Are the local banks sufficiently diversified to withstand the unrest in Hong Kong? Will they still be profitable and pay dividends?

SINGAPORE (Nov 18): The local banks — the mainstay in most institutional and retail portfolios because of their profitability and dividends — are warning of a challenging 2020. Macroeconomic variables based on the banks’ expected credit loss (ECL) models are indicating that higher provisions need to be made, impacting net profit.

In a month when bank chiefs were cautiously optimistic, the event risk came from an unexpected source. A video was being circulated of what looked like a DBS Bank branch burning in Hong Kong. A DBS Group Holdings spokeswoman pointed out that it was the China Mobile shop next to a DBS HK branch that was on fire. On Nov 13, Oversea-Chinese Banking Corp (OCBC) announced that some of its branches in Hong Kong were closed because the protests had disrupted traffic and staff could not get to work or return home. On Nov 14, A DBS branch was vandalised in Hong Kong.

Whatever the case, the three incidents brought home the seriousness of the Hong Kong protests, and their impact on our local banks. Are they sufficiently diversified to withstand the unrest in Hong Kong? Will the banks continue to accumulate capital — which is a result of putting aside some net profit — and pay dividends? Or will allowances and provisions for souring loans pare earnings?

For now, all three banks — DBS, OCBC and United Overseas Bank — continue to report substantial net profits — of $1.629 billion, $1.172 billion and $1.118 billion respectively (see Table 1). With such levels of net profit, the banks will continue to accumulate capital as a result of retained earnings, and will be able to maintain their dividends despite lower levels of Asian and global economic growth. Credit costs are being watched closely by the trio. If allowances for souring loans rise too quickly, they could impact earnings. And if the outlook turns decisively negative, the rating agencies could downgrade the banks, which would impact their funding costs.


The immediate concern is Hong Kong, where the protests are in their fifth month. Both DBS and OCBC have significant operations in the former crown colony.

Samuel Tsien, CEO of OCBC, who spent his formative years in Hong Kong, said during a recent results briefing: “In the medium term, it depends on how long the event is going to last, and if it has ended, we still believe it’s an event risk.” He was referring to the protests in Hong Kong, in the context of whether OCBC had taken sufficient allowances just in case the protests affect business.

OCBC Wing Hang, acquired in 2014, ia a full bank that provides commercial and consumer banking products and services and other financial services such as consumer financing, share brokerage and insurance, among others. It has a network of over 90 branches and offices in Hong Kong, Macau and mainland China. For the nine months to Sept 30, OCBC Wing Hang contributed 9% to group operating profit. Greater China’s contribution was much higher, at 20% of group core profit before tax. For the nine months to Sept 30, OCBC reported a PBT of $4.427 billion.

“At the time of the acquisition of Wing Hang Bank, we had said it’s not for Hong Kong’s domestic market. It is for Hong Kong as a flow centre for the Greater Bay Area and Southeast Asia. We will continue to pursue those opportunities, and in the medium term, our confidence in GBA’s being a promising region for OCBC and Asean continues to be there,” Tsien explained. He acknowledged that the reduction in investment, retail sales, F&B spending and tourism would impact economic growth. “We do internal stress testing all the time to make sure our portfolio is able to withstand stress, and [our] stress testing is [for a] significantly higher drop than we have seen in property values, tourism and retail sales,” Tsien said.

OCBC’s loan growth in Hong Kong dipped q-o-q in 3QFY2019, and for the nine months to Sept 30, it is down compared with the same period last year. “Our market share in Hong Kong is still quite small. We believe there are quality loans worth pursuing, but in the general market, we are reserved,” Tsien cautioned.

Piyush Gupta, CEO of DBS, also sees Hong Kong as a springboard into GBA. “We think opportunities in Hong Kong — as the Hong Kong strategy integrates with GBA to drive growth — will remain,” he said during a recent results briefing. “The uncertainty in Hong Kong is Chinese travellers into Hong Kong. If that trickles to a halt, that will be a headwind because it impacts a lot of things, including credit card spend.”

Profitable 3Q earnings despite higher allowances

For the nine months to Sept 30, OCBC Wing Hang reported a 5% y-o-y growth in net profit to HK$1.73 billion ($301.05 million), while 3Q net profit rose 11% y-o-y to HK$590 million. For this year at least, OCBC Wing Hang’s net profit has grown faster than the OCBC group’s net profit. For the nine months to Sept 30, OCBC’s net profit rose 2% y-o-y to $3.627 billion while in 3QFY2019, net profit fell 6% y-o-y and 4% q-o-q to $1.172 billion, because of a one-time charge taken for Bank OCBC NISP, OCBC’s Indonesian subsidiary.

