SINGAPORE (Feb 4): Singapore banks have delivered and are likely to continue to deliver both yield and growth to investors. Analysts are expecting the banks to continue to experience slow and steady growth this year and into 2020, global financial crises notwithstanding.
In a recent interview with The Edge Singapore, Harsh Modi, banking analyst at JPMorgan for Southeast Asia, indicated that Singapore banks stood out as the most visible in terms of margins and loan growth.
“We hosted 12 banks across Asean recently and most of the discussions [revolved] around the outlook for 2019. For Singapore banks, the key message is of reasonably high confidence on margins, but [loan] volume growth is going to be a bit slower,” Modi says.
The slower loan growth outlook for this year is partially self-inflicted. Last July, the government imposed further cooling measures on the property market, and these measures — which include lower loan-to-value ratios — coupled with rising mortgage rates, are the likely cause of lower loan demand in Singapore. In general, housing loans comprise 21% to 25% of local banks’ loan book. While Oversea-Chinese Banking Corp and United Overseas Bank have regional businesses, DBS Group Holdings’ housing loans are likely to originate mainly from Singapore.
Similarly, a higher additional buyers’ stamp duty for developers, more stringent development conditions for residential sites such as a higher average sizes for units and fewer government land sales for residential development are likely to curb residential property development, and hence new demand for building and construction loans.
“What banks have been seeing after the cooling measures is lower [loan growth] versus previous guidance,” Modi confirms. “My own estimation factors in not more than 5% [loan growth] for 2019. While it has been lower than what they’re guiding for, the street has factored that in.”
Singapore and Philippine banks communicated reasonable visibility on net interest margins (NIMs) — the difference between asset yields and funding costs. Modi points out that both Singapore and Phillipine banks rely mainly on their deposit franchise to fund loan growth. Current account/savings account (CASA) as a portion of total deposits is high in both Singapore and Phillipine banks.
“As domestic interest rates go up, the local banks end up repricing loans faster than deposits, and margins tend to move [up],” Modi says.
Since DBS has 90% of its deposits in Singapore dollar CASA (the highest among the local banks), and its loan-to-deposit ratio is 89% (also the highest among the banks), it offers the best combination for higher NIM, according to Modi.
In a report published by JPMorgan, Modi says he is expecting nine basis points of NIM expansion this year. This is because the three-month Singapore Bank Offered Rate and three-month Swap Offer Rate (SOR) rose between 25bps and 32bps in 4Q2018. Yet, the spread between USD Libor (London Interbank Offered Rate) and Sibor is at a 10-year high of 92bps. “This suggests further upside for Singapore dollar rates,” Modi says.
Singapore’s domestic interest rates such as SOR and Sibor generally track USD Libor. However, domestic interest rates can be lower than USD Libor when the Singapore dollar is expected to appreciate against global currencies. For instance, excess USD liquidity during USD weakness would result in Sibor/SOR falling. Sibor/SOR could be at a premium to USD Libor when the Singapore dollar is likely to depreciate against other currencies. During USD strength, USD liquidity is lower, and thus Sibor/SOR rises.
JPMorgan’s report states that Singapore banks have pricing power on Singapore dollar loans but lack pricing power on USD businesses. In 1H2018, Singapore banks attracted USD deposits in anticipation of lower USD liquidity, higher interest rates, and stronger USD loan demand, including trade loans. Trade loans did not materialise, and some of these deposits are likely to have been run off.
The local banks are in no hurry to raise yields on their loans, but may prefer to raise rates incrementally. “[In 2H2018,] banks refocused their attention on margins and using pricing power in a manner that gives them small, steady increases in NIM over the next three to five quarters. They are [increasing rates] portfolio by portfolio, and it’s going to be a steady increase in rates for the next few quarters,” Modi says. “Investors are expecting a subdued outlook, but if banks deliver what we expect them to, that’s where the positive surprise will come from.”
Credit costs to normalise; no systemic problems
After four rate hikes by the US Federal Reserve in 2018, Fed chairman Jerome Powell struck a dovish tone in the first week of January. Now, economists are pointing to just one rate hike this year. This should provide welcome relief for local small and medium-sized enterprises being pressured by higher borrowing costs.
On the other hand, the worst of the oil and gas credit problems are probably over. From 2015 to 2017, companies such as Swissco Holdings, Swiber Holdings, Pacific Radiance, Rickmers Maritime Trust, Ezra Holdings and EMAS Offshore defaulted on their bonds and were suspended, and the likes of Ezion Holdings, KrisEnergy and Marco Polo Marine were restructured.
Although crude oil prices were volatile last year and are now nearer the lower end of a one-year range, this has not affected the local banks. “When oil prices went up, the charter rates did not go up. Furthermore, none of the banks took major write-backs when oil prices went up, so when oil prices fell there was no shift [in banks’ positions],” Modi says. “They are very adequately covered. The haircuts they have taken in 2017 are deep enough. There is a limited risk of oil and gas coming back to be a problem.”
If the economy slows and interest rates rise, however, companies and people in general who are tightly stretched are likely to be affected, and could cause non-performing loans to tick up. But the probability of an idiosyncratic event that could lead to higher NPL formation has already been factored in. Modi says “the street” is expecting credit costs to rise 5bps across the three banks. Their average credit cost is in the range of 17bps to 18bps, so these could go up to 23bps or so.
The July tranche of cooling measures for the property market may slow growth, but they are also a net positive for the banks. “From banks’ perspective, the cooling measures were a good move. Banks are risk managers. Ultimately, higher asset prices mean higher risk. On a through-the-cycle basis, the probability of a large write-down in property loans, and building and construction loans reduced dramatically after the cooling measures,” Modi elaborates.
This is because the measures reduced the probability of investors’ entering the property market as it heated up. Banks prefer housing loan borrowers to be owner-occupiers because they are the safest customers.
Banks as dividend plays
Banks are increasingly turning into yield plays, which tend to do well when interest rates are not rising sharply. At any rate, as yield plays, the banks’ dividend yields will be measured against the yield of 10-year Singapore government securities, and not against the trend of Sibor/SOR. Yields on 10-year SGS are relatively stable at 2.2%.
The general view is that banks can maintain their current levels of dividends, given that interest rates are going up, return on equity is rising and growth is slowing down. Slower growth means banks may not need so much capital.
Modi explains: “Not only are the current levels of common equity tier 1 reasonably comfortable, but there is visibility on CET1. Over the last few years, we had meaningful shifts in Basel requirements, IFRS9 and asset-quality problems, and all that is behind us. By the end of 2017, rules and regulations were clarified and banks were confident of requirements. Led by DBS in 2018, the banks increased their dividends. UOB is guiding for [higher dividends]. OCBC has a policy of slow and gradual increases in absolute dividends.
“Whatever earnings banks are delivering, there is confidence for banks to sustain those earnings for a longer period of time.”
Two to three years ago, banks were conserving capital in view of the oil and gas NPLs, and in anticipation of moving to a fully loaded CET1. Now, with slower growth, and visibility on capital and earnings, banks can return money to shareholders. “The dividend yield for the three banks is quite impressive and we think it’s sustainable,” Modi says.
DBS reports FY2018 results on Feb 18, followed by UOB and OCBC on Feb 22.
