2.9% m-o-m. 

Business loans, on the other hand, fell by 0.55% y-o-y. This was due to a fall in loans across key industries such as general commerce (-6.2% y-o-y), financial institutions (-2.5%) and professional & private individuals (-9.6%).  This offset growth in manufacturing (+1.2%), transport, storage & communication (+7.2%) and business services (+23.8%).

But well-aware of the coming Covid-19 storm, Singapore’s banks are acting early to build up their allowances and reserves in anticipation of deteriorating asset quality. 1Q20 has seen banks provide guidance for credit costs between 80 to 130 base points, which will be spread over two years. The banks have maintained this credit cost guidance and have built up reserves between 20 to 45% of their guided credit costs. 

“Book-building seems well underway for DBS and OCBC, as increase in reserves in 1H20 represents at least 25% of total expected allowances to be booked over the next two years in the worst-case scenario where credit costs hit 130 base points,” remarks Tay. 

UOB’s seemingly lower reserve increment of $709 million was due to lower specific provisions (SP) recognised in 1H2020. Its GP increment of $671 million in 1H20 is comparable to DBS and OCBC. “Prudent reserves by the banks continue to put them in a good position to weather the economic impact as a result of the pandemic,” Tay writes. 

Banks will cheer, however, improved derivative performance and double-digit SDAV growth y-o-y in July. SDAV saw a 15% y-o-y improvement in July to $1.21 billion while August-to-date data reflects a 24% y-o-y improvement, putting SGX on a strong footing for the new financial year. 

DDAV rebounded in July as well to 1.05 million contracts, a 27% increment y-o-y. This is in contrast to 4Q20, which saw an average DDAV of 0.89 million contracts -- 18% less y-o-y. SGX’s FTSE Taiwan Index Futures contract debuted in July to more than 80,000 contracts in less than 10 trading days in July.

“SGX will be rolling out a suite of equity derivative products with FTSE that will replace expiring MSCI products. We believe that SGX will see a muted impact from the MSCIcontract cessation  with the FTSE replacements, which should see faster uptake as compared to new product launches by SGX previously,” Tay comments. 

But it may take a while for these green shoots to translate into dividends, as MAS has called on banks to cap dividends for the next four quarters at 60% of their respective FY19 amount. The move was intended to shore up capital reserves and ensure that sufficient funds are available to assist the economy through lending. 

Based on 1H2020 figures, savings from a dividend cut will reduce the impact on CET-1 levels of the respective banks by 0.2% for UOB to 0.4% for DBS and OCBC. Shareholders of DBS, UOB and OCBC will, unfortunately, have to make do with no more than $0.72, $0.78 and $0.318 per share respectively, lowering yields between 3-4%. Fortunately, banks will be required to implement a scrip dividend option for the next year, with OCBC the only local bank offering a discount of 10% on scrip shares. 

As of 3.15pm, DBS is trading 0.29 points up at $21.08 with a price-to-earnings (P/E) ratio of 9.85 and a 6.93% dividend yield. OCBC is trading 0.16 points up at $8.77 with a P/E ratio of 10.16 and a 3.69% dividend yield. UOB is trading 0.27 points up at $20.11 with a P/E ratio of 9.37 at a 4.74% dividend yield.