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Analysts still fret over banks' profitability, oil exposure in Q2

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With humdrum market and economic conditions, analysts are watching Singapore banks for any uptick in defaults in the second quarter, and a broader decline in profitability.


WITH humdrum market and economic conditions, analysts are watching Singapore banks for any uptick in defaults in the second quarter, and a broader decline in profitability. Concerns over the impact of oil prices - at below US$50 per barrel - still weigh on their minds, they add.

UBS estimates suggest this could be the weakest quarter in a long time for Singapore banks, with return on equity (ROE) expected at just about 10 per cent, said UBS analyst Aakash Rawat.

"We see potential for a bigger negative surprise from non-interest income, given pre-UK referendum risk off and the June-end volatility," he wrote in his report.

"Signs of good cost discipline will be key. The record so far has been mixed. While cost-to-income has risen across the board, OCBC and UOB have shown better cost discipline versus risk-weighted asset growth albeit from a higher base - something DBS has yet to deliver on."

Amid rising weakness, CIMB downgraded the banking sector in Singapore in early May. "The big problem for oil-and-gas and SMEs is insufficient revenue in a world of slow demand," senior CIMB analyst Kenneth Ng told The Business Times. "If jobs don't come in, people don't spend."

To be clear, Singapore remains statistically at full employment, though the pace of hiring has slowed. In particular, analysts have pointed out broad-based weaknesses in demand for resident PMETs (professionals, managers, executives and technicians).

Even as interest rates are expected to stay low - particularly after the shocking "Brexit" vote in June - analysts are not counting on lower rates to be enough to keep asset quality issues at bay. To be sure, Mr Ng said, provisions expectations at 30-45 basis points of total loans this year have been off the mark so far, but this could suggest that most of the bruising will show up only in 2017. (Provisions are a form of reserves taken against earnings and are typically measured as a percentage of all loans.)

"Street expectations are probably going to be proven as a little too pessimistic, but that doesn't mean such levels of provisions will not happen in 2017. It's delayed, rather than avoided," said Mr Ng. "A lower rate doesn't immediately translate to fewer defaults."

Likewise, Fitch Ratings analyst Ng Wee Siang said increases in the two main benchmark short-term rates - the swop offer rate (SOR), and the Singapore Interbank Offered Rate (Sibor) - were sharp, but did not bring rates to high levels in absolute terms.

"We believe the current retracement in domestic short-term interest rates should not have much of a positive impact on banks' asset quality," he told BT.

"All I can say is low interest rates are supportive of asset quality but they will not be a potent counteracting factor to the current uncertain economic climate."

The current three-month Sibor has fallen to under one per cent, which is below the 2016 peaks of around 1.25 per cent, though still notably higher than the 0.3-0.4 per cent in 2014. The low-rate environment has been in place for nearly a decade, on the back of quantitative easing (QE) policies by central banks, meant to spur lending to boost economic growth.

There are also concerns over banks' profitability, given that weak rates will also mean a compression in net interest margin, not just in the second quarter, but also in the later part of the year, analysts said.

Much hand-wringing over financial institutions in this region comes as Asia-Pacific banks - after years of strong expansion that beat much of the developed world - are converging to the norm of modest growth and steady returns on equity, said McKinsey & Co in a report in June. The study showed total profit from Asia-Pacific banks fell from US$548 billion in 2014 to US$538 billion in 2015 - the first decline since 2009 in the aftermath of the global financial crisis.

Ravi Menon, managing director of the Monetary Authority of Singapore (MAS), noted this month that banks must remain "reasonably profitable" to be sustainable, with retained earnings making up the highest quality of capital held by banks.

Analysts will also keep a close watch on the impact of oil, which is a key vulnerable sector for the banks.

Said S&P analyst Ivan Tan: "Most of the asset-quality weakness is coming from oil-and-gas exposure, particularly to service providers, that is not likely to be resolved in the near term as the oil price remains low."

Mr Tan pointed out that the gradual deterioration should be seen in the context of a very low-base non-performing loan (NPL) ratio. Indeed, Singapore banks have an NPL of between one per cent and 1.4 per cent.

Meanwhile, analysts have already built in assumptions that property curbs will be kept in place. And any stress from easing property prices appears to be easily handled, say analysts. "Property is the area we are least worried about," said CIMB's Mr Ng, noting the regulators have moved aggressively to pre-empt a property bubble. Loan-to-value (LTV) ratios have been tightened for second properties and for purchases by foreigners.

"Headline property prices will still be falling, rents will be falling, vacancies will rise. But these are translating to owners losing their equity if they cannot service their loans and the property is foreclosed and sold. At 50 per cent LTVs, banks tend to get back their loan via the collateral. Already, mortgagee sales are rising."

Fitch's Mr Wee said with property volumes low, property loans have not been the key driver. "The key loan driver is trade loans, which are contracting at the moment. We expect loan growth to stay lethargic, though still in positive trajectory, in 2016."

OCBC and UOB report their earnings on July 28, and DBS on Aug 8.

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