Saturday, November 26, 2016

LLoyds Bank

A quick look at Lloyds, the largest bank in the UK.

The only two UK-listed banks serving the UK market are Lloyds and RBS.  Both went under in 2008 and had to accept government bailouts - pages 3 and 4 here give a brief history.  They are slowly mending, though still making large provisions to pay for past misdeeds.  Lloyds is the stronger of the two.

Market Share

The UK banking market is highly concentrated for savings, less so for mortgages:
  • For savings accounts: A UK government report states "The four largest banks (LBG, HSBCG, RBSG and Barclays) in Great Britain (GB) accounted for approximately 70% of active PCAs (Personal Checking Accounts) and 80% of active BCAs (Business Checking Accounts) in 2014".
  • For home loans: Moodys is cited saying that in 2014 the top 5 players had 2/3rds of the market: "Lloyds was the industry leader, controlling 24 per cent1 of the market share, followed by Santander UK with 13 per cent, Nationwide with 12 per cent, and Barclays and Royal Bank of Scotland (RBS) with 10 and eight per cent, respectively."

There are new entrants:
  • There has been new entry into retail banking in recent years. Metro Bank (PCA and SME) was the first organic entrant to the UK banking market in more than 100 years when it received its banking licence in March 2010.  Aldermore Bank (primarily SME but not BCA) entered in 2009. Several other new entrants have their roots in ancillary financial/retail services such as Tesco Bank (PCA 2014), the Post Office (PCA 2013/14), Virgin Money (PCA 2014), and Marks & Spencer Bank (M&S Bank) (PCA 2012). Handelsbanken (PCA and SME) has also significantly extended its UK operations more recently almost doubling its network between 2011 and 2015.
  • There are also a number of banks that have just been authorised or are in the process of being authorised including Atom Bank (authorised in June 2015, digital-only PCA and SME), Starling Bank (digital PCA), Civilised Bank (SME) and OakNorth (authorised in March 2015 SME but not BCA). In addition to traditional bank lending, alternative finance has been growing very rapidly in recent years. It has been estimated that the alternative finance sector had grown by around 160% in the year to 2014. Despite the rapid growth, alternative finance currently accounts for a very small share of SME lending (less than 2% of SME lending). 

Non-Interest Income

Trading and Insurance

Lloyds says that they do "not have a programme of proprietary trading activities".  So why is their "Net Trading Income" so high?

The "Net Trading Income" is tied to its insurance profits 2 , 3.  I can't untie the numbers in any meaningful way, so I add them all together:

This follows the stock market.  Looks like a typical insurance operation where they lose money on insurance and make it up by investing the float.  As expected, a large part of their "Trading and financial assets" held are equities (43%), followed by bonds (33%) and Loans/Advances to Customers (21%) 4.  So the above number is gonna drop when the stock market falls.

Fee and Commission Income

Fees do not seem to be affected by the economy.  Gross fees (i.e.: ignoring their direct costs) are broken down below.  "Other income" includes "Fiduciary and other trust income", Insurance Broking, and others:

Combining all of the above categories, and deducting costs, gives us net fees:

Bank fees in the UK are high, and have been the target of a government inquiry.

Other Operating Income 

Operating Lease income (blue above) is from Lex Autolease.  The increase in 2009 is when Lex Autolease was created from the takeover of HBOS.  Since it happened after the recession, we can't tell if operating lease income is affected by the economy.

Other Income (red above) is very spiky. I have removed one-off items from it 5.  Fortunately its low in 2015, so we can ignore it.


To get an idea of how much of their earnings come from interest vs non-interest, the above income categories are shown for 2015:

This excludes operating costs, and any provisions deducted from interest income.

Other Numbers

The CET1 ratio was 13% at end of 2015, which is OK.   However, RWA does not account for systematic risk.  Tangible Assets were 18.6 times Tangible Equity6, which is too high.

In 2015, (non-interest) operating costs were 2.5% of Deposits.

For Derivatives: The notional amount of derivative exposure is 5.9X total asset value - very high.  Lloyds says that they only hold derivatives for their customers or use them for hedging.


After removing the one-off items from their 2015 results (PPI provisions and TSB sale), their EPS rises from 0.8p to 6.7p.  At a share price of 60p, thats a PE of 9.

Other Risks

The two main risks are:
  • A falling pound, from Brexit
  • UK house prices have been rising for 4 years, and are due for a correction.

