Fitch Ratings has said that notwithstanding extremely challenging macroeconomic conditions and reasonably-stressed assumptions simulated by the agency, the probability of capital impairment for Singapore banks still appears fairly low. The agency also notes that the banks’ earnings - although likely to be significantly lower in 2009 and 2010 compared with 2008 - appear adequate to fully absorb credit costs associated with asset quality deterioration.
This means the banks’ loss absorption capacity would likely remain sufficiently strong and financial strength largely intact - the main reason behind Fitch maintaining Stable Outlooks on the local banks’ high ‘AA-’ (AA minus) credit ratings despite all macroeconomic indicators having turned very weak. However, risks on junior capital instruments such as hybrid securities have become slightly elevated, although they are still nowhere close to where the risk of dividend deferral on such securities, and indeed capital loss, has become a real possibility. In line with Fitch’s moves to widen the “notching” for hybrid capital instruments globally, a wider notching off the senior debt may also be considered for the hybrid securities of Singapore banks.
In a forthcoming report - “Stress Tests on Singapore Banks” - Fitch simulates a fairly-stressed scenario for the local banks, with the aftermath of the 1997/98 Asian financial crisis being the main reference point. In this hypothetical scenario, NPL ratios are assumed to peak over a two-year period to around 11% at end-2010, from 2% at end-2008, which translates into annual credit costs of around 2.4%-2.5%. The results under this scenario indicate that pre-provision earnings of Singapore banks, even after assuming no asset growth and some contraction in revenues from 2008, are still sufficient to absorb such highly-stressed credit costs.
The agency estimates credit cost tolerance from pre-provision profits to be around 2.2%-2.3% for DBS Bank and Overseas-Chinese Banking Corp, and at around 2.7% for United Overseas Bank. Fitch emphasises that the credit costs stated above depict that of a stressed scenario, and therefore should not be construed as a forecast for 2009/2010. To put this point in perspective, credit costs of Singapore banks were only an annualised 25 bp in 9M08, but jumped to 80 bp in Q408, and would need to triple in order to reach the above stressed levels. This suggests that the deterioration in asset quality will have to be fairly dramatic and extremely rapid for banks’ profits to be totally wiped out. In the agency’s opinion, and despite the “doom and gloom” in the overall macro environment, the likelihood of such an occurrence is quite low. As such, Fitch projects that local banks would still register profits in 2009/2010, albeit much lower than in 2008.
Nonetheless, Fitch notes that further downside risks cannot be entirely ignored, and despite some improvement in market sentiment in recent weeks, there are no clear signs yet to support the notion that a sustainable recovery may occur over the next 12-18 months. The credit profile of Singapore banks may be negatively affected if economic conditions were to indeed deteriorate further and remain weak for a protracted period. In this regard, the Rating Outlook on Singapore banks may be revised to Negative from Stable if the likelihood of capital impairment risks becomes higher than currently expected. Indeed, the ratings may even be downgraded if the loss absorption indicators weaken significantly due to unexpectedly higher credit costs. That said, in view of the local banks’ fairly high capital buffer (and good quality of capital), their core capital ratios are unlikely to decline below 7%-8% under a worst case scenario, from 10% on average at end-2008.
Notably, Fitch highlights that the above scenarios do not take into account pre-emptive capital raising measures the local banks might undertake - based on their track records - to proactively strengthen their capital position should capital impairment risks indeed become more pronounced than currently anticipated. In any event, the need for Singapore authorities to inject capital directly into the banks - as seen in some other developed countries - appears extremely remote at this juncture, and indeed Singapore banks continue to be amongst the strongest financial institutions globally. “Stress Tests on Singapore Banks” will be available shortly on the agency’s paid website, www.fitchresearch.com.
–www.theasianbanker.com (May 12 2009)–
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Asian Banker
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