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How May Singapore Banks Perform In The Near Term?
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How May Singapore Banks Perform In The Near Term?

With Singapore’s banking sector accounting for a hefty 34% of the Singapore equity market, it is of little surprise that investors in the said market would be interested to find out about the likely challenges and the catalysts faced by the sector in the near term. In this article, we provide our views of the Singapore banking sector.

How Singapore Banks Have Done In 2016

In 2016, Singapore banks’ stocks have garnered an average total return of 7%, exceeding the (Straits Times Index’s) STI’s 4% total return. The year had largely been challenging for the banks, amid the country’s struggling oil & gas sector which was a significant headwind to the banks’ profitability and had dented their asset qualities. In addition, the city’s slowing economic growth and the region’s modest growth had further challenged the banks’ operating environment, presenting added headwinds to loan growth and revenue. Despite so, the banks reacted quickly, with efforts to grow non-interest income and segments such as wealth management, dispose of less beneficial properties, improve cost management, as well as reduce exposure to the Greater China region, from which trade loans have been known to be shrinking in the recent years due to more attractive onshore rates. Furthermore, the banks have also contained their oil and gas exposures. Unsurprisingly, the banks managed to pull through the first to third quarter with slight contractions in their earnings and managed to even see slight increases in net profit for some of the quarters. In the fourth quarter of 2016, strong economic momentum over in the US as well as the increased probability of more rate hikes had given a good boost to the banks’ stock prices as investors increasingly expected the city to soon be in a rising interest rate environment. The banks would be direct beneficiaries of this, as this would support the banks’ net interest margins and net interest income. With the boost in stock prices in the last quarter of 2016, the total return of Singapore’s banking stocks in 2016 had been supported.

Chart 1: Banks’ Stock Performance Compared to STI Over 5 Years

Looking ahead, how might the local banks perform?

How Banks May Perform In The Year Ahead & Near Term

Positives

1. Higher Interest Rates To Support Net Interest Income

The interest rate spread is one of the most significant factors affecting Asian banks’ profitability, as revealed in the Monetary Authority of Singapore’s (MAS) Financial Stability Review, November 2016 report. This is no doubt for Singapore banks, given their high reliance on net interest income— for the nine months ending 30 September 2016, the proportion of net income to total income for DBS, OCBC, and UOB were reported to be 63%, 60% and 62% respectively. Given continued improvements over in the US, and indications by the Fed to possibly hike interest rates by a total of 75 basis points this year, the likelihood that the benchmark 3-month Singapore Interbank Offering Rate (3-month SIBOR) would rise has increased alongside. The rising interest rate environment would in turn result in better interest rate spreads for Singapore banks, thus potentially boosting net interest margins, net interest income and profits.

Table 1: Rate Hike Probabilities As Per Fed Fund Futures

March 2017

32%

May 2017

49%

June 2017

71%

July 2017

76%

September 2017

84%

November 2017

87%

December 2017

93%

Source: Bloomberg, iFAST compilations.
Data as of 2 February 2017

2. Improved Regional Economic Growth To Support Loan Growth & Debt Servicing Capacities

While Singapore banks, as with other Asian banks, remain more domestically-orientated than externally-orientated, they remain one of the least domestically-orientated of Asian banks. With respect to 3Q 2016’s financial results, 35.5%, 41.3% and 43.7% of the net revenues of DBS, OCBC, and UOB are derived respectively from overseas and for the whole of 2015, the banks garnered 40.2%, 41.5% and 42.1% of their net revenues from external markets. “Net revenues” is calculated as the sum of interest income, trading account profits or losses, gain or loss on investments and loans, other income or loss, investment income or losses, commissions and fees earned, and other operating income, minus interest expense. Given the banks’ notable portion of overseas-generated net revenues, as well as expectations of improved global and regional growth this year including that of China, the banks could see improved external loan growth and debt servicing capacities as companies and households abroad see stronger profits and income respectively.

3. Provisions Accounted By Oil And Gas Sector Could Slow Down Or Be Maintained

Headwinds facing the profitability of the oil and gas sector remain this year and in the near term. The sector, which largely specializes in manufacturing oil and gas production and exploration equipment such as jack-up rigs as well as the conversion of Floating Production Storage Offloading units, could likely see the demand for its equipment and services squeezed in the coming year. This is in view of the agreement amongst OPEC and 11 non-OPEC members in November and December 2016 to cut oil supply by a collective 1.2 million barrels per day (bpd) and 558,000 bpd respectively. The countries involved in the oil supply cut agreements account for about 60% of the world’s oil supply and, for the month of January 2017, the OPEC have registered a strong 82% compliance rate to the respective countries’ promised cuts, thus possibly increasing the likelihood of reduced oil supply in the near term.

Nonetheless, the remaining oil suppliers, which account for approximately 40% of the world’s oil production, would likely be encouraged to increase supply amid recovering oil prices, which would provide some cushion to the reduction in demand from countries involved in the supply cut. Furthermore, while a notable amount of debt of Singapore’s offshore services companies would come due this year, the government’s financial support to oil-linked companies (extending as much as SGD 5 million to each company for as long as six years) available since December last year, would likely provide some support to the oil companies’ cash flows in the near term. In January this year, Moody’s had also released a report on Singapore banks, acknowledging the government’s supportive efforts for oil-linked companies and had expressed a hold on their current Aa1 rating for the Singapore banking sector. Additionally, the banks’ oil and gas exposures have been largely maintained through 2016 as the banks increasingly looked to manage risks in the oil and gas sector. Given the above points, it is probable that, in the near term, Singapore banks’ provisions accounted by the oil & gas sector in the near term could be maintained or could slow from their high in 2016.