The previously rising pound and rising house prices may have fed on each other on the way up, and might unwind now.


I like it because its simple bank which makes most of its profits from deposit, loans, and fees, with a little insurance on the side.  It has minimal proprietary trading.  And operates in one country.  When its legacy problems eventually go away, it will be cheap at today's price.

Its operations are simpler than the Singapore banks.  However, leverage based on the assets/equity ratio is too high...I don't fully trust the CET1 ratio as RWA can be manipulated and doesn't detect systematic falling house prices.  I prefer to use both.

The main risk is the economic and housing cycles: is this the top?

[Edit: 28th Nov 2016: Bought 7191 NYSE:LYG ADRs at USD 2.9192.  1 ADR equals 4 shares.  Total cost USD 21,000.92.]


1 Lloyds market share will have dropped since then, as TSB was 50% owned by Lloyds in 2014 and sold off in 2015.

2 See table 1.35 in 2015 AR: Of the 140,536m of "Trading and other financial assets" on the balance sheet, almost 2/3rds (63%) is held for insurance. 

3 From the A lot of their insurance products are ILPs, whose value rises or falls based on some underlying investment. The rise/fall in value of previously sold insurance products is recorded under "Insurance Claims" (See 2015 AR's footnote 10, the entries "Change in insurance and participating investment contracts" and "Change in non-participating investment contracts"). However this is offset by LLoyds holding the underlying investment, and the offset is recorded under "Net Trading Income".

4 2015 AR footnote 15

5 See the text in footnote 9 in the ARs. Lists costs for restructuring, or managing liabilities for their past misdeeds.

6 I am including the "Other Equity Instruments" (Convertible notes issued in 2014 - see footnote 45) as part of the Shareholders Equity.  Otherwise it jumps to 20 times.

Friday, November 25, 2016

Bought OCBC

Bought 3,400 shares of OCBC @ SGD 8.74 on 23rd Nov 2016.  Total cost SGD 29,887.70.  Thats a a TTM PE of 9.6 (or 11, excluding "Trading Income"), and a yield of 4.1%.

I'm buying bank stocks cause I'm holding lots of cash, and they're still reasonably cheap, after 7 years of ZIRP.  Which looks like its ending now.  But they could still get cheaper if theres a recession or crisis.

I am still more than three-quarters in cash:

Thursday, November 17, 2016

Singapore Banks and Rising Rates

If US rates go up, how much will Singapore banks benefit?

SIBOR tends to follow the fed funds rate:

And the banks' Net Interest Margins (NIM) roughly follow it:

Its hard to tell, because the correlation is not direct, and there is probably a lag.  I'll assume that NIM goes back up to 2%, which is about halfway back to the highest level, and roughly what it was in 2010.  If this happens, I estimate that all three banks would increase their earnings by 15-20%.

Tuesday, November 15, 2016

US Drug Wholesalers


Part 1: The Good

Drug wholesalers handle the logistics of buying, warehousing and transporting drugs from manufacturers to retailers.  Three companies: McKesson (MCK), Cardinal Health (CAH) and AmerisourceBergen (ABC), form an oligopoly with an estimated 90% of the US market.

Its a low margin business where you make money on turnover.  Operating margins average around 2%.  All three companies are profitable, generate free cashflow, and have low debt1.  As expected in a business like this, their main costs are inventory (COGS) and SGA.

Most of the growth in this industry is by acquisition, which consumes part of the free cashflow.  This industry was previously fragmented, and over time consolidated into the oligopoly it is today.  Even in today's concentrated industry, all three companies make acquisitions every year to expand their offerings and move into new fields, such as specialty drugs and oncology.

The long term trends look good.  The population is getting older and weaker.  Drug usage is expected to grow 5% pa.  As the middleman, these companies take their small cut off the drugs passing through their pipelines.  When analysing them, we don't have to worry about patent expiry, competition from other generic suppliers, or the intricacies of insurance payments in the US health system.  We just sit back, let the drugs flow through, and collect our money.  Whats not to like?

Part 2: The Bad

When we look at the details of this industry, there are some issues.

