As companies struggle to cope with virus fallout, potential loan default risk from SMEs may weigh on earnings

 

MOUNTING concerns over asset quality are likely to take centre stage at the upcoming quarterly results of Singapore' s banking trio as companies brace for a prolonged crisis.

 

With businesses facing a triple whammy of lockdowns, a deep recession and the gradual unwinding of relief support measures, analysts say there is already potential loan default risk from virus-battered small and medium-sized enterprises (SMEs) that will, in turn, weigh on banks' earnings in the second quarter.

 

Net profit is widely expected to come down for Singapore banks, with growing pressure as well to pull back on dividend payouts amid the regulator' s call to shore up capital.

 

Citi analyst Robert Kong said Q2 is likely to be the quarterly earnings trough for DBS and UOB. He is looking at DBS' s Q2 profit falling 37 per cent year-on-year OCBC, 29 per cent and UOB, 39 per cent.

 

As Singapore sinks into a deeper recession, there is " low visibility" on the pace of economic recovery, he noted.

 

Amid the sluggish operating environment, analysts flagged that SME loans, in particular, will come under pressure of default.

 

DBS analyst Lim Rui Wen said the sector' s Q2 earnings could take a hit from larger-than-expected non-performing loans (NPLs) from various sectors or as combined with commodities-related exposure.

 

While UOB and OCBC' s oil and gas exposures have " largely been taken care of" , Ms Lim said she remains watchful on asset quality, especially in the SME space, as higher credit costs could be indicators of an acceleration in economic slowdown.

 

She forecast that every 10 basis points (bps) uptick in credit costs might impact sector earnings by some 7-8 per cent.

 

Maybank-Kim Eng' s head of research Thilan Wickramasinghe said lockdown-driven NPLs are likely to pick up pace in Q2, particularly in the hardest-hit frontline sectors.

 

" Provisioning costs should see material quarter-on-quarter momentum as the brunt of regional lockdowns and economic downgrades manifest," said Mr Wickramsinghe.

 

About 12 per cent of Singapore' s economy is at the " epicentre" of the Covid-19 crisis, with the pandemic due to structurally impair some sectors, the Monetary Authority of Singapore (MAS) said in July.

 

CGS-CIMB has estimated for credit costs in Q2 to stay elevated at around 54 to 66 basis points (bps) from overlays, a pre-emptive move against potential credit quality deterioration at the end of the year.

 

Citi' s Mr Kong flagged a potential second round of asset quality pressure, due either to a second wave of Covid-19 cases - at worst case requiring a further period of lockdown - or with SMEs and unemployment impacted by the " cliff effect" of loan moratoria wearing off.

 

MAS has sent a fresh signal that government relief measures will have to start tapering off by end-December 2020. It would be unsustainable to have them continue indefinitely, given worries on debt accumulation, it said in July.

 

This revives questions on the full impact of such unprecedented relief on banks' earnings, which comes as some " zombie companies" are likely hanging on merely by the government' s helplines.

 

One uncertainty for the banks comes as a part of their quarterly income reflects accrued income from borrowers taking a debt holiday.

 

Maybank-Kim Eng estimated that about 12-16 per cent of total loans are under moratorium and other relief schemes from the local banks.

 

Citi' s Mr Kong said it may be prudent for investors to consider upcoming interim dividends on the basis that the banks' reported accounting earnings are higher than actual cash earnings received, even as the disparity is not material at this stage.

 

Another thing to note is the likelihood of such loans souring into bad debt when the moratoria eventually expire. Recent MAS data showed that more than 5,300 SMEs' secured loans have received repayment deferments till end-December 2020. To add, more than 10,600 enterprises have also taken up about S$9.4 billion of loans between March and June via Enterprise Singapore schemes.

 

The three local banks are also estimated to have granted payment deferments to more than S$15 billion worth of mortgages as at the end of June this year. All in, the total value of deferred mortgages in Singapore make up almost 10 per cent of all outstanding mortgages.

 

The S$15-billion worth of deferred mortgages account for nearly 80 per cent of approved mortgage debt relief applications, a MAS spokesperson told The Business Times last week.

 

DBS' Ms Lim said various mortgage and debt moratoria for SMEs amounting to S$26.4 billion will expire towards year-end, though she expects applications for moratoria to be on the rise through year-end.

 

Jefferies analyst Krishna Guha has factored in a peak NPL ratio of about 3.5 per cent for the sector, compared with the current 1.6 per cent.

 

While moratoria are expected to stay only till year-end, repayment schedules may be worked over the next two years. This is likely to lead to a protracted credit cycle, he said. " Further, revenue outlook is uncertain."

