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Bank stocks rerated amid challenging conditions

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It's puzzling to see a sharp turnaround in Singapore banks' share prices: They have gone from underperforming to outperforming since November, although fundamentally nothing on the economic front has changed.

IT'S puzzling to see a sharp turnaround in Singapore banks' share prices: They have gone from underperforming to outperforming since November, although fundamentally nothing on the economic front has changed.

In fact, there are many signs pointing to a worsening situation for businesses. This month, credit-rating agency Fitch Ratings said it has downgraded its sector outlook on the Singapore banking system to "negative" in the light of soft economic conditions that are expected to persist next year.

This could place broadening pressure on banks' asset quality and dampen earnings over the next year, Fitch said. "However, Singapore banks' solid credit profiles - characterised by steady funding and liquidity positions, strong loss-absorption buffers and healthy profitability - support our stable outlooks for their ratings."

Fitch has two types of outlooks - a sector outlook that reflects its views on the likely future performance of the sector, and a rating outlook that indicates an entity's future credit risk.

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Its downgrade of Singapore's banking-sector outlook comes as its overall-sector outlook on Asia-Pacific banks has become increasingly negative. This is a critical point because the exposure of the three local banks is in the region.

Three-quarters of the banking systems Fitch covers now have a negative outlook, including Australia, Hong Kong, Japan, Malaysia and China, compared with fewer than half in its outlook for 2016 a year ago.

These banking systems face a slew of economic risks that could affect their loan books and profits, Fitch said. These include economic headwinds from China, low commodity prices and related currency pressures.

Fitch said the key stress point for Singapore banks lies in the oil and gas (O&G) sector, which it expects will continue to exert moderate pressure on banks' asset quality next year.

This month also saw business confidence slipping further with trade and financial-sector players the most pessimistic, according to the Singapore Commercial Credit Bureau's latest quarterly business optimism index.

The index fell into the negative territory of 1.22 percentage points in the first quarter of 2017 from 2.87 percentage points in Q4 2016.

"The downward trend is most evident in externally-oriented sectors such as wholesale and financial services. For 2017, firms are projected to cut back on investments for business expansion. Lack of financing, higher business costs and reduced sales are some of the key challenges which have also been highlighted by firms," it said.

A report by ManpowerGroup said hiring sentiment is cautious in the next three months; the silver lining is that a survey of 630 employers found that on a net basis, hiring intentions have improved a bit from the previous quarter.

The local banks are proxies of the economy if nothing else and growth next year is likely to be as turgid as in 2016. DBS Bank research forecasts Singapore to grow 1.3 per cent in 2017, marginally better than the 1.2 per cent in 2016.

But it's like all the negative news has fallen on deaf ears since Donald Trump won the US presidential election. DBS Group Holdings, OCBC Bank and United Overseas Bank (UOB) have helped push the benchmark Straits Times Index (STI) past 2,900, the level it had ranged below since late July. The STI hit the 2016 high during intraday trading on Dec 8.

On Nov 9 (the day after Mr Trump's election victory), this column noted that year to date, DBS was down 8 per cent while UOB was 5 per cent lower and OCBC had lost 3 per cent. The STI was down 2 per cent for the same period. The column also wondered if the banks were underloved despite their double A rating and 4 per cent yield.

Well, the rerating came fast and furious.

DBS Vickers in a Dec 7 report said Singapore banks' share prices have rallied a good 8 per cent since the US presidential election and with more certainty of rate hikes.

"This is even before any real numbers have filtered through. The market appears to be disregarding any downside risk to further NPL (non-performing loan) issues albeit on a smaller scale and the sluggish economy," it said.

It raised its earnings estimates for the banks in view of rising net interest margins, resulting in OCBC being upgraded to "buy" though UOB remains a "hold". Sure, the expected hike in interest rates will help banks' margins, but will it be enough to offset more bad loans and low or zero loans growth?

Other reasons have been offered, including the recovery in oil prices and that the incoming US president will ease some tough banking regulations, which has made the US banks hold more capital.

But the rally in oil prices to US$55 per barrel this month (almost double the January low of US$28 per barrel), while positive, will not help the offshore O&G services industry, said one banker.

"As long as oil companies are reducing demand and cancelling projects, the market is still very challenging," he said.

There is no fundamental change for the better because there are too many players and too much capacity, he said, adding that 2017 will be the fourth year of decline for the O&G industry.

As for the US president rolling back onerous regulations for American banks, it's unlikely that if it happens, it will have much of a spillover effect on the Singapore banks. The Monetary Authority of Singapore regulates the Singapore banks according to local and regional risks and conditions. So the overnight change in sentiment is a little strange.

Maybe bank investors just needed a nudge - Trump euphoria? - to rerate the bank stocks. For a sustained rally, improved fundamentals will have to follow. With Christmas round the corner, why not take some money off the table to enjoy the partying.

Happy holidays!

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