First: retailer consolidation.  Distributors are most profitable when they work in "barbell" model.  That is: a small number of distributors in between a large number of suppliers and a large number of customers.  Giving pricing power to the distributor.  But one side of the barbell is shrinking.  The pharma retail industry has consolidated, with more and more sales going to the largest players (Walgreens and CVS) - see point 2 here.  This gives two problems:

  • Distributors margins for their small customers, such as independent pharmacies, are a lot higher that for their large ones.  Distributor operating margins average around 2%, but this is estimated to drop to 0.5% for their large customers.  Even these large customers make up 20-30% of a distributor's revenue, most profits come from their many smaller customers.
  • When retailers are taken over, they usually switch their drug distributor to the acquirer's one.  This makes it harder to project future revenue and profits.  For example, Walgreen's first indicated it will takeover Rite Aid in the middle of the year. Rite Aid's distribution contract with McKesson expires in March 2019, but will probably be terminated before then.  McKesson still does not know when, except to say that they will probably service Rite Aid at least till March next year.

To overcome this, all three companies have started franchises to help independent pharmacies start up.  They provide a broad range of services to help the viability and profitability of their smaller customers.  They have also been acquiring the smaller distributors that supply the independent pharmacies.

Second: pricing is complicated.  Distributors do not earn a fixed fee, like a postage rate.  Instead they buy drugs at some discount to the manufacturer's list price ("buy side profit") and sell at a profit ("sell side profit"), which may still be less than the list price.  See here for a good diagram of payments.  The distributors also benefit from price inflation when the price of items in their inventory increases, though less than before2.  

This leads to three more points:

  • The industry is hard to analyse.  Contract terms are not disclosed, so analysts have to estimate the revenue and profitability of each customer.  When analysing profitability, we end up making estimates based on other peoples estimates.  Its not modelling, just guessing.
  • In the past few years, wholesaler profits have been artificially boosted by price inflation in generic drugs.  This "generics bubble" was caused by few generics being approved for use - this pipeline is now clearing.  So those excess profits have gone down.
  • Theres a risk that the whole pricing model will have to change, so its no longer based around the manufacturer's list price.  Or medicaid may eventually be extended to everyone as a "single payer" system, like in a civilised country.  Even though drug wholesalers are performing an essential task in the system, with sustainable (that is, low) margins, any uncertainty associated with an industry overhaul could play havoc with healthcare stock prices.

Part 3: The Ugly

In October, McKesson said in their conference call that AmerisourceBergen has started a price war in the independent segment.  The stock fell 22% overnight.

I think the price war is temporary,and won't last in a market with 3 players.

Still, the level of stock volatility is sickening.  I may hold a smaller amount.

Comparing the companies

The companies are pretty similar in terms of cashflows generated, debt and the industry they serve. There's no point comparing their profit margins, since they vary so much between the large and small customers.  The main thing I want to look at is valuation.  How much would I be willing to pay for them?

I'm leaning towards McKesson or Cardinal.  Among independent pharmacies - the most profitable segment - AmerisourceBergen's market share has been falling, and they have a lower estimated margin3.  And they are the ones starting the price war.


All three companies report both GAAP and non-GAAP earnings.  Non-GAAP is supposed to exclude one-off items.  Guidance is only provided for non-GAAP.

The differences are:

  • Changes to LIFO Reserves: Stock is sold on a FIFO basis, as with any perishable good.  But the accounting is done on a LIFO basis.  When prices are rising, this lowers profits and taxes.  In other words, the profits on paper are lower than the cashflows.  The difference is added back to their non-GAAP earnings.  I think this is makes sense, and the amount is objective and easily calculated.
  • "Acquisition costs" and "Amortisation of acquisition related intangibles"4.  This is the largest part of the difference.  Since all three companies are serial acquirers, then do we ignore this by considering it a one-off cost that should be excluded from earnings?  Not sure, but I can probably accept it - its better than leaving the costs on the balance sheet as goodwill.
  • Litigation costs.  McKesson has such large and frequent litigation costs which makes me wary.  I'm wondering if they can conduct their business for another 5 years without getting their asses sued off.  Cardinal's litigation costs are small enough to ignore.

Earnings Estimates

For MCK, after accounting for:
  • the loss of OptumRx, Omnicare, Target, Rite Aid, partially offset by Rite Aid and Safeway
  • less generics price inflation than in FY2015.
  • a price war for supplying independent pharmacies, assuming operating margins are halved.
I get an EPS reduction of $3.84. This would give an non-GAAP EPS of $8.51.  At 12X earnings, thats a target price of $102.12.  At 15X, its $127.65.

If we exclude the price war, its $112.24 (12X earnings) and $140.31 (15X earnings).