 

Phillip Securities Research analyst Tay Wee Kuang told BT it would be a " wild guess" on the eventual default rate arising from at-risk loans. Meanwhile, the banks have set aside allowances to cater for future losses.

 

The eventual impact on bank earnings when loan moratoria taper off will largely depend on the amount of government aid that banks can receive - should conditions worsen beyond expectations, Mr Tay noted.

 

DBS' Ms Lim is expecting the weaker second-half outlook to persist beyond 2020 in the absence of a virus vaccine. " We believe extensions to moratoriums into Q1 2021 may be given, on a targeted approach."

 

With the recent collapse of benchmark interest rates, analysts have also projected record-worst net interest margin (NIM) compression in Q2 that will impact the sector' s interim dividend payout. Q2 NIMs are widely expected to be near their all-time post-global financial crisis (GFC) low.

 

CGS-CIMB analyst Andrea Choong cautioned that the risk of lower interim dividends due to NIM headwinds may trigger some profit-taking by investors. " With benchmark rates close to bottoming out, we think NIM declines in coming quarters will be comparatively subdued."

 

Q2 will likely mark the bottoming out of quarterly NIMs, said Jefferies' Mr Guha. While steep rate declines will pose a drag to margins and revenue, banks are likely to benefit from lower deposit rates.

 

That being said, he noted that earnings are unlikely to recover to FY19 levels over the next three years.

 

Questions around dividends come too as MAS last week called on Singapore banks to cap dividends for FY2020 at 60 per cent of the amount in the previous financial year, in a move to conserve capital amid the uncertain climate.

 

Shareholders should also be offered the option of receiving the dividends to be paid for FY2020 in scrip in lieu of cash, said MAS.

 

Analysts cautioned that banks are likely to see steep declines in share price in the short term following MAS' s announcement on the dividend cap. On Thursday, a day after MAS' s announcement, DBS shares closed 63 cents lower at S$19.77, OCBC shares fell 34 cents to S$8.56, and UOB shares dropped 63 cents to S$19.39. The Singapore Exchange was closed on Friday due to a public holiday.

 

DBS and UOB will report their Q2 earnings and interim dividends on Aug 6, while OCBC will wrap up the results season on Aug 7.

If banks can reward neither shareholders nor management, they might as well front-load bad loan provisions in 2020

 

THIS past week, the Monetary Authority of Singapore (MAS) dealt a blow to investors by calling on the local banks to cap their dividends.

 

" We are fortunate that banks in Singapore entered the Covid-19 pandemic with strong capital positions. All the same, MAS wants to ensure the banks' capital buffers remain ample in the face of significant uncertainties ahead, so that they can sustain lending to the economy," said MAS managing director Ravi Menon, in a statement on July 29.

 

Specifically, MAS wants the local banks to cap their dividends per share for FY2020 at 60 per cent of what they paid for FY2019. MAS also wants the banks to offer their shareholders the option of receiving their FY2020 dividends in scrip in lieu of cash. " We have carefully calibrated the restriction on dividends, taking into account the needs of investors who may rely on this income," Mr Menon added, in the statement.

 

The move by MAS was hardly a bolt from the blue. Only a fortnight ago, Mr Menon said that MAS was in close discussions with the local banks on their capital management, and flagged the possibility of their dividends being restricted.

 

Yet, the market reacted quite negatively to the imposition of the dividend cap. The day after MAS made its statement, shares in DBS, OCBC and UOB suffered declines of 3.09 per cent, 3.82 per cent and 3.15 per cent, respectively. The benchmark Straits Times Index fell 1.7 per cent on the same day.

 

Why was the market seemingly so unprepared for the dividend cap?

 

One possible reason is that many investors believed the appropriate moment for such regulatory action has passed. If the purpose of the dividend cap is to ensure that the banks have ample capital buffers to sustain their lending activities, then surely MAS should have acted in March, when increasingly tough measures to curb Covid-19 were being implemented and financial markets were crumbling.

 

The second possible reason for the negative market reaction is that the dividend cap was viewed as a signal of sorts from MAS that the local banks should now adopt a more prudent stance in their operations. Interestingly, its statement included this line: " MAS encourages banks to conserve and carefully manage their capital, by exercising restraint in discretionary expenditure and management compensation."

 

This seems out of step with the current mood in the market, which is geared towards expectations of a rebound in economic activity as Covid-19 restrictions are gradually lifted or modified.

 

MAS shifted position

 

Some background might be useful here.

 

MAS did, in fact, unveil several regulatory and supervisory measures in early April to help the banking system cope with the Covid-19 fallout.

 

Among other things, MAS loosened certain capital and liquidity requirements for banks, to allow them greater capacity to support borrowers, until September 2021. MAS also advised the banks to consider the " extraordinary measures" taken by the government when assessing the impact of Covid-19 on the economy and estimating loan loss allowances.

