Lloyds Bank

Quick Notes on LLoyds Bank in the UK.

Competition

Lloyds is the largest local bank with a 16-19% share in mortgage lending, the next largest is NatWest (formerly RBS) at 12-13%.  The largest 5 banks have a 60% market share.  Lloyds has ~20% market share of current account balances.  From these numbers, the UK market has 6 large players with > 5% market share.  So there's limited competition, but its not as comfortable as the Australian or Singapore market, controlled by 3-4 banks.

What do they do?

• They primarily make their money from interest (~70% of their Net Income in 2Q).  Primarily mortgages (book size of 307m mortgages, 40m other retail loans and 88m commercial).   Their deposits are 2/3rds retail, 1/3rd commercial (slide 16).  All pretty standard stuff - they are a traditional bank doing savings and loans.
• For their ~30% non-interest income ("other income - slide 18"), 75% of it is from commercial and retail banking.  I assume bank fees.  The remainder is Insurance, Pensions and Investments.

Balance Sheet

• CET1 ratio is 14.1%.  But they want to reduce it to 13% by 2026 and return excess capital to shareholders (slide 24).
• Loan to deposit ratio is 95%, which is on the high side compared to Singapore (low 80s) or US banks (10-year average of 72%).
• They have a large "structural hedge" (slide 17) from the pre-covid zero-interest rate period.  It yields around 1.35% interest, as the hedges expire in a 4% interest rate environment they'll yield more.  The hedge reduced 2023 profits by an estimated 800m (page 4), or 10% of 2023's PBT.  It depends what the interest rates are (actually what the forward curves are) when they expire.

Risks

Digital banks like Starling, Monzo and Revolut have been growing and taking market share.  Especially among young people.  Now 10-15% of the population has bank accounts with each of them.  Lloyds bank fares badly in customer satisfaction, trailing behind them.  But I'm not sure how much money they manage to capture, or how many people use them as their primary bank account and deposit salary - banking is a 2-sided market and you need scale to be profitable.  Only Starling is profitable.  Although the newcomers have made banking easy with mobile app features, its not a moat and can be copied by the incumbent banks.  (FT article).

The UK has been suffering through a recession in the past 2 years.  I think they will tax dividends on foreign shareholders.  Its a no brainer.

Biggest risk is the UK's long term prospects.  It has recovered from its recession, but may continue with weak (below 1%) growth as the past 2 years.  The UK's long term prospects look gloomy due to cheap energy from the North Sea running out, the end of Russian gas, and Brexit.  Politically and economically, they are probably going to become the 51st state - not a bad thing, but a big step down from being Europe's financial centre, or the old "empire on which the sun never sets".

Capital allocation

I like their capital allocation:

There are around 66bn shares issued (p302).  Buying 2bn pounds per year at a price of (lets say) 1 pound each removes 3% of shares every year.

Business Cycle

Banks are cyclical.  Where are we in the business cycle?

UK has been in a tough spot due to rising energy prices from the Ujkraine war and Brexit.  You can find YouTube videos of boarded up sops and houses.  They do have some structural problems to work through.

1Q24 just exited a recession, putting an end to almost 2 years of low/negative growth:

Source: Trading Economics

Hedgeye predicts the UK will have increasing yoy GDP growth in the second half of this year.  But that can change tomorrow.

Valuations

Price to book is 0.85.

At 70p, it would have a 1H annualised PE of 10.2.

Using 2023 numbers (a period of sub-1% growth but very high rates), the PE would be 9.2

Summary

The leading bank in a not-too-competitive market.  Its been recovering and recapitalising from its 2008 blow-up, and is now starting to return money to shareholders.

The stock shot up 6% yesterday when results were released.  I may be late to the party, is a recovery already priced in?  Biggest risk is that the UK recovery is weak.

Interactive Brokers

Business

IBKR is a fast growing international stockbroker.  They make most of their money from interest (2/3rds of revenue in 2019), and the rest from executing trades (1/3rd).  Trading commissions were only 7% of PBT in 2019 - that was an exceptionally bad year for trading - the average from 2015 to 2018 was 23%.  They also do some market making, which is negligible.

Institutional customers make up half their accounts and 65% of their total customer equity.   Over 60% of their accounts are form outside the Americas.

Competitive Position

I don't know who the players are for institutional investors, but assume its competitive.  For US retail investors, a market share estimate does not even include IBKR as its such a small player.  So numbers wise, they have a small share in a highly competitive market.