For CAH, after accounting for:
  • the loss of Safeway, plus the potential loss of Pharmerica
  • less generics price inflation than in FY2015.
  • a price war for supplying independent pharmacies, assuming operating margins are halved.
I get an EPS reduction of $1.12. This would give an non-GAAP EPS of $4.24.  At 12X earnings, thats a target price of $51.03.  At 15X, its $63.78.

If we exclude the price war, its  $58.39 (12X earnings) and $82.87 (15X earnings).


1 Less than 2X EBIDTA
2 McKesson2Q17 Conference call: "90% of our [branded] income is fixed, 10% is variable."  And Cardinal 1Q17 Conference call: "about 15% of our branded margins are based on a contingent basis, which means that generic or a branded inflation is a piece of the driver of the value that we receive."
3 From the DrugChannels 2016-17 Wholesalers and Specialty Distributors Report.  All my estimates are calculated from the estimates in the report. 
4 Defined in Supplemental non-GAAP information here.

Bought UOB

Bought 1500 shares of UOB at SGD 18.81 on Friday 11th Nov, total cost SGD 28,378.03.  Thats a TTM PE of 9.8 (or 12.5 if we exclude "Trading Income"), and a trailing yield of 3.7% (excluding their special "80th Anniversary" dividend).

Singapore banking stocks are quite cheap.  One reason is because of seven years of falling interest rates.  After Trump won and gained control over two houses, the market narrative is that US inflation and US interest rates will go up.  Bonds jumped on the news:

 As did banks:

So the market believes ZIRP is dead.  Lets see if it comes true.  The Singapore banks are cheap enough to buy anyway, even without that.

Monday, November 7, 2016

Sold Seaspan

Sold Seaspan at USD 9.57 yesterday.  The stock was still falling in a rising market.  The market is now valuing the common shares as though the dividend will be cut, possible eliminated.  Loss of USD 5311.62 (incl. dividend).

The shipping sector is still interesting, and I'll look at Maersk or Seaspan again later for a cyclical recovery.  But its a long way off.

When I'm so far underwater on a position, better to sell and realise the loss first.  It helps me to clear my head when thinking about whether I would buy the stock at the current price.

Saturday, October 1, 2016

Singapore Banks: Part 4: Returns and Valuations


So far we've been looking at different aspects of the business separately.  All these parts operate together to generate a return.  How do we measure the returns generated?

The most common measure is ROE:

This doesn't account for differing leverage that different banks may have, so its used in conjunction with ROA:

ROA doesn't take into account the quality of assets.  To do this, we would look at Returns over Risk-Weighted-Assets:

Finally, we can use Revenue over Risk-Weighted-Assets, for cases where the banks have a lot of one-off expenses that affect their returns1:

Why the spike in OCBC's in 2012?  They had an one off $1.3bn sale of securities2.


We use book value to value banking stocks for two reasons.  Firstly, because earnings are highly cyclical.  Secondly, because for a financial business, accounting rules require the assets (i.e.: loans) on the balance sheet to be constantly updated to reflect future earnings3.

Specifically, we use Tangible Book Value (Book Value minus Intangible Assets):

How are the banks valued compared to the past?  I have to use simple book value to compare this, since I can't find any past P/TBV values4.  Price/BVs over recent downturns were:

                (Source: Share Investment: Ernest Lim: Singapore Banks Trading at near Global Financial Crisis Low Valuations).

Current Price/BVs are close to 1:


I would buy either UOB or OCBC, because of their historically high returns and lower write offs.

Would I buy now?  Banks stocks have been grinding lower for the last year.  They are fairly cheap, though not at crisis levels.  If I bought, I would only buy half a position now.  No telling when the next recession or crisis will come.

1 Not for these 3 S'pore banks, but may be used when comparing them to other countries' banks.
2 Note 7 in 2015 AR.   1.35bn "Disposal of securities classified as availiable-for-sale", which is 27% of PBT. 
3 Unlike other businesses where where the amount recorded on the balance sheet is the amount paid minus depreciation.
4 To calculate them I would need past stock prices un-adjusted for dividends/splits.

Friday, September 30, 2016

Singapore Banks: Part 3: Deposits


A low-cost deposit base is a competitive advantage for a bank.  If the cost of a bank's deposits - both interest and non-interest costs - is less than the AAA corporate bond yield for example, then they could simply buy the bonds and get free money off the spread.