 

MAS told the banks at the time that sustaining lending activities should take priority over discretionary distributions. It did not, however, put any limits on their dividend payouts. " While MAS does not see a need to restrict banks' dividend policies, the release of capital buffers should not be used to finance share buybacks during this period," MAS said in a statement on April 7.

 

Since April, all three of the local banks have paid out dividends that were higher than corresponding payouts in previous years.

 

On June 5, OCBC paid a final dividend with respect to FY2019 of S$0.28 per share. Along with an interim dividend of S$0.25 per share paid last year, its total dividend payout for FY2019 was S$0.53 per share.

 

For FY2018, OCBC paid an interim dividend of S$0.20 per share and a final dividend of S$0.23 per share, for a total of S$0.43 per share.

 

On June 29, UOB paid out a final dividend of S$0.55 per share as well as a special dividend of S$0.20 per share with respect to FY2019. Including an interim dividend of S$0.55 per share paid last year, its total dividend payout for FY2019 was S$1.30 per share.

 

For FY2018, UOB paid an interim dividend of S$0.50 per share, a final dividend of S$0.50 per share and a special dividend of S$0.20 per share, amounting to a total of S$1.20 per share.

 

Then there was DBS. On May 26, it not only paid a final dividend of S$0.33 per share for FY2019 but also an interim dividend of S$0.33 per share for Q1 2020.

 

For FY2019, DBS paid interim dividends of S$0.30 per share for the first three quarters of the year. Along with the final dividend, that adds up to a total dividend of S$1.23 per share. For FY2018, DBS paid an interim dividend of S$0.60 and a final dividend of S$0.60, for a total of S$1.20 per share.

 

While MAS took its time restricting dividend payouts by the local banks, regulators in the UK acted more aggressively at the outset. Earlier this year, HSBC and Standard Chartered said that they would withhold dividends they had already declared for 2019, and suspend their interim dividends for 2020, at the behest of their regulators in the UK.

 

Managing virus impact

 

To be clear, I am not arguing against regulatory curbs on bank dividends during times of uncertainty. Back in March, this column called for the local banks to stop their share buyback activities and cap their dividends in order to preserve their capital.

 

Yet, the local banks are well-capitalised and well-provisioned, and things are not as uncertain as they were four months ago. While Covid-19 remains a problem, countries around the world are becoming more adept at managing the virus. In fact, at least one analyst has been speculating about the possibility of blow-out 2Q 2020 earnings at DBS.

 

Daniel Tabbush of the Tabbush Report, who publishes on Smartkarma, pointed out in a July 14 research note that total impairment costs at DBS hit S$1,086 million in Q1 2020, versus S$703 million for the whole of 2019. Meanwhile, oil prices have rebounded strongly, reducing the risks DBS faces in the energy sector.

 

" With oil and gas credit risk effectively cratering and a reopening of the Singapore economy and with sharply better economies in most regions globally, credit costs can end up being markedly lower during Q2 2020," Mr Tabbush said, in the report.

 

Of course, even if the banks are in good shape, some segments of the economy will feel a great deal of pain in the quarters ahead because of ongoing efforts to contain Covid-19.

 

This past week, The Business Times reported that the three local banks had granted payment deferments to more than S$15 billion worth of mortgages as at June 30. In addition, SMEs have deferred principal payments on some S$11.4 billion of secured loans.

 

As the fiscal measures that have enabled businesses to keep their doors open and their workers employed begin to expire in the months ahead, there could well be a surge in loan defaults, bankruptcies and fire-sales of collateral.

 

This shouldn' t pose too much risk to the banks though. DBS alone had a gross customer loan book worth S$362.4 billion as at end-FY2019. Of that, S$168.7 billion related to loans to Singapore customers. For FY2019, DBS reported total income of S$14.5 billion, and net profit of nearly S$6.4 billion.

 

However, with MAS now seemingly demanding more prudence, DBS and its peers might choose to front-load bad loan provisions in the remaining quarters of this year. After all, if they can reward neither their shareholders nor their management in FY2020, they might as well try to postpone any improvement in profitability until FY2021.

 

Indeed, it may not be a bad thing to avoid unseemly profits while the country is hurting.

 

Research house Jefferies is now forecasting FY2020 dividends of S$0.87 per share for DBS, S$0.31 per share for OCBC, and S$0.78 per share at UOB. Its previous dividend per share forecasts were S$1.23, S$0.46 and S$0.90, respectively.

 

On those dividend forecasts, the three banks are now trading at yields of 3.6 per cent to 4.4 per cent, versus 4.6 per cent to 6.2 per cent previously.

