New virus strains, above-target inflation key risks to financial stability in 2022: MAS

CORPORATES, households and banks in Singapore have remained stable over the year, buoyed by strong capital buffers, Covid-19 support measures and improving financial conditions.

But even as economies have adapted to living with the pandemic, it continues to be a source of considerable uncertainty as the emergence of mutated virus strains threatens to derail progress, said the Monetary Authority of Singapore (MAS) in its annual Financial Stability Review on Monday (Dec 6).

Even as Singapore's economy is expected to expand by a "creditable" 3-5 per cent next year, the consequent increase in global risk aversion could lead to a tightening in domestic financial conditions, reducing the flow of credit to the economy.

These stresses could be exacerbated by persistently above-target inflation that could trigger a sharper-than-expected tightening of global financial conditions, MAS cautioned.

Singapore's corporate sector will likely have to contend with some growth unevenness. Sectors such as manufacturing will gain further traction, while the more pandemic-sensitive sectors could be subject to sporadic mobility restrictions.

Households should be cautious in taking on large new commitments, paying due regard to their ability to service long-term mortgage obligations, especially as interest rates are expected to rise, said MAS.

Banks would be able to meet the credit needs of businesses and households in the adverse scenario, even as they continue to adhere to prudent provisioning practices.

Corporate vulnerabilities ease but growth uneven

As at Q2 this year, firms' vulnerability to shocks has eased from elevated levels a year ago, with leverage risks also broadly stable.

Corporate debt ratios rose to a high of 172 per cent in Q1 before easing slightly to 164 per cent in Q2 amid the rebound in economic activity.

Earnings of SGX-listed companies, measured by return on assets (ROA), improved across the board with median ROA rising from 0.3 per cent in Q2 2020 to 1 per cent in Q2 2021.

Recovering profitability has also bumped up the debt servicing ability of companies, as reflected by the increase in the interest coverage ratio (ICR) which measures the ratio of earnings to interest payment.

A company is considered to have difficulties servicing its debt if the ICR is less than 1. The median ICR of all SGX-listed companies rose from 1.7 in Q2 2020 to 2.8 in Q2 2021, a sign that corporates had comfortable buffers, said MAS.

That said, the pace of earnings recovery varies across sectors. Debt servicing abilities of the construction sector, for example, had remained weak with a negative ICR. This means companies would have to draw on cash reserves to meet their interest cost commitments.

The Singapore banking system's corporate non-performing loan (NPL) ratio fell from 3.4 per cent in Q1 2021 to 3 per cent in Q3.

However, the transport and storage, wholesale trade and construction sectors saw higher NPL ratios of 11.8 per cent, 6.2 per cent and 5.9 per cent respectively as at Q3, reflecting continued weakness.

Overall, MAS's stress test on the balance sheet of SGX-listed companies suggests that most would be resilient to interest rate and earnings shocks, with cash reserves providing additional buffers.

Under a scenario of a 25 per cent increase in interest costs and 25 per cent decline in Ebitda, the percentage of firms-at-risk rises from 30 to 37 per cent of all corporates, and their share of debt-at-risk grows from 20 to 32 per cent.

But after taking net cash reserves and hedging into consideration, the share of firms-at-risk and debt-at-risk would drop to 18 per cent and 21 per cent, respectively.

Small and medium-sized enterprises (SMEs) continue to have weaker cash buffers than large firms. The proportion of vulnerable SMEs is about 30 percentage points higher than that of vulnerable large firms, relatively unchanged from last year.

But bank lending to SMEs has remained supportive, up 2 per cent year on year as at Q2 2021, with credit quality stable amid the gradual tapering of relief schemes.

The falling trend of applications and take-up of relief schemes in 2021 also suggests that most SMEs are recovering well and have resumed loan repayments, said MAS.

Households' leverage risk remains elevated

While short-term debt has fallen, overall household indebtedness has increased amid a robust property market.

Housing loans were the single largest contributor (2.4 percentage points increase) to the overall 3.7 per cent growth in household debt since end-2019. Compared to Q4 2019, household debt ratio in Q3 2021 was higher by 3 percentage points. Accordingly, leverage risk has increased from pre-Covid levels.

MAS warned that stretched equity valuations relative to fundamentals and rising property prices relative to incomes increase market susceptibility to a "sharp and disorderly" correction.

In the event of a shock to the property market, the correction in property prices could impact domestic demand, given that residential properties and loans account for the bulk of the household balance sheet representing about 40 per cent of assets and 75 per cent of liabilities.

Highly leveraged households should refrain from taking on more debt and build up financial buffers where possible to cushion against weaker macroeconomic conditions, the regulator said.

For now, MAS's stress test found that household mortgage servicing ratios (MSRs) remain manageable.

Specifically, the observed median MSR remains below the maximum threshold of 60 per cent for the total debt servicing ratio guideline, even if income falls by 10 per cent from the lows seen during the pandemic, and interest rate rises by 250 basis points.

As the bulk of household liabilities are housing loans, the results suggest that the median household would still be able to service its debt.

Meanwhile, most borrowers who had applied for mortgage relief are now able to resume repayments. The number of borrowers granted extended relief has fallen sharply to 5,000 as of Q3 2021, from 36,000 on the first set of the earlier relief measures.

"Most households on mortgage relief have been able to resume payments, while bespoke arrangements continue to be available for those with ongoing difficulties," said MAS.

Resilient private residential property market

Private residential property prices have been increasing for 6 consecutive quarters since Q2 2020, accelerating to an average of about 2 per cent between Q4 2020 and Q3 2021.

This brought the cumulative price gain to 8.7 per cent since the start of the pandemic, outpacing the nominal gross domestic product growth of 5.3 per cent.

The quarterly average volume of transactions since Q1 2020 was close to 20 per cent higher than in pre-Covid times. The resurgence in demand was driven by both new sales and resales, with volumes in Q3 2021 at their highest quarterly levels since Q2 2013 and Q3 2009, respectively, said MAS.

Banks continue to support credit demand

Throughout the crisis, Singapore's banking sector has maintained strong capital and liquidity buffers, said MAS.

Credit growth declined over the first quarter of 2021 before recovering to hit 5.1 per cent year on year in October, largely driven by non-bank lending as economic prospects improved.

The banking system's overall NPL ratio remained low at 2.2 per cent as of Q3 2021.

Still, asset quality could deteriorate should economic activity be impacted by more severe disruptions to global supply chains than anticipated from a resurgence in infections and tighter containment measures, the central bank flagged.

That said, banks' strong capital buffers and adequate provisions make them well-placed to weather further downside risks.

Results from MAS's reverse stress test suggest that macroeconomic stresses would need to be "considerably worse" than those during Singapore's past crisis periods for banks' capital adequacy ratios to fall below their regulatory requirements.

Local banks have continued to expand their loan books while maintaining healthy asset quality and provisioning coverage.

Loan growth accelerated to 8.1 per cent year on year in Q3 2021 due to an increase in both resident and non-resident lending.

Banks' net profits have also been healthy, boosted by non-interest income even as net interest margins remained low, said MAS.

The lenders continued to maintain healthy provisioning coverage at 219.1 per cent as at Q3 2021.