Their main product, IBKR pro, is for sophisticated traders/investors.  The user interface is complex and hard to use.  But they are one of the few retail brokers that allows you to trade a wide range of markets, currencies and instruments around the world.  IMO, they are not really a direct competitor to the other US brokers, but more occupy a high performance niche.

Despite being low cost, operating margins are amazing:

With these margins, they must have some competitive advantage.

Balance Sheet

Looks good.  Debt and operating lease liabilities almost zero.  2.8bn of cash acts as a buffer around 27bn of cash and securities in client accounts (Financial instruments are not included in cash, as they are mostly options - p86).

Risks

Like a bank or finance company, lending money is inherently a risky business.  One where the risks often don't appear on the balance sheet or cashflow statements.

Stockbroking risk is shorter term, as you mark-to-market every day.  But you have to deal with wild price swings:

• In 2015, when the Swiss unpegged their currency, IBKR lost 137m (down to 115m in 2019 after some debt collection).
• In 2019, there is an unusual loss of 42m (possibly up to 50m) for margin to "a small number of brokerage" customers who positioned in a US stock that had a drastic change in price (TSLA, maybe?)

These losses look OK in light of their cash and profit numbers.  A normal part of doing business.

However, financing businesses are a black box.  In every crisis a few go bust, and its hard to tell from the financials which ones.  If I buy, size this position accordingly.

Growth

Main growth driver is new accounts, which has been in the teens (number of accounts), or twenties (customer equity):

Source: 2019 Goldman Sachs Conference

IBKR is also a platform used by other stockbrokers ("introducing brokers").  The new Chinese broker Tiger, which they own a stake in, performs its trades through IBKR.

Profitability

Most profits are from interest:

Short term profitability is affected by:

• Interest Rates.  Lower rates mean "lower net interest income from customer deposits due to interest rate spread compression".  Management stated that 2019 profits would be 22m lower with a 0.25% decrease in rates.  I guess that with rates at zero, interest will be 130m to 200m lower.
• Market volatility.  "Historically, our profits have been principally a function of transaction volume and price volatility... rather than the direction of price movement."  More volatility means more trades.  2019 was a bad year due to low volatility.  Now the VIX is over 60....yeah, they probably didn't want that much volatility...but lets assume trading revenue goes up to 2018 levels, which is around 200m higher.

Conclusion

This may be a Buffet buy-and-hold company.  No debt, minimum capital required, may have a sustainable competitive advantage.  What price would I pay for it?

• For a company growing 15-20%, I'd catch a falling knife at 12X earnings. Thats $25.
• In a more normal market, maybe 12-15X earnings would be fair.  Thats up to $31.

Alternatively, since the majority of earnings are from interest, wait till we see signs of interest rates rising.  Right now, we probably get a recession, then one or two quarters of growth (off a low base)... then we start to expect interest rates to rise.

Misc

Glowing report on IBKR from SumZero.

IBKR used to have a larger market making operation, but have reduced it due to HFT.

Bought CSE Global, Gazprom and a European Bank

Made three trades in the past month.

Bought CSE Global at 46c.  They are a technology company, primarily servicing the oil and gas sector and secondarily, government infrastructure.  Most of their work is project based - they talk about recurring income, but I'm not sure how 'recurring' it really is.  I bought because it was fairly cheap and it 5% yield is probably sustainable.  I can collect it while I wait for oil sentiment to improve.  Key numbers to watch are its order book, and receivables (they had a big problem with them in mid-2017).  Its 2% of my portfolio, due to its lumpy (project based) earnings.

Bought Gazprom at USD 6.91, a Russian gas giant supplying Europe and China.  It was cheap, paying a 7 percent yield (before 10% Russian withholding tax, plus ADR fees).  It should grow dividends to a 50% payout ratio, as their capex winds down and sales increase.  This idea is from Sven Carlin, here.   I'm not analysing it, as its a big company, not transparent, and theres no advantage to me doing so.  Its also 2% of my portfolio, with 2 big risks.  One, geopolitical risk (eg: wars) means gas to Europe may be disrupted, even if its cheap. And two: Putin decides this company should belong to the Russian people, once again.