 

DBS and UOB are due to report their H1 financial results on Aug 6, while OCBC is scheduled to report on Aug 7.

Shares of Big Three local banks slide on Thursday after Wednesday' s news

 

SHARES of Singapore' s local lenders extended their slide on Thursday, after the central bank asked them to cap dividend payouts.

 

At the closing bell, DBS had dropped S$0.63 or 3.1 per cent to S$19.77 OCBC Bank had tumbled S$0.34 or 3.8 per cent to S$8.56, and UOB fell S$0.63 or 3.2 per cent to S$19.39. They were the most actively traded counters by value on the bourse for the day.

 

The Monetary Authority of Singapore (MAS) on Wednesday called on Singapore banks to cap their total dividends per share (DPS) for FY20 at 60 per cent of FY19' s total DPS, and offer shareholders the option of receiving dividends in scrip in lieu of cash.

 

This is a pre-emptive measure to ensure the lenders have adequate capital buffers to absorb economic shocks and continue to support recovery in the real economy. It is also in line with other central banks' actions.

 

In a research report, DBS analyst Lim Rui Wen said the cap implies a dividend payout ratio of 40-44 per cent, based on FY20 forecast earnings.

 

" We believe Singapore banks' valuation, now trading at about 0.8-1.0 times of FY21 forecast book value, was supported by their relatively high dividend yields," she wrote.

 

Therefore, the support levels could be pushed down by the latest move, which implies lower DPS for FY20 translating to lower dividend yields of 3.6-3.9 per cent, compared with the previously forecast 5.2-6.5 per cent, she said.

 

Goldman Sachs' reduced FY20 DPS estimates, based on FY19 DPS, imply a dividend yield of 3.9 per cent for UOB and 3.6 per cent for OCBC. DBS will have a dividend yield of 4.3 per cent for FY20, wrote Goldman Sachs analysts Melissa Kuang and Siward Ludin in a research note.

 

OCBC analysts noted that there had been higher street expectations of over 5 per cent dividend yields for FY20, so this cap will be disappointing in the near term.

 

Likewise, Citi said it will be viewed as negative for the banks as their dividend yields are an important component of the investment thesis for owning these names.

 

UBS analyst Aakash Rawat believes the impact will be the greatest for DBS, which investors see as a bigger proxy for generating dividend income than its peers, said Bloomberg' s report on Thursday.

 

The cut in dividends will add to the pain of a sharp quarter-on-quarter fall in the trio' s net interest margins for Q2, said Citi' s Robert Kong and Weldon Sng.

 

" With reduced market expectation of high dividends, we hope banks decide to front-load profit-and-loss provisions to pave the way for 2021 (return on equity) recovery," they wrote.

 

Meanwhile, UOB Kay Hian expects knee-jerk selling pressure on the stocks, and sees buying support for DBS at S$18.45, OCBC at S$7.95 and UOB at S$19.50. The brokerage has " buy" calls on both DBS and OCBC.

 

Despite the short-term hit to share prices, the dividend cap will place Singapore banks in a stronger position to combat challenges ahead, the DBS research team pointed out.

 

As at Q1 2020, the Common Equity Tier 1 (CET1) ratio stood at 13.9 per cent for DBS, 14.3 per cent for OCBC and 14.1 per cent for UOB, among the highest across Asean banks. DBS analyst Ms Lim estimates that the dividend cap will add 0.2-0.3 per cent to her projected CET1 ratio as at the end of FY20.

 

She expects the lenders to eventually pay out special dividends should their CET1 ratios remain well above pre-pandemic levels, if the Covid-19 situation stabilises and economic outlook improves towards FY21-22.

 

OCBC analysts reiterated that for the banking sector, time will be needed for asset quality deterioration to pan out, and a stronger capital build-up should provide room for higher dividends in the future.

 

" We expect a deteriorating credit cycle from 2020 to 2021. For Singapore banks, credit costs are expected to reverse from prior years' benign levels (FY19 sector range of 18-33 basis points), with cumulative increases expected at 100-130 basis points over 2020-2021, or 50-65 basis points per year," they added.

 

UBS also sees the central bank' s move as prudent, and believes it does not threaten the sustainability of payouts, Bloomberg reported. " Investors with a slightly longer-term horizon are likely to see this weakness as a buying opportunity," Mr Rawat said.

 

Goldman Sachs upped its target prices (TPs) for the trio, to S$27.40 for DBS with a " buy" call, and S$24.70 for UOB and S$10.34 for OCBC, both rated " neutral" .

 

DBS' analyst maintained " hold" calls on OCBC with a S$9.30 TP and UOB with a S$20.90 TP. OCBC Investment Research kept its " hold" ratings for DBS with a S$20 fair value, and for UOB with a S$21.50 fair value