Singapore Bank - too early, not cheap enough

Large system reliance on foreign banks: As with most aspects of the Singapore economy the provision and availability of foreign capital is critical. The banking system is no different. Foreign banks now provide ~42% or ~S$115bn of system credit. In our opinion, this is not an ideal position in the current global macro setting. The Singapore economy could confront a credit shortage, which could further exacerbate the macro stresses, should the foreign banks retreat/exit and/or scale back commitments due to capital constraints, pro-cyclicality and intensifying risk aversion. The local banks do not have enough capital to fill any credit void, in our opinion.

Complete exit is a S$9bn capital hole: In the unlikely event the foreign banks made a complete exit tomorrow, but for illustrative purposes, the local banking system would need to find ~S$9bn or ~27% of their current market capitalisation to provide the same level of system credit in support of the economy. We believe a large reduction in foreign bank balance sheets is foreseeable.

Depressed organic capital generation … dividend cuts look like a certainty: We forecast a 50% reduction in the capital generating capacity of the Singapore banks … i.e. RoRWAs falling from ~150bps to ~75bps. This means, cet par, maintaining current dollar dividends leaves capacity for only 1% RWA growth. A loss position (LLP charges > 240bps loans) would likely trigger capital action depending on the severity of the loss, the degree of pro-cyclicality (hard to forecast) and the extent of buffer erosion. Sector core tier one is 10%.

Retain Underweights, despite the Singapore banks being at or just below our target prices (DBS S$7.50, OCBC S$4.00, UOB S$9.00). While we may see a technical bounce, downside to our bear case scenarios (0.7x NTA with losses in FY10e) is still ~30%. We are only in the first of generally three phases to a credit cycle … visibility is poor and the economy appears some way from a bottom in our view. Add the heavy reliance on foreign capital and hence further domestic capital strain. Current valuations – P/NTA of DBS 0.9x, OCBC 1.1x and UOB 1.3x may appear reasonable … but they were 0.7x in the Asian Crisis … too early, not cheap enough.

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