Bought call options on a European bank.  This bank has gone through several rounds of capital raising and NPL disposal.  Its cheap, trading at half tangible book value, where similar banks from the same country are trading at 70+ percent.  It will probably pay a 5% yield (@ 50% payout ratio).  If it reaches 70% of tangible book by June 2022, my money gets multiplied 2 and a half times.  If not, then zero.  Its a 1% position.

[Edit 8-Nov: Bought more options, expiring in Dec 2021.  Another 1% of my portfolio].

Last month I finished buying Manulife US REIT, its now around 10% of my portfolio.

Resona Bank (TYO:8308)

Japanese banks are trading at single digit PE ratios and below book value.  After 20 years of near-zero interest rates they are still profitable.

I'm looking at Resona, the fifth largest bank in Japan, because its purely a domestic play and makes most of its money from deposits and loans.

Market Share

Japan is 'over banked'.  The top four banks have around half the market share, and theres a 'long tail' of smaller banks due to each province historically having their own bank.  

     (Source: Credit Suisse, Midtier banks, Jan 2015)

The Japanese banking market is more competitive than Singapore, Australia or the UK, where the top 3-5 banks have 60-75% of market share.  Consolidation has been occurring for years, but still has a long way to go.

To escape the competition and ever lowering interest rates, the larger banks (MUFJ, Mizuho Financial Group, Sumitomo Mitsui Financial Group and Mitsumi Sumitomo Trust Holdings) have expanded overseas and have built up their investment banking.  For example, MUFJ owns 20% of Morgan Stanley, plus banks in the US and Thailand.  Resona is the largest Japanese bank that is still purely domestic.

Resona's market share in certain prefectures:

     (Source: Feb 2017 Company Investor Presentation)

Income Breakdown

The vast majority of their operating income is from interest:

Interest income seems to track interest rates, with a spike in 08/09, amidst a general downtrend (the time period in the red box below):

This 'single focus' on deposits and loans makes it easier to analyse than the other large Japanese banks:

• They have no investment banking or overseas operations.
• And very little trading.  Most of their trading profits are from derivatives.
• Fee and commission income is the second largest contributor, and seems to track the economy¹:

Losses

Loan losses² are slightly favourable compared to other Japanese large banks:

Leverage

Resona's CET1 CAR is 8%, far lower than the other 4 big banks which are in the low teens.  This is because of their low capital base.  In 2015 they finished paying off public funds which were injected in 2003.  They now expect to increase their capital and aim for a 9% CET1 CAR in 2019.

As a domestic Japanese bank, their required CET1 CAR is only 4.5%. 

Returns

Resona's ROE is artificially higher than its peers, due to its low capital base:

As they increase their capital in future years, ROE will go down.

ROA is comparable to the other large Japanese banks:

This is far less than other countries.  Singapore banks for example, have ROAs of between 0.5 and 3%.

Others

David Eirnhorn bought a stake in 2014 at 547 yen, and probably still has it.

At 620 Yen, Resona yields 2.7%.  Withholding tax for Singapore residents is 15.315%.

Summary

Reasons to buy:

• Pretty Cheap.  At 620 yen, its trading at 9X earnings and price/book of 0.87  (From year-ending March 2016).
• It is still profitable, despite operating in a fiercely competitive environment with interest rate headwinds.

Risks:

• Japanese banking market is more competitive than other countries.
• Japan's well know demographic problems.
• Risk of a sudden Yen devaluation if Japan loses control of its bond and currency markets.  May not happen as Japan's debt is domestically funded (1) (2).
• Cyclical risk.  Japan is now in a boom, with record corporate profits and full employment.  The boom may end if it was solely due to money printing.

Overall, I think its an OK company trading at a cheap price.  Not a 'Buffet buy-and-hold-forever' stock.  The risks are priced in.

[Edit: Bought 2900 shares at 612.4 Yen on Friday 12th May.  Total cost in SGD is 29,505]

I like their mascot too:

                 ___________________________________________

1 There is a breakdown of their fees on p16 here, but it doesn't say much↩

2 From JGAAP financial results. "Loan losses" calculated as: 
     (Provisions for loan losses - Reversals in provision for loan losses) + (Write off loans - Recovery of write-off loans) ↩

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.

Overall

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.

Valuation

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.

Conclusion

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 risk...like 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.↩

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:

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%.

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.

Singapore Banks: Part 4: Returns and Valuations

Returns

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.

Valuation

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:

Conclusion

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.^↩

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.^↩