When Good News Doesn't Excite

Source : The Business Times, September 12, 2007

BANKS here should be cheering record loans growth; instead, they have borne the brunt of the sub-prime debacle.

According to a DBS Group Research note, banks' loans growth has hit an all-time high, rising nearly 11 per cent from a year ago. Consumer loans - in particular, housing loans - grew the strongest since August 2005.

Normally, this would have been enough to send bank stocks soaring. However, banks have seen their shares fluctuate wildly with every mere mention of any exposure to the sub-prime market through investments in collateralised debt obligations, or CDOs. Investors are shying away from picking up bank shares should there be more repercussions from the crisis in the US.

To be fair, banks here have been quick off the mark to announce how much they hold in direct exposure to the sub-prime market.

Now the issue is to find out how much they hold in terms of non-direct exposure to CDOs through special investment vehicles or bank-sponsored conduits which hold asset-backed commercial paper, which is a type of corporate debt. Banks are responsible for the assets if there are no investors in the commercial paper. These vehicles have invested in CDOs and thus pose a risk to the banks too.

Last month, DBS stock fell after investors learned about DBS's increased exposure to CDOs through a $1.4 billion asset-backed commercial paper conduit called Red Orchid Secured Assets.

DBS's total exposure to CDOs of $2.4 billion was almost double its original amount disclosed earlier. Its bank spokesman clarified that it had not included the $1.1 billion in its previous estimate of $1.3 billion of direct exposure to CDOs, because the vehicle was fully funded by short-term commercial paper sold to third-party investors. The risk of the CDOs rested with those investors, not DBS.

However, with the turbulence in credit markets spreading to commercial paper, there was a risk that DBS would have to make up any shortfall in funding if it failed to find buyers for the commercial paper, which is due for renewal soon. This would mean DBS would bear the risk of the underlying CDOs equivalent to the level of funding it needs to add.

Other banks, UOB and OCBC, have come out to say that they have no such similar special conduits invested in CDOs.

Although numerous analyst reports have also come out to say that Asian banks' exposure to the sub-prime market is manageable, and that the local banks have been very transparent about their CDO holdings, the race is on for banks here to find out exactly how much they are exposed to, especially indirectly.

As DBS's case had earlier shown, it was not in the line of fire since the risk of the CDOs belonged to investors holding the commercial paper. But as the contagion effect quickly spreads, banks find themselves in a hot spot as they have to provide back-up funding. As sub-prime fears threaten to overwhelm other issues, it seems banks' share prices are now dependent on how timely and comprehensive their information is on risks they may face in the sub-prime space.