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Not time to take a shine to Singapore banks

SINGAPORE banks have been trading on a premium on hopes that a combination of rising rates and receding pain from the oil and gas (O&G) sector would lift the business in 2017. But there is a long, hard slog ahead for these lenders that does not justify the share bump.

Investors looking for a rate boost from rising US rates should note that the two benchmark rates - the swap offer rate and the Singapore Interbank Offered Rate - are less sensitive to US rates today than they were in 2014 and 2015.

Indeed, the short-term rates - off which most of the loan books make money - have barely moved, with the Singapore banks recording weaker net interest margins (NIMs) in the fourth quarter from a year ago. Banks themselves are expecting, at best, stable NIMs in 2017, with OCBC Bank flagging the higher competition in lending to top corporates, with banks more averse to risk now as the asset cycle turns.

Meanwhile, O&G problems look to be prolonged, said DBS Bank, even as the lender expects the largest specific provisions to cover possible loan losses in the O&G sector to have been taken in 2016. UOB, too, has chimed in with the same view.

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Specific provisions have been set aside to cover an estimated expected loss in the value of specific loans under stress. These allowances are taken out of earnings, and so hurt the bottom line. Even as DBS and UOB have shrugged off the odds of higher specific provisions in 2017, there is good reason to keep OCBC's wariness in mind. OCBC has significant exposure to the offshore support segment of its O&G portfolio, where there has been sharp stress, data from the banks show. UOB has the smallest.

OCBC took pains to underscore the fragile demand for oil at this point, with much hinging on oil prices heading to US$70 per barrel before oil firms can make decent margins.

Its house view is for oil, now trading at about US$55 per barrel, to head to US$65 per barrel by year-end. But as the world was caught off-guard as oil crashed to a 12-year low of US$26 per barrel in early 2016, any calls on oil today will have to be viewed with caution. Geopolitical tensions add no certainty to the direction of oil prices.

Banks have pointed to the recent roiling from the collapse in charter rates. With the rates falling, the market value of assets used as collateral has also fallen, meaning banks would have to set aside more to make up for the portion that is no longer covered by the asset value. And as charter rates fell, banks have had to refinance loans to match their customers' weaker cash-flow position.

DBS pointed to the higher recovery from the sale of certain ships as examples of conservative estimates on collateral values. But a CIMB report pointed out that larger purpose-built vessels may be harder to sell or need steeper discounts. OCBC further hinted at pre-emptive steps taken by trade creditors that could hurt the restructuring process for O&G companies.

The capital needed to support this stressed segment is also missing, be it in the form of white knights swooping in on distressed offshore support companies or in capital expenditure (capex) among oil majors.

To be clear, there are some green shoots. ExxonMobil said this month it would raise capex in 2017, setting aside US$22 billion this year, up from about US$19 billion in 2016. China's CNOOC will also raise spending for the first time in three years. But this comes after Chevron said in December it would reduce spending. Shell likewise said last year it would keep 2017 capex at US$25 billion, down from around US$29 billion in 2016.

Analysts worry about underinvestment, noting a high chance of cost inflation beating price recovery later. A recovery in prices may not bridge the US$750 billion to US$2 trillion gap between operating cash flows and capex, noted a 2016 Deloitte report.

So more precarious times ahead for the upstream industry, and while much of the pain for the Singapore banks may have been taken in the fourth quarter of last year, questions will remain on their future exposure to this sector. OCBC said it's too early to write off the industry in Singapore, but noted there will need to be tweaks to the operating model. This will require the government to step in to refine the future of this segment for Singapore. Latest Budget measures suggest mainly short-term relief.

And as Budget 2017 stresses Singapore's restructuring efforts, other parts of the banks' portfolio - such as retail, and food and beverages - bear watching. Finance Minister Heng Swee Keat said firms in sectors that are facing structural shifts will need to "dig deep" to change their business models to stay viable. Dig or die is the message, and Singapore banks will feel the heat as these firms undergo massive change.

For Singapore banks then, the call to expand in Asean will gain urgency. But this will have to be balanced against cost pressures, even as they work against entrenched domestic banks in this region.

UOB posted a cracking 9 per cent jump in loans from a year ago, boosted in part by gains in Thailand and Greater China. But its operations in Thailand - the third-largest profit contributor after Singapore and Malaysia - have a cost-to-income ratio of about 60 per cent. Notably, the high costs have been coming down from a year ago, and the expense ratio is much better for UOB's Malaysian franchise, at under 40 per cent. At OCBC's Indonesia operations, the expected growth engine for OCBC this year, the cost-to-income ratio has similarly fallen to about 46 per cent. But amid heightened competition, costs may not trend lower.

In this regard, DBS's long-awaited expansion into Indonesia will be interesting. Can it push into this market with a digital bank that is expected to be less costly? It's more haste, less speed for DBS, as its lesson over Bank Danamon will give it pause. But as it looks to pivot from the two open economies, Singapore and Hong Kong, the pressure is also on.

All in, these constraints should take some shine off Singapore banks for now. Buyers should keep their optimism in check.