Local banks still facing oil and China woes

The twin troubles of oil and China continue to beset Singapore banks, which are due to report their earnings in the second half of February.

Investors should take some comfort with the allowance already set aside by the banks for bad loans, with the trio - DBS Group Holdings, United Overseas Bank (UOB) and Oversea-Chinese Banking Corporation (OCBC) - stashing away a fiscal cushion that is more than one time the total amount of souring assets.

Still, there are some pain points to determine how badly the banks will be hurt by the two large issues. On oil, the price assumptions taken by banks, as well as loan-restructuring processes for small oil service players, should be of interest. More provisions can be expected, especially for oil-and-gas (O&G) exposure. As for China, the worry is less on asset quality, but more on growth prospects in the world's second-largest economy that is also at a tipping point.

With a rough 10 per cent exposure to the commodities' sector, Singapore banks are still facing headwinds in the O&G sector, as seen in the recent fall of oil prices below US$30 a barrel.

Three months ago, DBS Group chief Piyush Gupta sounded assurance over the asset quality of the bank's O&G portfolio and, to his credit, detailed the bank's stress-testing criteria: the price of West Texas Intermediate (WTI) at US$35 and that of Brent crude at US$40, over two years. At those levels, he said then, the bank expects credit concerns in about 5 per cent of that portfolio.

No one knows if the oil market has found the floor, but assumptions will be tested again and DBS is not alone in facing a rolling target. Standard Chartered, for example, said in its first-half results that it was offering loans to O&G producers that were either large state-owned-enterprises, or had a breakeven oil price of below US$50.

DBS went further with its disclosure in the third quarter, and showed that S$9 billion of its O&G exposure - or 40 per cent the total S$22 billion - belonged to the support services segment, which include shipyards, and other offshore marine services players. DBS was watching the small services' players closely, noting that those would be the most vulnerable to the collapse in oil prices. The large shipyards are brand names that are resilient, and are diversified.

More details will likely have to emerge if loan restructuring has begun for the smaller oil service providers, which had raised their gearing in expanding their fleet between 2012 and 2014.

The blow to demand caused by the oil rout will hit their earnings and raised further questions whether the companies will be able to meet debt commitments. A quick screening reveals a few having negative free cashflows and facing stress in the measure of income against interest expense. More than 10 small oil services firms listed in Singapore nearly always cite all three local lenders as principal bankers.

As it is, OCBC said in the third quarter that it had restructured certain O&G loans, though it did not name firms. UOB's non-performing loan (NPL) ratio is up 1.3 per cent from 1.2 per cent a year ago, on O&G exposure.

As for China, Singapore lenders should not bear deep scars from their exposure. Counterparties for trade finance have been limited to top-tier Chinese lenders that should have insignificant exposure to shadow banking, where rolling debt in high-yield wealth management products is due for reckoning.

Trade financing is short, making it less risky, and there is now greater regulatory scrutiny over capital outflows through trade invoices that do not match up.

Lending that is not trade-specific mostly goes to foreign enterprises and state-owned enterprises; banks cherry-pick smaller enterprises. As one measure, OCBC's Greater China NPL is, for now, better than its overall NPL.

China rebalancing

Where the real concern is, should be sustainable growth in China's so-dubbed economy of two halves as it rebalances from a traditional manufacturing powerhouse to one buoyed by service innovation, and shift from investment to consumption. Lenders here work in a saturated domestic market and must bank on China, which is still growing above global trend, but is at a point of transition.

And this comes as some analysts are needling at the simplistic view of consumption as the new driver of growth, with HSBC noting that it's an effect - not a cause - of sustained long-run GDP growth, that depends on supply-side factors and labour productivity. China needs industrial upgrading, and not a premature shift from industry to services, it argued.

This comes alongside the surprise depreciation of the yuan against the US dollar that roiled global markets, exacerbated by an ill-designed - and now dead - stock market circuit breaker. Then, there's that black comedy of disappearing billionaires in China.

With the anti-corruption sweep extending beyond pure state-related entities, it is unclear where true motivations lie: are political powers being calcified, or is this part of a larger movement to build a cleaner system of governance?

All of this translates to heightened pressures for well-paced structural and capital-markets reform in China. Just a year ago, the Street was littered with bankers in high praise of Chinese leaders. Now, there is growing doubt over successful reforms of state-owned enterprises, which are running less efficiently than private sectors. A looming, nagging question remains over China's ability to manage the trillions in debt.

Some have taken comfort with the view that a centralised leadership, while flawed, would allow for a soft landing for fears of social unrest. China has also said it will press on with structural reform. But given scepticism over how soon the Chinese leadership is able to pull China out of the rut, the narrative for Singapore lenders' China exposure will still hold a bias towards risk.

This article was first published on February 2, 2016.
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