DBS has an even more substantial business in Hong Kong than OCBC. DBS Hong Kong contributed $1.089 billion, or 22% to DBS’s net profit of $4.883 billion, for the nine months to Sept 30. DBS HK’s net profit rose 5.4% y-o-y, while the DBS group’s net profit rose 13.3% y-o-y. For 3QFY2019, DBS’s net profit increased 15% y-o-y to $1.629 billion, with allowances up just 8% y-o-y. DBS HK’s net profit rose 12% y-o-y to $334 million in 3Q. The growth would have been higher, but allowances for Hong Kong more than doubled to $59 million.

For the quarter, DBS reported a 17% y-o-y rise in fee income — from businesses such as wealth management, brokerage and investment banking — to a new quarterly high of $814 million. Other non-interest income, such as trading income, surged 35% y-o-y to $549 million.

While UOB’s non-interest income in 3Q rose 14% y-o-y to $551 million, and other non-interest income such as treasury customer flows and investment income jumped 52% y-o-y to $371 million, allowances allowances for impaired loans surged 53% y-o-y to $145 million. This translated into a total credit cost of 23 basis points (bps). Part of the reason is because of loan growth. UOB’s loans grew 8% y-o-y and 1% q-o-q to $275 billion as at Sept 30.

The accounting standard followed by the local banks, Singapore Financial Reporting Standard (International) 9, is very sensitive to the macro environment and must capture what banks are expecting over the next few months, which is likely to be subdued economic indicators such as GDP growth, which translate into higher ECL (stage 1 and 2, previously known as general provisioning).

The big surprise in allowances and provisioning was from OCBC, where allowances rose 252% y-o-y in 3Q, to $179 million, translating into total credit costs of 24bps.

OCBC takes pre-emptive action

OCBC recorded new non-performing assets of $683 million in 3Q, while DBS’s new NPA was $367 million and UOB’s was $180 million.

“OCBC’s Tsien says: Our NPL ratio was up 11bps to 1.6% because of two corporate accounts — one in the offshore support vessel sector, and one in the transport sector. We believe by taking these actions, we will be able to reflect the current operating environment; we continue to be in a strong position to move forward.”

In addition, OCBC took additional provisions in 3Q for non-impaired loans in Indonesia, which amounted to $91 million on a net basis, in preparation for the country’s move to the IFRS 9, the international equivalent of SFRS 9.

When asked, a UOB spokeswoman says UOB took action in provisioning at the group level for subsidiaries that might not have had to transition to IFRS 9 in FY2018. These included those in Indonesia and Thailand.

Similarly, DBS’s chief financial officer Chng Sok Hui says the bank had transitioned to IFRS 9 in 2018. “When we implemented IFRS 9, it was a group-wide standard, and it didn’t matter which country goes on to IFRS 9 next year. When the Indonesian subsidiary moves to IFRS 9 on Jan 1, 2020, that will have already been catered for,” Chng says.

Single-digit growth next year

The banks’ growth plans centre around their ongoing digital transformations. According to Gupta, DBS’s digital bank, digibank, was recently launched in Hong Kong and targeted the affluent market. “We are relatively upbeat about digibank in Hong Kong,” he says.

When asked if he planned to acquire Bank Permata in Indonesia, Gupta declined to answer. However he outlined what DBS looks for in an acquisition. First off, it must not distract the bank and its management from its focus. “Our key agenda is digital transformation and organic growth. Anything that distracts us from that, we will not be interested,” Gupta says. Hence, in size, it should be no more than 5% of DBS’s market cap. Of course, the acquisition needs to make strategic sense in terms of DBS’s growing the lines of businesses, and must be accretive in a reasonable period of time.

Tsien says Indonesia is an important market. “Bank OCBC NISP’s market share five years ago was 1.7% and now it’s 2.3%. We do have expectations that earnings from Indonesia as a percentage of group earnings will continue to expand.”

He expects low single-digit loan growth in 2020, along with the narrower net interest margin that OCBC has achieved this year. For the first nine months, NIM averaged 1.77%. “We believe NIM will gradually come down if interest rates come down. We are not only talking about US interest rates, we are also talking about regional interest rates,” Tsien says. Indonesia’s lending rates have been reduced three times in the past four months, and Malaysia has also reduced its board rate once in 3Q.

“A lower interest rate environment is to encourage demand for loans. We hold quite a bit of operating balances [loans], so we will not be able to earn as much as before,” Tsien cautions.

UOB guided for mid-single-digit loan growth in 2020, NIM that is 5 to 10bps lower than the 1.79% achieved year to date and credit costs in the range of 20 to 25bps.

DBS is guiding for low single-digit loan growth, NIM that is around 7bps lower than the 1.9% achieved this year and credit costs at 21bps. Gupta says DBS should be able to achieve 4% growth in income and net profit in 2020.

All in all, given the environmental headwinds, UOB and OCBC should still be able to clock more than $1 billion in earnings a quarter, and DBS is likely to report almost $1.7 billion a quarter, leaving them room to keep dividends flowing and underpinning book values and share prices (see Table 2).