Regardless the increase in operating profit for Oversea-Chinese Banking Corp (OCBC) or the resilient performance of United Overseas Bank’s (UOB) regional subsidiaries or the strength of DBS Group Holdings’ net interest income and non-interest income; the banks made huge amounts of provisioning in 2QFY2020 and 1HFY2020 which impacted their bottom lines.
DBS made a special provision (now classified as expected credit loss or ECL stage 3) of $672 million in 1HFY2020, almost double that of last year, due to a significant exposure to an oil trader that became non-performing in the first quarter. The oil trader is likely to be Hin Leong Trading. In 2QFY2020, DBS continued to increase its general provisions to $849 million, with specific provisions at $173 million and taking total credit cost in the second quarter to 90 basis points (bps).
OCBC and UOB both also had specific provisions related to Hin Leong but these were less than that of DBS. Under its special provisions, OCBC took the opportunity to further write-down its loans to offshore service vessel (OSV) providers to just 10% of the collateral. Meanwhile, its general provisions — which are now classified as ECL stage 1 and 2 — were boosted by $614 million in 1HFY2020 comprising management overlay of $300 million, and macro-economic variable (MEV) adjustments of $194 million.
The MEV model is based on outlook for GDP growth, unemployment and inflation, among other indicators. When the MEV model darkens, banks are required to increase their general provisioning, and they have been doing this. Management overlay is the amount of general provisioning above and beyond what the MEV model requires a bank to have.
Exercising prudence
The amount of gross provisioning or GP depends on MEV models and management overlay and they are part of ECL stage 1 and 2. DBS had $3.23 billion in GP reserves at the end of 1QFY2020. DBS added around $560 million to this, taking its total GP reserves to $3.8 billion. Since this is more than 1% of gross carrying amount of the selected credit exposures net of collaterals (this is also called minimum regulatory loss allowance), DBS no longer needs to add to regulatory loss allowance reserve (RLAR). RLAR is required when GP falls below the MAS minimum requirement of 1%. DBS’s RLAR is at 1.24%. Since DBS’s GP reserves are raised beyond Tier 2 eligibility by $1 billion, it can be used as Common Equity Tier 1 (CET1) to buffer against unforeseen credit deterioration.
The RLAR — which are set aside from retained earnings — is part of banks’ loss allowances which are usually only granted limited recognition as Tier 2 capital. In April this year, MAS announced it will allow full recognition of RLAR as Tier 2 capital.
As at end 1QFY2020, UOB had just under $2 billion of GP reserves. In 2QFY2020, it added $403 million, taking it to $2.39 billion, which is also above the 1% MAS minimum regulatory loss allowance. However, UOB has decided to maintain its RLAR at $379 million, up marginally q-o-q. OCBC’s GP is below 1% of minimum regulatory loss allowance and maintained an RLAR of $874 million, unchanged q-o-q.
Outlook for provisioning
During the results briefing, UOB CFO Lee Wai Fai says he expects total provisions to amount to $2 billion for the best-case scenario, and $3 billion for the worst-case scenario, which translates into credit costs of around 100bps to 130bps for 2020 and 2021.
“Loans under moratorium are the major focus but they are heavily secured. We will proactively manage or record as provisions ahead of time. Where the [business] model is not functioning, we will take special provisions (SP), like this quarter (2QFY2020). I will add to GP to take it up to 60bps. Our view under this environment is that the crisis will stabilise by year-end,” says Lee.
Similarly, OCBC has also guided on credit costs of 120-130bps for two years. Already, in 1HFY2020, OCBC recorded total credit costs of 91bps.
DBS expects $3 billion to $5 billion in total allowances which works out to be 120bps over a two-year period. In 2QFY2020, it has already taken 90 bps of total allowances, including 26bps in special provisions. In 1HFY2020, DBS’s credit cost is around 1%, with special provisions at 30bps.
If indeed economies get back to work by the end of this year or the beginning of next year, credit costs could abate, and the huge provisions that the local banks have taken could be written back eventually.
