Credit costs likely peaked, asset quality stabilises, dividends to normalise for Asean banks

“Because of the seven-year period of building up provisions and write-offs, loan loss coverage buffers are high,” Modi says, indicating that risk aversion among Thai banks are likely to be very high following several years of asset problems.

TMB reported its 4Q2020 and FY2020 results on Jan 20 this year, with net profit of THB1.2 billion ($53 million), down 23.5% y-o-y; and THB10.1 billion, up 40% y-o-y, respectively. Pre-provisioning operating profit was within the street’s estimates but bottomline net profit came in 3.5% below estimates. TMB recorded credit costs of 178 basis points (bp) for the full year, with 4Q2020 provisions higher than previous quarters by a fair amount. Non-performing loans (NPLs) adjusted for write-offs and sales increased in 4Q2020 by 9% q-o-q. Stated NPLs also grew by 8% on a q-o-q basis. TMB has attributed the increased provisions as reflecting a forward-looking outlook to cover macro downside risk.

“TMB is on track to deliver a turnaround, which positions it well for sustained re-rating,” the JP Morgan report says. Modi points out that Thai banks are still meaningfully lagging behind on multiples, that is, valuation, and the perception around profitability. “If we get a positive surprise on tourism borrower cash-flows, asset quality will hold up much better than currently feared. This can lead to quite sharp re-rating. Some of the gains on re-rating can hold on for next few years. So Thai banks look positive,” he says.

Peak credit costs ‘behind us’

Within Asean, different countries had different forbearance measures which have in general been rolled back. Peak credit costs are likely behind us, Modi reckons. “The perception or worry about credit quality was at the peak in mid-2020. The banks provided as much credit costs, as was possible,” he says.

In most Asean countries, provisions were taken on the basis that debt servicing obligations have already been reduced to match the reduced cash flow from banking customers. In 4Q2020, Asean economies such as Singapore and Malaysia have moved to more targeted forbearance measures, providing relief to certain segments of the economy.

Because of the combination of a meaningful amount of provision, a sharp rise in provisioning may not be necessary, Modi suggests. “Provisions are starting to improve quite meaningfully. As a result, profitability for 2021 should start healing and getting closer to 2019 as a base case,” he says.

NPLs are likely to rise this year. This is because customers which still have debt servicing problems are likely to be classified as non-performing. Banks, in particular the Singapore banks, have already taken this step on provisioning, hence there could be some coverage drawdown, but profitability should improve in 2021.

Part of the banks’ improved performance that is expected this year is due to the pandemic being contained. Within Asean, Singapore and Vietnam have been the most successful. Clearly, in terms of public health outcomes, Singapore has been one of the most successful — so far — globally. Ideally, Singapore’s success at containing the pandemic should feed into a rebound in business activity — which in turn feeds into better operating cash flows. Unfortunately, Singapore needs the external environment to improve for a sustained economic rebound to kick in.

Still, Modi points out that the Singapore banks overall provisions came in at the lower end of their guidance for the first three quarters of 2020. “That trend continues. The extent of success of the vaccine rollout will determine scale of broader economic activity. This will determine extent to which credit costs will be at the lower end of the guidance range. Singapore is setting up measures to vaccinate 70,000 a day, which has implications for travel and so on, and there is reasonable likelihood that we get a pretty decent outcome on provisions, even if reported NPLs go up,” Modi says.

The situation in Malaysia is more challenging. The Malaysian government has announced an emergency to last till August, and has implemented a movement control order in some parts of the country. At a bank-specific level, banks which are focused on the upper end of the income level and on SMEs which have good cash flows and high collateral values are likely to be better off than mass market banks, Modi believes. Some banks have had credit risk building since 2019, and those risks have become more elevated.

“Banks with multi-country operations, large corporate credit book and mid- to lowend consumers loans, would have more risk. So investment view is more bottom-up and bank-specific,” he says.

Impact of credit costs, NPLs on asset quality

If the local banking sector’s peak credit costs have indeed been made in 2020, profitability could have bottomed. If so, banks’ earnings could continue to accrete to capital, preserving their net asset values. In the general global economy, asset quality has held up.

In fact, in the US the Dow Jones Industrial Average, the Nasdaq Composite and Nasdaq 100 indices and the S&P 500 Index have all made new highs. And till, January this year, yields on the 10-year US treasuries were ultra low, all thanks to quantitative easing and ultra-low interest rates.

In Singapore, based on URA’s latest announcement on Jan 22, prices of private residential properties increased by 2.1% q-o-q in 4Q2020, while private residential property prices rose 2.2% y-o-y in FY2020.

“The single largest reason why asset quality has held up well is because asset prices have gone up and a big chunk of collateral value is property. And if share and bond prices rise, there is no panic selling of property. Hence, the lender is not in a hurry to liquidate the collateral. So the vicious cycle of lower asset prices leading to forced selling was avoided,” Modi points out.

While some businesses may not survive, banks have created provisions in advance, and write-offs may not have a worse than anticipated impact. “Book values appear reasonably well protected. Banks’ stock prices have started going back to January 2020 levels, which shows that fear of book value erosion has reduced quite a bit,” Modi notes.

Dividends in 2021 higher than 2020, lower than 2019

In a nutshell, Singapore banks’ dividends this year could be higher than 2020, and lower than 2019’s. In FY2019, DBS distributed $1.23 per share. Singapore’s largest local lender pays a quarterly dividend. It paid 33 cents per share in 1Q2020, 18 cents per share in 2Q2020 and a further 18 cents per share in 3Q2020.

