SINGAPORE (April 30): When Hin Leong Trading filed for court protection on April 17, it emerged, in affidavits by its owner Lim Oon Kuin and his son Lim Chee Meng, that the local oil trader owed 23 banks a total of US$3.85 billion ($5.45 billion).
The largest exposure was to HSBC Holdings which announced on April 28 that its expected credit loss (ECL) of US$3.0 billion in 1QFY2020, US$2.4 billion higher than in 1QFY2019. This was mainly due to charges relating to the global impact of the Covid-19 pandemic as well as weakening oil prices on the forward economic outlook.“ECL in 1QFY2020 included a significant charge related to a corporate exposure in Singapore, which was the primary driver of the US$0.7 billion increase in ECL in [commercial banking] in Asia,” says the banking group.
The affidavits by the Lims indicate that bank claims were secured partly by oil inventory but the senior Lim had sold the inventory.HSBC’s announcement may lead the way for local banks to follow its example and charge the losses to specific provisions. The largest exposure among the local banks is DBS Group Holdings with US$290 million.
Interestingly, HSBC CFO Ewen Stephenson explained that the bank’s ECL macroeconomic model has changed a lot since end-December 2019 and these new models are likely to impact the provisioning levels of the local banks as well as the migration to higher risk weights for their risk-weighted assets as a result of a deterioration in the outlook.
Covid-19 causes higher provisioning
Indeed, the Covid-19 pandemic has caused a swift deterioration in the global economy. Hence, HSBC is considering three scenarios — mild, moderate and severe — in its ECL macroeconomic model where ECL for this year could range from US$7 billion to as high as US$11 billion.
In the mild scenario, Hong Kong’s GDP growth could recover by 3QFY2020, while the US and UK could record positive GDP by 1Q2021.
In the moderate scenario, the recession is deeper. Hong Kong GDP growth turns positive in 4Q2020, while UK and US GDP growth turn positive in 1QFY2021, but they reach their low points later this year.In the severe scenario, GDP growth of all three markets turns positive only in 2Q2021.
HSBC has guided that if the ECL were estimated solely on the basis of the severe scenario as at March 31, 2020, which assumes a slower economic recovery, the allowance for ECL would increase by approximately US$4 billion. HSBC’s US$3 billion of ECL in 1QFY2020 translates into credit costs of 118bps of gross loans, and is several times higher than its credit costs of 28bps for 4QFY2019 and 24bps in 1QFY2019.The ECL system is pro-cyclical. When economic conditions deteriorate, banks’ earnings are likely to be negatively impacted because ECLs are likely to rise.
In addition, deterioration in the credit outlook for banks’ customers will cause a “ratings migration” upwards for RWA. HSBC says its RWA rose by US$13.7 billion as at March 31, 2020, compared to Dec 31, 2019. “Changes in asset quality led to an RWA increase of US$4.3 billion... These changes included credit rating downgrades caused by the Covid-19 outbreak, mostly in North America and Asia,” says HSBC.
Singapore economy to contract this year
On April 28, the Monetary Authority of Singa-pore said in its Macroeconomic Review that the Singapore economy is expected to con-tract this year, and Singapore’s GDP growth is projected at –4% to –1%.
While the Singapore government has announced forbearance measures in the form of more the $64 billion worth of stimulus and passed a Temporary Measures Bill, the economic contraction is likely to cause the local banks’ ECL models to raise provisioning, and subsequently raise RWA levels which could impact common equity tier 1 (CET1) ratios.
HSBC’s CET1 ratio of 14.6% as at March 31, 2020, was down just marginally from Dec 31, 2019, helped by a US$1.2 billion rise in CET1 capital. The cancellation of the 4QFY2019 unpaid dividend of US$3.4 billion and capital generation of US$1.9 billion through profits helped to keep CET1 ratio stable. Previously HSBC had guided to maintain a minimum CET1 ratio of 14%.
“We can imagine scenarios where CET1 ratio will fall below 14% as we progress through the pro-cyclical impact of IFRS 9 on credit cost and RWA,” says HSBC CEO Noel Quinn. However, he adds that UK regulators would prefer banks to lend to support the local economy.
Halting job losses
Quinn also says HSBC would halt parts of its transformation plan, “I take the well-being of our people very seriously. We have therefore paused the vast majority of redundancies related to the transformation we announced in February to reduce the uncertainty they are facing at this difficult time. We continue to press forward with the other areas of our transformation with the aim of delivering a stronger and leaner business that is better equipped to help our customers prosper in the recovery still to come.”In February this year, HSBC had announced it planned to cut 35,000 jobs as part of its transformation plan.
“We think this is the right thing to do, to pause this. We want our people to be 100% serving customers and not be fearful of a redundancy. The foregone savings would be US$380 million and we think we can mitigate this by cost savings elsewhere that are not people related. We’ve guided total cost base for 2020 will be lower than 2019.”
In 1QFY2020, HSBC reported profit after tax of US$2.5 billion, down 49% y-o-y while total revenue declined just 5% y-o-y to US$13.7 billion. “While global performance in the first two months delivered good results, the global impact of the Covid-19 out-break and weakening oil prices had a significant adverse impact on performance in March,” Quinn says. Nevertheless, HSBC is prepared for a range of economic scenarios.
“Our job is to position the bank to manage a variety of different outcomes from Covid-19. We are modelling different scenarios and we’re prepared for each of them. We are confident we can handle this. Our job is to be prepared for all,” says Quinn of the three economic models in HSBC’s ECL modelling, mild, moderate and severe.
“We’ve been impressed with the pace that governments in Hong Kong, China, UK and US have put in support schemes and [these] are very material. We are positive on them and factor them in our scenarios to provide mitigations,” Quinn adds.
Among the Singapore banks, DBS will be the first to report 1QFY2020 results on April 30. It is likely that, although Hin Leong Trading had asked for court protection on April 17, the local banks will provision for their losses in their 1QFY2020 earnings. Based on a Bloomberg poll, analysts expect DBS to report $1.138 billion in net prof-it in 1QFY2020, compared to $1.508 billion in 4QFY2019, and $1.651 billion in 1QFY2019. For the quarter to Dec 31, DBS’s credit costs for specific allowances was 21bps and its CET1 ratio was 14.1%.