This article gives an example of working through a bank's numbers to determine its cost of deposits.  Unfortunately, we can't do this for Singapore banks because:
  • 30-40% of their income is non-interest income, and we can't really apportion the costs between the segments.
  • And their deposits are in different currencies.  Non-interest costs are broken down between countries, but interest costs are not.
The best we can do is look at their non-interest rate costs, while accepting that some of it accounts for the non-interest income too.  And try to find some proxy for interest costs.

Non Interest Costs

For Singapore dollar deposits, non-interest operating costs as a percentage of deposits were:

In other words, they paid this percentage in non-interest operating costs (e.g.: rent, staff) in Singapore, for their SGD deposits.

No real difference between the banks, but at around 1%, these costs are extremely low.  And remember, this includes the cost of generating the 30-40% of non-interest income1 .

Their costs for deposits in other countries will be higher, since they lack scale.

Interest Costs

None of the banks break down their total interest costs by the different currencies they hold.  We can't just look at the total when dealing with such disparate currencies such as the SGD (interest rate 0.4%) and Malaysian Ringgit (interest rate 3%).

The CASA ratio is the ratio of (current plus savings) accounts to total deposits.  Since current and savings accounts usually have low interest, a higher ratio means a cheaper source of deposits.  

DBS has a consistently higher ratio of deposits from savings and current accounts.


Buffet's "weapons of mass destruction".  Here we compare the notional amounts of all derivatives on the balance sheet to total assets:

DBS stands out.  The large notional amounts are larger than bank's assets. They are not as scary as they seem - when buying or selling futures, its normal to have 10X leverage2.  You are betting/hedging on the change in price, not the absolute price itself.   Still, a couple of things strike me:
  • For all 3 banks the vast majority of their derivatives are for trading, not hedging.3
  • For the derivatives held for trading: for both OCBC and UOB, over 90% of them are OTC4. For DBS around half5 are. If you are trading, shouldn't you be using exchange-traded securities?
The banks' derivative disclosure is too complex for me to understand.  Probably for anyone else too.  But I just use the notional amount divided by total assets to get a rough idea of derivatives exposure.  Not sure if it means anything.

1 But wxcludes allowances & write offs.  
2 And even more for low volatility assets.  
3 From 2015 Annual report footnotes.  For OCBC: around 98% of derivatives are for trading (note 18); UOB does not give the breakdown of derivatives used for trading or hedging, but the amounts in note 37a suggest only a small amount is for hedging. For DBS, over 99% of derivatives are for trading (note 36.2 on p149).  
4 Forwards and swaps are OTC  
5 Not sure if their "FX Contracts" are OTC - if they are, the amount rises to 78%  

Wednesday, September 28, 2016

Singapore Banks: Part 2: Losses and Leverage


Allowances and write offs are a normal part of doing business for a bank.  Even for a successful one.  Write-offs are during a downturn are the biggest source of losses: from when people stop paying their loans or the securities held drop in value...permanently.

Over the long term, these can be measured by the allowances made for bad debt and investments.  General Allowances are made when loans are taken out, with the expectation that some will turn bad.  Specific Allowances are for individual loans or investment that have already turned bad.  If less loans turn bad then expected, or the debtors starts paying off bad loans, the allowances can be written back.  The graphs below show the sum of all allowances1.

Since loans are the largest part of the banks' business, lets look at the allowances for loans first:

Now lets look at all allowances - this includes the above loans, plus for investments, acquisitions, etc:

In both cases, OCBC has historically been more conservative in their lending and investments.

Due to the recent Oil & Gas Industry scare, lets look at more recent bad loans.  Non-Performing Loans are loans for which required payment has not been made - the criteria is objective.  I'm looking at Non Performing Assets here (which include NPLs), because I couldn't find NPL information for one of the banks:

Nothing conclusive.   Over the last 3 quarters, DBS is going up, the others going down.  Will be interesting to see if that becomes a trend.

Another chart showing how many of the NPAs are secured loans:

OCBC has a higher number of NPAs that are secured.  Meaning they have more chance of getting something back.

Does OCBC make less losses because it has a higher proportion of (safer) housing loans?  Not really:


Due to the possibility of a debt crisis in China: lets take a quick look at the Singapore banks' China exposure.  UOB has the least:
   (Source: Andy Mukherjee: China infects Singapore Banks)


Before looking at a business' profits, we look at its leverage to see how much risk it is taking to get those profits.

What does leverage mean for a business that lends out money?

