Singapore banks, which have substantial capital buffers, face a happy problem, says Rena Kwok, credit analyst at Bloomberg Intelligence.
All three banks have the potential to optimise their capital structure by issuing capital securities as their sizeable buffers – due to regulatory requirements – are mainly built on excess costly common equity tier 1 (CET-1) capital, says Kwok in her June 7 report.
“Overutilising CET-1, the most expensive form of capital, is suboptimal,” she writes. “Despite [the banks’] CET-1 excess being more than 5% above the minimum regulatory hurdle [of] 9%, their total buffers are lower on a total-capital basis, indicating a lack of capital securities.”
As banks can issue additional tier 1 (AT1) debt for up to 1.5% of risk-weighted assets (RWAs) and tier 2 (T2) debt for up to 2% of RWAs, they can raise dividends as they substitute CET-1s in their capital stacks.
To Kwok, the move will benefit the banks’ shareholders with a better payout and profitability on any remaining common-equity base. “However, the credit implications would be mixed,” she writes.
Assuming the banks are looking to fully optimise their capital structure by filling their AT1s and T2 capital stacks, they may need to collectively issue US$7 billion ($9.41 billion) in AT1s and US$6 billion in T2s by 2025. This includes refinancing existing capital securities callable by 2025, notes Kwok.
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The issuance needs are estimated based on the banks’ disclosed figures from their 1QFY2024 business updates ended March 31 and total debt outstanding as at May 29.
In the analyst’s view, the market’s expectations of interest rates being cut in the later part of 2024 could make such issuances more attractive to the lenders, says Kwok.
“They usually receive favourable pricing on their issuance due to their track record of solid credit fundamentals, ratings and investor demand,” she writes.
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Among the three Singapore banks, DBS may need to issue the highest amount of AT1s and T2s by 2025.
In FY2024, Kwok expects the banks’ robust capital base to remain “ample”. As at 1QFY2024, they have at least $10 billion in excess CET-1 capital as at 1QFY2024.
“[This is] due to a modest growth in risk-weighted assets and solid earnings amid a shift in expectations to higher-for-longer rates, notwithstanding the banks' higher dividend plans and continued appetite for inorganic acquisitions, mainly in overseas markets,” she writes.
“Their CET-1 capital would also get a transitional uplift on the implementation of final Basel III reforms this year, in line with guidance,” she adds.
As at end-March, Oversea-Chinese Banking Corporation’s (OCBC) CET-1 ratio of 16.2% is the highest among all three banks, although United Overseas Bank U11 ’s (UOB) expanded Asean franchise – with the consolidation of Citi’s retail units – may boost the bank’s medium-term earnings and narrow its CET-1 gap compared to its peers, says Kwok.
Basel III impact ‘manageable’
The capital impact of final Basel III rules for all three Singapore banks looks to be modest. Given the banks’ capital buffers, the impact may not change the banks’ payout policy or require new capital raising, notes Kwok.
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The banks’ diverse portfolios may see shortfalls in some RWAs, but those can be offset by RWAs that are above the output floor in other cases, she adds. The banks’ trading books are moderate as well.
“The output floor and risk-insensitive standardized approaches have the most impact on low-risk assets. Banks with big trading books will be hit by Basel's review of the books,” Kwok writes.
“As DBS and UOB said, a move to final Basel III rules may lift their transitional CET-1 ratios by about 2%. That's due to provisions such as removal of the 1.06 multiplier for internal ratings-based RWA and a lower loss given default for loans to unsecured firms under a foundation internal ratings-based (FIRB) approach,” she adds.
As at 4.40pm, shares in DBS, OCBC and UOB are trading at $35.55, $14.27 and $30.74 respectively.
