Singapore Banks - Maybank Kim Eng 2016-06-29: Added to Post-Brexit Complexities

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Singapore Banks DBS GROUP HOLDINGS LTD D05.SI  OVERSEA-CHINESE BANKING CORP O39.SI  UNITED OVERSEAS BANK LTD U11.SI 

Singapore Banks - Added to Post-Brexit Complexities

Remain NEGATIVE

• Our recent macro-analysis (The Singapore Fix, dated 29 June 2016) concluded that property curbs may just be made permanent in Singapore. If so, we estimate that this would affect mortgage and building & construction (B&C) loans by less than 1%. 
• Add to that expectations of fewer lending opportunities and rising NPLs from the oil rout, we remain NEGATIVE on banks. 
• For sector exposure, prefer UOB.

1. If Property-cooling Measures Stay...

• Brexit adds to the complexity of cyclical and structural challenges confronting Singapore. In our recent macro-analysis (The Singapore Fix, dated 29 June 2016), our research team suggests that the government may not dismantle property-cooling measures. This is in view of excessive flow of private capital into residential property, leading to asset inflation and a likely misallocation of capital. The result is a loss of competitiveness, risk aversion and dearth of entrepreneurship.

1.1 ...what’s the impact on mortgage lending?...

• We currently assume 1-3% loan growth for Singapore banks for FY16-18E. Banks’ loan books in Singapore are anchored by mortgages and building and construction (B&C) loans. In the event that property-cooling measures are made permanent, sales of private residential units and executive condominiums could slow down further.
• We estimate that for every 10% decline in housing sales volume from 2015 levels, the system stand to lose SGD600-900m in mortgage opportunities. But as margins for new housing loans are typically tight, at 1% above 3M SIBOR, the pre-tax earnings impact for the system should be less than SGD10m.

1.2 ...and the impact on B&C lending?

• B&C loans form 21% of DBU loans. B&C lending is extended to construction and project companies for property development and construction financing. Projects are not limited to residential housing; they include commercial buildings and infrastructure projects. Government spending in this sector has been taking up the slack of private-sector construction in recent years.
• On the assumption that private housing market activity slows, B&C activity should decelerate as well. With the government stepping up spending, the impact would be cushioned. As public projects such as the construction of new MRT lines and North-South Expressway are ongoing, B&C loans are more likely to accelerate than decelerate. The Building and Construction Authority (BCA) expects average construction demand to be sustained at SGD26-37b over 2017-2020E. 
• Still, if private housing sales slow, B&C lending cannot escape unscathed. Our channel checks suggest that lending rates for the biggest construction companies average about 2%, although the smaller ones are likely to be paying more. Assuming a 2% lending spread over SIBOR and for every 10% drop in private-housing construction, we estimate that the system’s pre- tax earnings would dip by SGD20-25m.

1.3 Limitations of linear analysis

• It is possible that cooler sentiment in the housing market could reduce transaction volumes by more than the 10% we have assumed. Transaction volumes in 2015 are already down by 61% from the peak in 2012. We also have not factored in declining capital values for property in our analysis.
• If B&C loans, which have swelled almost 350% since 2007, experience a pullback of far bigger magnitude, this would have spillover effects for the other sectors and economy.
• Increases in loan-to-value ratios and decline in collateral values could also bump up loan delinquencies, affecting credit costs and earnings.

1.4 Housing and B&C NPLs

• Mortgage loan quality has been resilient after the Asian financial crisis. Singapore banks’ housing NPL ratios have stayed below 5%, with the exception of OCBC’s 9.8% in 1999 and 5.8% in 2000. NPLs for most mortgages tend to be charted by unemployment rates rather than collateral values, from our analysis.

2. Overseas Investments

2.1 Returns hold up

• As common equity is the first capital recourse for banks to absorb losses, we use ROE and COE instead of ROIC and WACC to assess returns from their overseas investments.
• Currently, 33-45% of banks’ assets are overseas. PBT from these contributed 30-45% to their total in 2015. Since GFC, global banks have been retreating from Asia as part of their cost rationalisation and operational realignment. Singapore banks have been profiting from this, by filling their shoes.
• For 2015, core ROEs exceeded COEs for all three banks. Overseas assets helped to maintain their returns. DBS’ COE has also trended down, helping to keep its ROE above COE. The gap between OCBC’s ROE and COE has been widening since 2012, reflecting better returns from its Indonesian franchise and Bank of Singapore unit. UOB’s ROEs have been consistently above COEs, aided by higher NIMs for its SME franchise.
• That said, we think credit costs in a downcycle could decide the success or failure of their overseas diversification.
• The geographical breakdown provided by the banks is based on where their assets are booked. Our observations are:
  • DBS: Total ROAs came down after 2008, after which they have been stabilised by domestic returns and improving returns from Greater China. ROAs for South and Southeast Asia have been declining since 2013, as weakness in the Indian economy hit the bank’s mid-cap portfolio.
  • OCBC: Indonesia produced the highest ROAs in the past three years. ROAs from Malaysia and Indonesia exceeded domestic returns, except in 2012. Returns from Greater China also increased after its acquisition of Wing Hang Bank.
  • UOB: Malaysia has consistently outperformed total returns, while Greater China has been underperforming. Indonesia used to generate ROAs of 2.3-3.5% before 2014, but no longer did so after 2014 due to currency depreciation and higher loan impairment.
• In most periods, banks’ total ROAs were either on par with or higher than Singapore’s. This implies that the returns from their overseas investments have helped to maintain overall returns.

2.2 Wealth management next?

• Wealth management can provide banks with their next source of growth, in our opinion. This is a fee-based, low-capital and high-ROE business. Acquisitions are increasingly seen as the fastest way to scale up, such as: 
  1. OCBC’s acquisition of ING Asia Private Bank (IAPB) in 2009 and Barclays’ Asian wealth unit in 2016; and 
  2. DBS’ acquisition of Societe Generale Asia’s private-banking business in 2014.
• We think OCBC’s improving returns since 2012 could be partly traced to its acquisition of IAPB in 2009. ROEs for Bank of Singapore – its private- banking arm formed after the addition of IAPB - leapt from 2.7% in 2010 to 9.7% in 2015, albeit at a heavy price tag of P/AUM of 5.8% or USD1.5b. Increasingly, this business may have to bear higher compliance, regulatory, staff and technology costs as the government tightens regulations against tax evasion and money laundering.

Ng Li Hiang Maybank Kim Eng | http://www.maybank-ke.com.sg/ 2016-06-29

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