The key requirement is shareholders equity: this is the money available under all circumstances for the bank to pay off any losses.  Leverage used to be measured by the the Shareholder Equity Ratio - the ratio of Shareholders Equity to Assets.  Most "assets" for a bank are loans, so this ratio roughly measures "How many loans have you made compared to shareholders equity?"  If you have 20X more assets than equity, then a 1% decrease in assets values reduces shareholder equity by 20%.  And a 5% decrease wipes you out.

[Edit: 26/11/16: The best measure of this is the Tangible Equity Ratio. All three local banks have Tangible Assets of 12X (or less) Tangible Equity.]

Nowadays, leverage is measured by the under the Basel III capital adequacy ratios.  To understand these, we need to take a detour and look at:

  • Common Equity Tier 1 (CET1) is the highest quality of equity.  Roughly, it is Shareholders Equity minus Intangible Assets (p4). 
  • Risk Weighted Assets (RWA).  Banking profits are traditionally measured by "Return on Assets".  But this ignores how risky the assets on the balance sheet are.  The RWA calculation tries to account for this by adding up the weights of different types of assets based on their risk.  For example, safe assets like short term government bonds have a multiplier weight of zero.  Riskier assets, such as loans, are given higher scores, depending on the loans' terms and repayment records.  This adding process is done three times: for credit risk, market risk, and operational risk, as shown below:

          The final value is the sum of all three numbers.  A lower result is better, meaning less risk.

          RWA does not measure systematic risk.   For example, the Housing markets in Australia and Sweden are in a bubble likely to burst.  RWA calculations will not show this extra risk for Australian and Swedish banks.

          Like any metric, RWA can be gamed.

Basel III requires banks to have CET1 capital of at least 4.5% of RWA.  Singapore requires banks to have CET1 capital of between 9% to 11.5%3 by 2019.  All three look like they've already made it2:

OCBC has a lower ratio than the other banks because MAS ruled that its insurance subsidiary, Great Eastern Life, cannot be included in CET1 capital.


Historically, OCBC has made less bad loans and write-offs than UOB and DBS.  They have been more conservative in their lending and investments.

UOB has the lowest exposure to China.


1 General plus specific allowances, including write backs.
2 The graph shows the CET1 CAR for MAS Basel III rules, effective 1st Jan 2018.  These are not the 'headline' numbers presented in the 2015 Annual Reports - those are higher and computed using an older methodology.
3 Its a 9% CET1 CAR, plus a 0 to 2.5% 'Countercyclical Buffer', which MAS may adjust to slow down lending.

Sunday, September 25, 2016

Singapore Banks: Part 1


I'm looking at he local Singapore banks, as some are trading below book value and at single digit PEs, due to fallout from the local O&G industry and fears of a China slowdown.

I've always avoided banking and finance companies due to their performance in the 2008 crisis.  Basically I had the idea that they are all black boxes, stuffed full of derivatives, bad loans and 3-letter acronyms, who would report rising profits for years, before one-day turning around and writing them all off.   Like this:

The counterpoints are that:
  • In many countries, banking is an oligopoly, with the top 3-4 players having 50-75% of the market.  They are still price competitive, but new entrants are limited.
  • Banks provide a large amount of detail about their loan book (aggregated by industry, country, percentage of loans secured, etc).  As well as Non-performing loans (NPLs) which are decided by objective criteria.
  • We can see their long-term history of write offs and NPLs - a bank that was conservative in the past is likely to be so in the future.  Corporate culture does not change quickly.
  • The cost of funding (deposits) is known and provides a distinct competitive advantage for some players.  Cheap money.

Learning about Banking

I haven't found any single, complete book on "Analysing bank stocks for idiots and value investors".  Rather there were many online sources and examples:
I'll start with the Singapore banks since I live there, but I want to use the same steps for other countries.

Market Share

Most countries have a "big four" handful of banks that dominate the local market and are backed by the government as 'too big to fail'.  Singapore has 3.  Before investing in a country's banks, we want to see how competitive the market is.  A simple measure of market competition is the market share that these banks have for:

  • Home loans.  Best I could find is a report showing the big 3 local banks had a 63% market share in 2013.  Standard Chartered and HSBC are the only other significant competitors.
  • Deposits.  A Moodys Report gives says the 3 major banks had 60% of deposits at end 2012  (p13).
What do I expect in the future?
  • I think that the Singapore banking market has become more competitive for deposits after it was liberalised in the 2000s.  But from the above chart, not yet for loans.  
  • I don't think it will become less competitive: I can't imagine any of the ten Qualifying Full Banks packing up and leaving in the future.  And if they do, they'll probably just be taken over.
  • Government savings schemes, such as Singapore Savings Bonds or CPF Life could provide competition for deposits.  Though Singapore Savings Bonds seem to be dying.
So going forward I expect either the same or more competition.  Especially if more of the Qualifying Full Banks can achieve scale.  I don't see less competition.

