Singapore Banks Sector
SECTOR REVIEW
Earnings and book value risks
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We evaluate three risks: 1) Is a 120 bp credit cost assumption in 2009
too drastic? 2) Will banks take a further mark-to-market hit to book
value? 3) Will this mean dividend cuts in 2009?
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From about 50 bp in 2008E, we expect loan loss provisions in P&L to
jump to 121 bp in 2009, based on our assumption of NPLs rising by
2.5% of loans (NPL ratio currently 1.3-2.0%). We believe this is
reasonable, given the experience during the Asian financial crisis and
the fact that turns in the asset quality cycle are rather sharp.
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Apart from the depreciation in market value of trading book (reflected
directly in P&L), we are also worried about the AFS book. Government
bonds have rallied, but the market value of corporate bonds and
equities has fallen since 30 September. Already by 3Q08, book values
had taken a hit of 5% in DBS and 10% in UOB/OCBC, and we expect a
further hit in 4Q08 (roughly 2% in DBS; 6-7% in UOB and OCBC).
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At the group level, the three banks are running very comfortable Tier 1
ratios. However, four things to note: 1) the core equity Tier 1 is much
lower than reported Tier 1, 2) the solo-bank level core equity Tier 1 is
not very different among the three banks, 3) we are projecting more
than a 100% payout ratio in 2009 and 4) the risk-weighted assets may
increase due to Basel-2 even though we expect zero loan growth next
year. Hence, we see a real possibility of a cut in dividends next year.
DBS is likely to be seen as being under the greatest pressure, given its
lower core equity Tier 1 and corporate exposure. In our view, though,
the risk may not be significantly different among the three banks.
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We remain UNDERWEIGHT banks within Singapore context with a
preference for UOB, followed by OCBC. UOB’s P/B premium to DBS
seems justified given the risks in DBS. In the Asian financials context,
we find Singapore to be one of the few safe havens on a relative basis.

Earnings and book value risks
120 bp credit cost too drastic?
From about 50 bp in 2008E, we are expecting loan loss provisions in P&L to jump to
121 bp in 2009, before coming back down to 63 bp in 2010E. This is based on our
assumption of NPLs rising by 2.5% of loans (from 1.3-2.0% currently) and we are
providing about half of that as credit cost in 2009E. We believe this is reasonable given the
experience during the Asian financial crisis and the fact that turns in the asset quality cycle
are rather sharp. During 1997-99, banks suffered a credit cost of 512 bp in total (138 bp in
1997, 224 bp in 1998 and 150 bp in 1999) and NPLs peaked at 12.9% in 1999 (from 1.8%
in 1996). While the proportion of loans outside of Singapore has gone up (DBS in HK,
UOB in TH, MY, ID, and OCBC in MY, ID), we do not believe the cycle will get as bad as
last time because: 1) the loan book has changed in favour of mortgages, while
building/construction loans have not changed much, 2) customers are not overly leveraged
and likely matched on currency, 3) credit has not been over-extended in Singapore with a
five-year loan CAGR of 9.6% being the same as nominal GDP growth, 4) domestic
consumption and investments should still grow, although GDP may slip into a recession
due to exports and, most importantly 5) interest rates are much lower this time around.
MTM hit to book value
Apart from the depreciation in the market value of the trading book (which is reflected
directly in the P&L), we are also worried about the large investment portfolios of banks
being carried as available-for-sale (AFS). Government bonds have rallied but the market
value of corporate bonds and equities has fallen since 30 September. Already by 3Q08,
book values had taken a hit of 5% in DBS and 10% in UOB/OCBC, and we expect a
further hit in 4Q08 (roughly 2% in DBS, 6-7% in UOB and OCBC). This markdown should
significantly exceed the retained profit for the year, hence banks would end the year with a
book value lower than at the beginning. Consequently, the P/B multiple on 2008E book
value is higher than that in 2007.
Dividend cuts in 2009?
At the group level, the three banks are running very comfortable Tier 1 ratios (DBS is at
9.7%, UOB 11.2% and OCBC 14.4% as of 3Q08). However, there are four things to note:
1) the core equity Tier 1 at the group level stands at 7.8% in DBS, 9.3% in UOB and
10.6% in OCBC, i.e., significantly lower than reported Tier 1, 2) the solo-bank level core
equity Tier 1 is estimated to be around 8.3-8.5% for DBS, around 8.5% for UOB and 8.5-
9.0% for OCBC. Hence, these are not very different from one another, 3) we are projecting
profits in DBS and OCBC will fall below the dividend payable if they maintain the same
dividend per share as that in 2008E. In other words, we are projecting more than a 100%
payout ratio in 2009 and 4) the risk-weighted assets may increase, even though we expect
zero loan growth next year, due to corporate credit rating downgrades and an increase in
the “probability of default” and/or “loss given default” as property prices decline. Hence, we
see a possibility of a cut in dividends next year, depending on how the cycle unfolds. DBS
is likely to be seen as being under the greatest pressure, given its apparently lower core
equity Tier 1 at the Group level (banks do not disclose the solo-bank Tier 1) and corporate
exposure but in our view the risk may not be significantly different among the three banks.
Net net
We remain UNDERWEIGHT the sector with a preference for UOB, followed by OCBC and
DBS. UOB’s P/B premium to DBS has expanded lately, but we think it is justified given the
risks in DBS (refer DBS: Headwinds galore, 20 October 2008). Our forecasts for the three
banks are 35-50% lower than consensus for 2009E. In the Asian financials context, we
find Singapore (mild OW) as one of the few markets in which to seek shelter.