Banks’ Showing May Be As Good As It Gets Amid Credit Turmoil

Source: The Straits Times, Nov 9, 2007

NEWS ANALYSIS

IS THIS as bad as it gets? This was the question on many investors’ minds as they scrutinised the impact of the global credit market turmoil on the third-quarter results of the three Singapore banks.

They have reason to be jittery, given the financial haemorrhage suffered by Wall Street banks.

Merrill Lynch has made write-downs of $8.4 billion while Citigroup is owning up to US$11 billion (S$15.9 billion) of possible losses over risky debt instruments.

They are called collateralised debt obligations (CDOs) and are packaged from sub-prime, or risky, mortgages in the United States.

Analysts warn the worst may not be over for these investment banks. So it is hardly surprising attention in Singapore has been gripped more by local banks’ provisions for CDOs than by their robust core earnings growth.

They are reaping the benefits of a booming Singapore economy, which have helped them deliver a 13 per cent rise in combined net profits to $1.57 billion for the quarter. This came despite write-downs, volatile markets putting pressure on interest margins and a rising Singdollar, which affected the value of overseas earnings.

The quality of the banks’ overall assets remained pristine, with non-performing loans dwindling.

Meanwhile, each bank’s provisions for asset-backed CDOs proved quite different from expectations. OCBC’s provisions surpassed market estimates by up to eight times as it aggressively set aside $221 million, or 82 per cent of its total exposure to CDOs. Analysts praised the safety-first move as one of the most conservative by any bank worldwide.

DBS set aside $70 million, about a quarter of its $275 million of CDOs. This was much lower than the average forecast of $125 million in a Reuters poll.

UOB made provisions of $55 million, or almost 60 per cent of its total asset-backed CDOs.

Analyst opinions differ widely over whether the bad news on CDOs is almost over.

Daiwa Securities’ Mr David Lum is among those who say the three banks tend to be conservative in making loan-loss provisions, so the worst may have passed.

But others, such as JPMorgan analysts, warn: ‘It ain’t over yet.’ They note that the prices of asset-backed CDOs continue to fall, slumping 50 per cent since Sept 30.

They also predicted that DBS has further mark-to-market losses of $116 million in the fourth quarter, while UOB has just another $10 million to go.

But one thing is clear to all: The three banks’ core businesses have proved robust so far. Not surprisingly, lending has been a star performer for all three amid a buoyant property market.

OCBC posted loans growth of 15 per cent - lower than DBS’ 23 per cent but close to UOB’s 15.6 per cent.

Fee income was also going strong. DBS, in particular, benefited from what CIMB-GK analyst Kenneth Ng described as ‘unexpectedly powerful’ capital market related-fees. Its net fee income rose 38 per cent to a record $403 million, riding on activities like stockbroking and wealth management.

However, wider credit spreads for trading instruments, triggered by the sub-prime crisis, took their toll on trading income.

DBS recorded a net trading loss of $47 million compared with a net trading income of $100 million in the previous quarter. UOB’s foreign exchange, securities and derivatives income fell from $97 million to $26 million.

Despite the solid performance of their underlying businesses, the banks are warning of risks and challenges on the horizon. In the near term, there will be pressures on net interest margins, amid a downward trend in Singapore interest rates and widening credit spreads.

The spreads are the difference in yield between a riskier corporate bond and a relatively risk-free government bond. Wider spreads may force the banks to take larger mark-to-market losses, which in turn will whittle down trading and investment income.

In the third quarter, UOB’s net interest margin had already declined 0.04 of a percentage point to 1.93 per cent compared with the same period last year. This was because it had more investment in shorter-term assets - less risky but with lower yields.

The banks’ earnings growth momentum may also be stifled if there is a sharp slowdown in the US - Asia’s biggest export market.

Other risks include ‘peaking loans growth’, while the axing of the deferred payment scheme for housing loans in Singapore may cause the high-end residential property market to cool, noted Morgan Stanley analyst Matthew Wilson.

So perhaps investors should start asking instead if the third-quarter showing is as good as it gets - at least until the credit market turmoil simmers down.