Non-interest Income

I start by looking at a bank's non-interest income, for two reasons:
  1. I am looking for banks that do 'traditional' banking: the simple collection of deposits and lending them out.  We don't want banks where the majority of income is from complex, risky activities like investment banking, or worse still - derivatives trading.
  2. Although banks try to generate fee-based income from other activities to 'smooth out' credit cycle fluctuations, these earnings are often still subject to the same cycle.  Or may be highly volatile, year-on-year.  So these earnings should be discounted a bit when looking at PEs.

Categorizing Non-Interest Income

The Singapore banks' non-interest income has been built up over the years and now accounts for 30-40% of their income.  Lets look at the different categories of non-interest income to see whether we can spot any long term trends, and check if they are cyclical.

Loan Income and Trade Related income have grown steadily, and were not affected by the 2008 downturn.  I would categorise this as "Steady Growth":

Credit Card income surprisingly grew steadily for DBS and UOB, only OCBC's dropped after the GFC.  I'll put this under the "Steady Growth" category too:

Trading Income1 has grown tremendously since the GFC, but is highly volatile - it can rise or fall 20-50% a year.  I've put OCBC's bancassurance income here too as it correlates so closely to the Trading income2 .

Fund management, Wealth Management and Investment Banking are less volatile, but highly cyclical, dropping 50% of more during the GFC:

"Services and Other Fees" is also quite cyclical, surprisingly:

For simplicity, I'll put the last last 3 items under a "Volatile or Cyclical" category.

So now we have 2 categories of non-interest income: "Steady Growth" and "Volatile or Cyclical".

Interest vs Non-Interest Income

Lets compare the interest income and categories of non-income for each bank:

As percentages:

30-40% of all 3 banks' income is from non-interest sources (red and blue above).  How did it fare during the financial crisis?

  • In 2009, UOB's non interest income dropped 20%.  
  • In 2008 and DBS' non-interest income dropped by 13%.   
  • In 2008, OCBC's non-interest income dropped by 42%.
BUT, interest income did not drop - it actually rose. The drop in profits came from write-offs, which are not included here.


  • 30-40% of all Singapore banks' income is from non-interest sources
  • Non-interest income for the Singapore banks has been cyclical and/or volatile.  More than interest income.  It fell 13 to 42% in the previous downturn.
  • So I'd factor in a 5 to 16% drop in total earnings (from non-interest earnings alone) if we were expecting a crisis.
  • Interest income - excluding write-offs - was pretty steady during the crisis. Maybe because the crisis was so short.
  • This is all excluding write-offs, which I'll look at next.
1 Mostly forex
2 Thats to be expected, as insurance makes money by investing their float. But, I think they would invest in stocks and bonds, not trade forex.

Bought Singapore Savings Bonds

Bought 50K of SSBs in July, held in my CDP acct, bought from UOB bank acct.
Security code: SBAUG16 GX16080S

Friday, July 29, 2016

Seaspan (NYSE:SSW)

Seaspan is a REIT-like company that leases out container ships.  Its business model is simple: borrow money, use it to buy ships which are leased out, and pay the difference between the lease payments and the operating/finance costs as dividends.  The key story here is that long lease periods on the majority of their fleet should allow them to ride out the next few years downturn.

Income Statement and Dividend payments

A quick look at its 2015 income statement shows what we'd expect - the biggest costs are depreciation, ship operating costs, and interest payments:

Theres a catch here: the "Change in fair value of financial instruments" (outlined in green).  This is normal for companies that hedge their debt through interest rate swaps1.  Usually the hedged rate of interest will be included in the interest expense, and the "Change in the value of the swaps" is just an accounting entry to be ignored2.  But Seaspan has recorded them differently: The interest expense records the unhedged (variable) rate of interest, and the "Change in fair value of financial instruments" includes the difference between the hedged (fixed) rate and unhedged (variable) on the interest payments3.  We want to include this as part of operating expenses, and ignore the 'accounting entry' part4.  After adjusting for this (all figures in USD 000's):

For REITs we need to check how much of earnings are paid out as dividends:

In 2014 and after, they have paid out more than 100% of their earnings.  This means they are paying out of their depreciation.