Oversea-Chinese Banking Corp (OCBC) distributed a dividend of 53 cents per share last year, and has paid out 15.9 cents per share for 1H2020. Last year, UOB’s ordinary dividend was $1.10 per share and shareholders also received a special dividend of 20 cents per share, making a total dividend of $1.30 per share. In 1H2020, UOB paid out 39 cents per share. Both OCBC and UOB pay dividends half yearly.

In July last year, the Monetary Authority of Singapore (MAS) recommended that banks pay out 60% of 2019’s dividends in 2020. This was for banks to retain capital to lend to businesses to support the economy. Now, it appears we are past the worst.

Still, banks’ ability to generate returns such as return on equity (ROE) is lower. On the other hand, the risk to book value is also much lower.

“Logically it’s more likely than not we get to a normalised level sooner rather than later but a normalised level depends on regulators’ assessment on the sector, individual banks’ asset quality, return on assets, and ROE generating ability, and whether the growth outcome is going to sustain over next three to six months and next few years,” Modi says.

The MAS may only clarify nearer the banks’ half-year results which could be announced in July–August. Dividends are a measure of profits because the banks have guided for payouts of around 50% on average. Hence, the number could be volatile depending on net profit which in turn depends on provisions and other metrics such as income growth, interest rates and so on.

Digitalisation and digital-only banks

As the pandemic clears — as it is likely to do eventually — Asean banks are facing a challenge from digital-only banks. This was highlighted when MAS, and then Bank Negara announced new banking licenses for digital only banks.

In Singapore, Grab–Singapore Telecommunications and Sea were awarded digital full bank (DFB) licenses. Ant Group, and a consortium comprising Greenland Financial Holdings Group Co, Linklogis Hong Kong and Beijing Co-operative Equity Investment Fund Management Co were awarded digital wholesale bank licenses (DWB).

According to a Jan 12 report by UOB Kay Hian, incumbent brick-and-mortar banks have multiple sources of income compared to digital-only challenger banks that are reliant on transaction fees.

“Customers at digital-only banks hold 1.5 products compared to five for incumbent banks. Digital-only banks’ weakness centres on the inability to generate revenue: Digital-only banks’ loss per customer has deteriorated from EUR10– 60 [$16–97] pre-Covid to EUR20–75 post-Covid. Incumbent banks’ profit per customer has deteriorated from EUR150–350 pre-Covid to EUR50– 200 post-Covid”, UOB Kay Hian says.

Funding could also be a challenge for digital-only banks. Monzo, a top digital-only bank based in the UK, raised funds at a 40% discount to the previous valuation in June 2020. In its annual report for 2020, Monzo warned that its ability to continue as a going concern is subject to material uncertainties. “The party years have ended and investors have started to closely scrutinise the profitability of digital-only banks,” UOB Kay Hian cautions.

Monzo and Revolut received a barrage of complaints from customers shut out of their accounts frozen during the lockdown. Hundreds of customers complained that they could not access their funds as their accounts were frozen without notice. This episode of poor customer service will affect customers’ perception on reliability of digital-only banks.

Elsewhere, Xinja Bank, a digital-only bank in Australia launched in 2019, has refunded customer deposits and handed back its banking licence to the Australian Prudential Regulation Authority in December 2020. Xinja Bank explained that raising capital had become impossible due to Covid.

Full service banks, on the other hand, can continue to spend on technology — as the Singapore banks are doing, including copying some of the new technologies digital-only banks and FinTechs use.

“In 2012–2013, when we had a lot of buzz about North Asian payment players gaining a foothold, Singapore moved very quickly with the regulatory regime, with the regulatory sandbox to try out new products. This allowed incumbents to create a skill set and gain scale in digital channels rather quickly e.g. PayNow, and PayLah! Now all of us use these modes of payments multiple times during a day. That tells me the digital offerings of the incumbents is pretty good, which makes it difficult for challengers to gain market share,” Modi elaborates.

Idiosyncratic challenges

While Singapore banks are likely to hold their own against the challenger banks, they have their idiosyncratic challenges. For instance, DBS was instructed to amalgamate Lakshmi Vilas Bank (LVB) with DBS Bank India (DBI) on Jan 25, under special powers of the Reserve Bank of India (RBI) and Section 45 of the Banking Regulation Act. LVB has a history of 94 years and a retail and SME customer base. The amalgamation enables DBI to scale up in South India, which has longstanding and close business ties with Singapore.

DBS has injected Rs2,500 crore ($463 million) into DBI. However, absolute NPLs are estimated at $614 million, UOB Kay Hian says. The accounting treatment for these NPLs is unclear.

In addition, LVB is alleged to have serious governance issues and lacked internal control. LVB’s loan book is said to have expanded five times from 2007 to 2019. Bad lending practices and the aggressive expansion into corporate loans have led to a spike in the NPL ratio to 25%. Moreover, LVB suffered losses over the past three years and it has experienced continuous withdrawal of deposits.

Elsewhere, UOB Kay Hian points out that DBS is likely to recognise its exposure to the troubled Huachen Automotive Group as an NPL.

In its Jan 14 report, JP Morgan retains an overweight recommendation on DBS. “The bank is delivering on asset quality, with 3Q2020 book under moratorium at 5% of loans (vs 5% at OCBC and 10% at UOB as of October). This is a possible source of long-lasting stock price premium. DBS has finessed credit risk management over the years, which likely accelerated after O&Gled losses in 2015–2016. In some sense, this was the final piece of the puzzle for the stock to rerate meaningfully,” the report states.

DBS’s 4Q2020 results will be announced on Feb 10.