Although Singapore banks are capital-rich, they may capitalise on strong investor demand for yield to “optimise their costly capital structures” through subordinated debt offerings given the likely interest rate cuts, says Bloomberg Intelligence analyst Rena Kwok. Equity is viewed as the most expensive capital, followed by hybrids such as additional tier 1 (AT1) securities, bonds, and covered bonds.
Out of the three Singapore banks, DBS Group Holdings, Oversea-Chinese Banking Corporation (OCBC) and United Overseas Bank U11 (UOB), DBS and OCBC have higher weighted average cost of capital (WACCs) with at least $4 billion in excess common equity tier 1 (CET-1) capital, higher than their target operating range of 12.5% to 14%. According to Bloomberg, WACC for DBS and OCBC were 7.9% and 8.7% respectively as of 2QFY2024, exceeding their local bank peers’ last five-year average of 7.7%.
However, they could reduce their WACC by borrowing amid the likely interest rate cuts. This would bring their WACC in line with the average of other big local banks, potentially boosting shareholder returns, Kwok says. The potential for refinancing has resurfaced, with existing capital bonds such as additional tier AT1 and tier 2 (T2) capital nearing their call dates. As of Sept 9, OCBC has $1 billion in T2 and DBS has $1.7 billion of AT1s that are callable in 2025.
Singapore banks have “room to optimise” their costly capital structure by issuing debt rather than relying on CET-1 buffers to achieve regulatory hurdles, Kwok mentions. This could allow them to substitute CET-1 and increase shareholder returns through higher dividends but has varied credit implications.
While local banks such as DBS, OCBC and UOB have CET-1 excess of at least 4% above the regulatory minimum of 9%, their buffers are lower on a total-capital basis, highlighting a lack of debt.
According to Kwok, existing AT1s face “limited pressure” by the Australian Prudential Regulation Authority’s (APRA) proposal to remove such securities in regulatory capital as they are not trading at a significant premium to par. As such, it is unlikely the Basel Committee will eliminate AT1s and Singapore’s regulator generally follows global guidelines, allowing banks to issue AT1s for up to 1.5% and T2 debt for up to 2% of risk-weighted assets. Furthermore, Kwok notes that AT1s in Singapore are offered only for institutional and accredited investors or transactions in denominations of at least $200,000, limiting the impact.
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Further to the report, Kwok highlights that capital reserves remain a “key credit strength”. Singapore banks have capital bases of at least $10 billion in excess CET-1 capital, well above the minimum regulatory hurdle of 9% in 2QFY2024 and will probably “remain robust in 2024 due to modest growth in risk-weighted assets and solid earnings”, Kwok notes. The banks’ CET-1 capital are likely to receive a transitional uplift following the implementation of final Basel III rules this year.
According to the report, OCBC’s CET-1 ratio was the highest at 15.5% as of 2QFY2024. However, Kwok noted that UOB’s bigger Asean franchise may enhance its medium-term earnings and narrow the CET-1 gap between UOB and its peers.
According to 2QFY2024 figures disclosed by banks and the total debt outstanding as of Sept 9, compiled by Bloomberg, the report has found that Singapore banks may need to issue $7 billion in AT1 and $6 billion in T2 bonds in 2025 in total. This follows the assumption that the banks fully optimise their capital structure by maximizing their AT1 and T2 stacks and refinancing their existing capital debt that is callable by 2025. The report finds that DBS may need to issue the highest amount of AT1s and T2s in 2025 to fully maximise its capital structure.
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Kwok notes that “investor demand for high-coupon debt amid pending rate cuts could make such issuance more attractive to lenders for capital optimization” and that banks often receive favourable pricing for their debt, in part due to their “track record of solid credit and ratings.”
As at 10.09am, shares in DBS are trading 0.17% down or 17 cents lower at $37.77. Shares in OCBC are trading 0.26% down or 4 cents lower at $15.24, while shares in UOB are trading 0.99% down or 32 cents lower at $32.12.
