Pressure on capital adds caution over Singapore banks' ratings: Fitch

SINGAPORE banks' core capital ratios should be sustained at around 14 per cent over the next few years, or they risk triggering a rating downgrade, warned Fitch Ratings.

This comes as deteriorating asset quality and profitability is likely to put downward pressure on capital ratios at a time when there is "limited rating headroom", the credit ratings agency said in a report on Sunday night.

The banking trio is rated AA- and placed on rating watch negative by Fitch Ratings to reflect the weakening operating environment.

All three banks have targeted for common equity Tier 1 (CET1) ratios between 12.5 per cent and 13.5 per cent. As at the second quarter this year, DBS's CET1 ratio stood at 13.7 per cent; OCBC at 14.2 per cent and United Overseas Bank (UOB) at 14 per cent.

Fitch Ratings said such targets will be "inconsistent with current scoring" if there is no credible plan to restore them "within a reasonable horizon".

"The capital score is likely to be lowered should the banks sustain CET1 ratios well below 14 per cent without a credible plan to rebuild them to around 14 per cent within the next couple of years."

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The agency noted that while Covid-19's impact on profitability will hurt financial profiles through thinner margins, higher credit costs and slower credit growth - which have been factored into the ratings assessment - capitalisation will have a larger impact on the ratings as it is one of the three factor scores rated aa-, which is the same as the viability rating (VR).

The prospect of lower capital scores consequently adds to "significant" downward pressure on the lenders' VRs and long-term issuer default ratings.

That said, the Monetary Authority of Singapore's call for local banks to cap total dividends per share for FY2020 will "go some way" to helping banks maintain capital ratios at a level "commensurate with risk" for the year, said Fitch Ratings, noting that this move has saved the banks up to 40 basis points (bps) of capital each.

Overall, the agency has a negative outlook on the banks' earnings and profitability scores, which implies a downside risk to profitability mainly due to impairments that are "larger than currently expected".

Fitch Ratings is expecting the lenders' earnings this year to fall by about a third from end-2019. In turn, credit migration is also likely to have an impact on their capital ratios.

In the second quarter, all three banks recorded a sharp dive in earnings as benchmark rates collapsed and the trio lifted provisions. DBS's Q2 net profit fell 22 per cent to S$1.2 billion; OCBC's slumped 40 per cent to S$730 million; while UOB's tumbled 40 per cent to S$703 million.

"Lower earnings score would add further pressure to the VR of each of the banks, and may be sufficient by itself to result in a rating downgrade," said the agency.

Net interest margin (NIM) compression started in late 2019, with a big drop in Q2 2020 as the Singapore Interbank Offered Rate (Sibor) fell significantly. "We expect continued margin compression due to the lag effect of Sibor reduction, which will pressure revenues for 2020. We believe margins are likely to be flat in 2021," said Fitch Ratings.

In the second quarter, NIM stood at 1.62 per cent for DBS, 1.6 per cent for OCBC and 1.48 per cent for UOB.

The agency said there may be some residual lag from falling benchmark rates, although banks are likely to price new loans higher, given the potentially higher incremental risk, less competition in the market and potentially tighter liquidity. Banks have also been cutting deposit rates to lift margins.

Fitch Ratings has projected for non-performing loan (NPL) ratios to peak at a little over 3 per cent in FY2021 for the trio. As they continue to build buffers in the second quarter, all three have kept to their earlier guidance from the first quarter. Q2 NPL ratios remained steady at 1.6 per cent for OCBC and UOB, and at 1.5 per cent for DBS.

"Regulatory relief has generally held NPLs stable year to date," said the agency.

But it cautioned that the full extent of the coronavirus pandemic's impact may only be reflected in FY2021 NPL ratios, as debt repayment moratoria offered to borrowers around the region will delay much impaired-loans recognition.

That said, the banks are expected to continue to book significant general provisions in FY2020. "We give the Singapore banks benefit for their high leverage ratios," Fitch Ratings said.

As for credit costs, the banks' guidance range from 100 to 130 bps cumulatively through to FY2021. Fitch Ratings does not forecast credit costs to reach the three-digit mark in any one year.

"We expect all three major Singapore banks to continue to generate profits throughout the downturn, with the trough being in 2020."