Amongst the 15 affected banks are Credit Suisse, which received the maximum reduction of three grades, Morgan Stanley (two grades), while Citigroup and Bank of America are now left the lowest-rated of them, standing at only two levels above junk status.

The downgrade is set to shake up competition amongst Wall Street’s largest financial institutions as downgrades may force banks to post additional collateral to trading partners in derivatives deals while boosting the companies’ borrowing costs.

While investor confidence in banking stocks may be rattled following these downgrades, a Macquarie Equities Research (MER) report on Asia banks published on 20 June 2012 indicates that Asia banks are still in a sweet spot.

In further detail, MER observed the below:

Expecting higher NPLs & provisions, but… MER’s broad expectations are for higher non-performing loans (NPLs) and provisions in Asia this year, though largely as a function of the normalisation process. MER is not expecting NPLs of crisis proportions hitting the sector, and banks have generally not conveyed alarm bells thus far. MER simply thinks banks have been riding the tailwinds of low provisions over the past few years. This is consistent with previous cycles, where banks typically post low credit charges for two to three years coming out of a crisis on the back of recoveries and write-backs.

…asset quality remains benign. Up to this point, however, MER has yet to see their expectations play out – NPLs and provisions have remained low, and in some places, continue to trend down. The deterioration in asset quality has largely been benign, and MER may increasingly have to consider the scenario that provisions may remain low for yet another year in some countries.

Here in Singapore, MER notes that NPLs in Singapore remain low. The Singapore banks’ offshore exposures are more of a concern, as always. However, capital positions are very strong, as per MAS guidelines. All three Singapore banks have now ceased the discounted scrip dividend schemes. DBS Group’s CET1 ratio will be close to 1ppt less than (11-12%) peers if the Danamon deal goes through. This could mean a reduced capacity to grow. A cash offer for AFG might result in a rights issue.

Bank rates remain very low, in line with global rates. Property lending is key for both corporate (developers) and consumer (mortgages). Both are likely to remain strong and stable. Trade finance is the key swing factor for corporate loan growth which has been far more volatile. Looking at deposit growth, there is still plenty of liquidity in Singapore. Expectations of further currency appreciation should allow this to persist. However, there is some competition kicking in as fixed deposit rates have ticked up slightly.

MER remains overweight on Sing banking sector*. MER continues to see the Singapore banks as defensive and has an Outperform rating on UOB (TP: $20.61), DBS (12-month TP: $16.61) and OCBC (TP: $9.59)