Negatives

1. Provisions accounted by SMEs at risk of worsening amid Tepid Domestic Economic Growth

With the absence of signs of robust growth in 2017 thus far, the Singapore economy seems positioned to see tepid growth in the near term (expected 1.5% and 2.0% GDP growth in 2017 and 2018 respectively), and this would likely detract from corporate earnings and their debt servicing capacities. The banks’ loan growth contributed by greatly affected corporations could reasonably be expected to be weak as well. Small and Medium Enterprises (SMEs), rather than the large corporations, would likely be hit harder, as a large number of them remain highly domestic-orientated. Additionally, the rising cost of funds amid rising interest rates would likely further challenge the SMEs’ debt servicing capacities. On a more positive note, it is worth noting that the largest portion (30%) of SMEs are involved in the construction sector, which is expected to see an increase in demand this year amid greater public sector construction, although the private sector’s construction activity would likely remain muted. The increase in public sector contracts for smaller projects would likely provide some revenue support to the SMEs involved in the construction space.

Given the SMEs notable contribution to the city’s economic growth (accounts for 48% of Singapore’s 2015 GDP) as well as their vast numbers (99% of the enterprises in Singapore are SMEs according to 2015 data), it would be unsurprising that a notable portion of the banks’ loans are extended to SMEs. Yet, the SMEs’ credit quality had deteriorated through 2015 and 2016 amid slowing domestic growth, with the Singapore banks’ 1H 2016’s NPL ratio accounted by SME loans coming in at 2.1%. On a more positive note, as revealed by MAS’s latest Financial Stability Review report, retained earnings (36%) and paid-in capital (26%) make up the majority of SGX –listed firms’ funding profiles, indicating largely low leverage levels and this could be supportive in meeting existing debt obligations. The report also revealed that MAS’s recent corporate stress test suggests that “most firms would remain resilient to interest rate and income shocks on the back of adequate financial buffers, including cash reserves”. Given the above considerations, it remains that provisions accounted by SMEs remain at risk of worsening, although provisions are not likely to be significantly larger than that in 2016.

2. Weak Real Estate Sector To Continue Posing Headwinds To Provisions And Asset Qualities

According to 4Q 2016 property statistics, Singapore’s real estate sector looks to continue being weak in the near term. Prices and rents had continued to fall while vacancy rates had continued to rise. Particularly in the office property space, on a quarter-on-quarter basis, the change in available property space had significantly outpaced the change in occupied properties in 3Q 2016 and 4Q 2016, thus signalling a notable excess of office properties amid more office properties set to come onboard this year. Furthermore, the take-up rate of such properties would likely be closely related to economic growth, which currently looks to be modest. The prices, rents, and vacancy rates for retail properties could also be challenged given the weak domestic labour market which could possibly result reduced demand from some retailers. Higher interest rates could result in more expensive mortgage loans which could deter demand over in the residential property space, although the private residential property space has stated the best vacancy rates (on a quarter-on-quarter basis; the take-up rate was 16.9% in 4Q 2016 and the vacancy rate fell, rather than rose, by -0.3% points). Meanwhile, the demand for industrial properties could be supported should Singapore’s manufacturing sector continue to see good growth.

Given the real estate companies’ prominence amongst Singapore companies (the real estate sector is the heaviest weight sector in the STI apart from the banks themselves) it is unsurprising that the banks’ exposures to the property sector remains significant. While the exact numbers are not revealed in their annual reports, Singapore banks are regulated by Section 35 of the Banking Act, which limits the banks’ real estate exposures to not more than 35% of their total eligible loan assets. Consequently, provisions accounted by the real estate sector could no doubt be maintained or increased slightly in the near term. Yet, it is worth noting, that in 2016, where the real estate sector was sluggish, the Oil & Gas sector was still the main contributor to the banks’ provisions and asset quality deterioration.

What This Means For The Investor Of The Singapore Market

Conclusively, the operating environment for Singapore banks in 2017 could improve slightly from that in 2016, thus supporting earnings growth and thus their stock prices. This is as the effect of the positives would likely outweigh than of the negatives given that net interest income has historically been shown to be a major factor impacting the profitability of Asian banks (and not surprisingly Singapore banks too). Furthermore, the banks pose a notable orientation to overseas markets for loan growth and global as well as regional economic conditions seem positioned to improve in the near term. The main contributor to the banks worsening provisions and asset qualities in 2016, the Oil & Gas sector, seems likely to pose lesser new non-performing loans (NPLs). Headwinds to provisions, asset qualities, as well as loan growth remains given strained profits from the SMEs and real estate sector and an overall modest domestic economic growth.

Chart 2: Banking Sector, A Heavy-weight In The STI, Remain One To Look Out For

Banking stocks have been one of the largest movers of STI in the 4Q 2016 where their stock prices rose an average 8%. Given the above points, it would be unsurprising that banking stocks see improved gains as compared to that in 2016 (average price return for banks in 2016 was 3%), when excluding interim stock movements. While the around 66% of the STI remains dependent on the performance of stocks in other sectors (the real estate sector accounts for 19%), the banking sector which itself comprises 34%, could no doubt pose a notable impact on the overall performance of the STI in 2017 and remains one for the Singapore market investor to look out for.


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