Singapore Banks: Part 3: Deposits

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.

Derivatives

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%  ^↩

Singapore Banks: Part 2: Losses and Leverage

Losses

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:

China

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)

Leverage

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.

Conclusion

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.↩}

Singapore Banks: Part 1

Introduction

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:

• Oddball Stocks: A Banking Primer (Sign up for the free chapter "Are banks Risky?".  Well worth reading if you know nothing about analysing banks - the book is not out yet.)
• David B. Moore: Analysing and Investing in Community Bank stocks.  Short online book giving the concepts (e.g.: capitalisation, liquidity) needed to understand and measure bank performance.
• Valuebuddies thread: Discussion on Singapore bank write offs.
• Berkshire Hathaway 1990 letter. Wells Fargo.
• Gannon and Hoang on investing: Wells Fargo, others (1) (2).
• Geoff Gannon: How do you calculate a bank's intrinsic value?
• John Hempton (Amalthea fund): brief history on RBS and the UK banking industry (pp 3-4)
• Value and Opportunity, on: Handelsbanken and Lloyds

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.

Conclusion

• 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