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.

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