Yesterday, the Monetary Authority of Singapore published data showing weak loan growth in Singapore banks possibly due to the global economic slowdown, moderation of trade flows and tightening of underwriting standards. Total system loan growth in October 2015 grew only 2.6% from the previous year, and was down 1.4% from the previous month.

The share prices of Singapore banks, particularly DBS’, have taken a hit over the past three weeks. For the period of 4 November through yesterday, DBS has fallen -7.4%, OCBC -5.6%, UOB -4.7% versus the STI’s -5.6% loss.

The Monetary Authority of Singapore (MAS) published its Financial Stability Report (FSR) on 27 November 2015.

The credit cycle has started to turn and the MAS sees signs of increased credit risks. The wording suggests relatively more concerns about tail risks in the corporate sector – particularly highly levered and/or FX exposed SMEs - and fewer concerns about household and property sector.
 
Impact

Credit cycle turning – In short, loan growth has been slowing, non-performing loans (NPLs) are rising (from very low levels) – or in other words the credit cycle in Singapore is turning. Asset quality tail risks have increases significantly since July, not only for the Singapore banks but for most ASEAN banks (excluding Philippines).

Risks shift from households to corporates – It looks like risks have shifted to the corporate sector from the household sector. In particularly small-medium enterprises (SMEs) that are (i) highly levered and/or (i) exposed to currency risks look particularly vulnerable. First signs of asset quality deterioration among the more vulnerable firms are already visible. The MAS sounded less concerned about tail risks in the household sector – including mortgage lending – compared to the past, in MER’s view. It looks like that the macro-prudential measures which were introduced post the global financial crisis reduced risks in the Singapore household sector. In addition, there appears to be fewer concerns by the MAS on tail risks relating to liquidity and funding for the financial sector in Singapore.

Macquarie Stress Test on Singapore banks – Based on MER’s stress test scenario, the current trading multiples of Singapore banks suggest an increase in loan loss provisions from currently 0.28% to 0.5% (average until end 2018). This implies that 85% of total special mention loans turn into NPLs. In other words, the market is already discounting for a rather adverse asset quality scenario for the Singapore banks, in MER’s view.

Outlook
At the moment MER has an Overweight view of Singapore banks on a regional sector basis. Their top pick among Singapore banks remains DBS.
 
MER assumes that increasing asset quality concerns would result into a ‘flight to quality’ in ASEAN which will point towards the Singapore banks. This has not worked out well because despite decent quarterly earnings, the market has started to question ‘quality’ and re-priced for tail risks much faster than MER expected.
 
Based on their ‘stress test scenario’, MER believes that a lot of asset quality uncertainties for Singapore banks are already priced in. They continue to see fundamental upside for the stocks. That said, it will be difficult for banks to outperform the broader market when the credit cycle is turning. This is a headwind for most ASEAN banks (excluding Philippine banks).

Source: Macquarie Research - 2 Dec 2015