Debt structure

The table below shows all debt, including preferred shares, and when it is due:

Can repayments be covered?  All required payments are shown below: the minimum interest repayments, plus rolling over the loans/notes on maturity, plus operating leases:

How much is of the variable rate debt is hedged at fixed rates?  Not much.  And not for long.  Out of approximately 3.4bn floating rate debt:

On the bright side, most of their swaps require payment of LIBOR at 5%, so when they expire, these repayments drop. The 2015 interest payments would be 92m lower if there were no swaps.  On the other hand, finding long term projects - 8 to 17 year leases on assets with a 20 to 30 year lifespan - is a risky business in the long term.  A spike in interest rates could cause problems.  More on this below.


When their charter contracts expire?  They have some expirations in 2016/17, and more after 2020:

By 2018 they will have a number of ships with expired charters:
  • 25 panamax vessels (23 x 4250 TEUs and 2 x 4600 TEUs)
  • 2 X 8500 TEU ships
  • 2 x 1000 TEUS, expected delivery in 2017 which they have not charted out yet. May be deferred to 2018.
Assuming these are contracted out at today's market rates, I estimate 2018 'normalised' earnings to be 140m5, down 13% from 2015.  If dividends were maintained6, they'd be digging into 62m from depreciation - sustainable over a few years, since depreciation is around 220m.

Stress Test

3 ships are charted to Hanjin, at rates far above market.  Hanjin has requested a fee cut of 30%, Seaspan refused and said they'd rather take the ships back.  Unlikely, but what if it did happen? If they did take the ships back and re-lease them out at current market rates, I estimate revenue/earnings would drop by 33m7

What if the LIBOR rose to 5%? ...which last happened in 2007.  I estimate that 2015 interest and operating lease payments would raise by 56m if this happened:

If LIBOR rose to 2%, 2015 interest and operating lease payments would raise by about 15m.


Good way to play the container shipping cycle, while getting paid to wait out the downturn.

The main risks are:
  • The shipping cycle downturn may go on for more than 3-4 years, if demand decreases, or if more supply is bought onto the market.
  • Since 2014, Seaspan's dividends are greater than earnings.  Hopefully they are only doing this for a few years to ride out the cycle.  Management cannot lower dividends, as this would hammer the stock price, making equity raising difficult.  This is not a company that grows organically to build long term shareholder value. Think of it as a bond, paying out the difference between its lease rates and costs as a yield (with occasionally a bit of capital returned as well).
  • They are exposed to rising interest rates.
  • About 60% of their 2015 revenue came from China companies (YM, COSCO, CSCL, and COSCON).
Buying this stock is a bet that:
  • The container cycle will recover by 2020, when Seaspan has more vessels coming off fixed-rate charters, and,
  • Interest rates don't rise too much.
This is a cyclical stock.  But when the industry is under dark clouds, sell a few years later when the sun is shining.   Need to remember that it is not a 'buy-and-hold-forever' stock.

See "Illustration of an interest rate swap" here as an example.
This entry will be armortised away later if the swap is held until it ends.
Page 54 of the 2015 Annual report: "Although we have entered into fixed interest rate swaps for much of our variable rate debt, the difference between the variable interest rate and the swapped fixed-rate on operating debt is recorded in our change in fair value of financial instruments rather than in interest expense."  Why....? 
This is done in the press releases for their results, e.g.: see Section B "Normalised Net Earnings and Normalised Earnings per share" here.
Based on: a) 2018 minimum contracted revenue of 794m (2015 Annual Rpt footnote 14a), b) Revenue of USD 5.1K/day for a panamax and USD 10K/day for a 8500 TEU vessel, c) Utilization rate 97%, d) Operating cost for 10000 and 11000 TEU vessel of 15K/day, and for 14000 TEU vessel of 15k/day (from "Daily Operating Cost" graph, p23 here), and e) Excludes latest announcement of 2 11000 TEU craft bought from CGI. 

Assuming dividends of 202m, based on 1H 2016 annualised dividend for both common and preference shares
Assuming current charter rate of 10000 TEU vessel of USD 12K/day, and 97% utilization rate.