Yesterday, Macquarie Equity Research (MER) published a research report that downgraded DBS from “Outperform” to “Neutral”. The downgrade comes on the back of am MER analysis of the impact of falling commodity prices on Asia’s multinational bank. MER believes the commodity finance exposure of DBS accounts for 9% of total loans and that S$1.8bn of commodity-related losses are possible based on MER’s stress test…
Quantifying the commodity finance exposure – DBS has commodity finance exposure (including off balance sheet and derivatives) of S$28bn, which is about 0.9x of tangible book value, based on MER estimates.
Stressing the commodity finance exposure – Based on MER’s assumptions of (i) 10% defaults in the commodity finance related exposure and 60% specific impairments and (ii) S$112m revenue losses on these defaults, MER estimates S$1.8bn total pre-tax losses in their stress test. This compares to 34% of pre-tax profit estimate for 2015.
Lower probability of stress test losses occurring – In MER’s valuation, they discounted for a 50% probability that these losses will occur. A large proportion of DBS’s Commodity Finance exposure relates to trade finance, which is of relatively low risk in MER’s view. At the moment MER is more worried about revenue headwinds (in trade finance) from falling commodity prices for DBS.
Earnings and target price revision Yesterday, MER changed their earnings per share estimates marginally. DBS’ target price is now reduced to S$21.00 from S$22.00 by discounting for potential commodity finance related losses.
Action and Recommendation MER downgraded their recommendation on DBS to Neutral and cut their Target Price to S$21.00.
MER still believes DBS is in a good strategic position to take market share from the struggling multinational banks. However, after the relative share price outperformance over the past six months, MER thinks it is time to take a break.
DBS is a consensus buy (85% buy and no sell rating on Bloomberg) and MER believes the market is too optimistic on the impact of rising US rates for DBS.
Revenue growth headwinds from falling commodity prices, renewed margin pressure in trade finance, a more uncertain outlook for financial market-related income and moderating loan demand will make it challenging for DBS to meet the 10% YoY top-line growth expectation by the market in 2015.
The commodity finance exposure of DBS is more of a risk for revenue growth outlook for DBS and MER is less worried about immediate asset quality deterioration at this stage.
Commodity financing exposure in Asia-Pacific hits banks hard
ANZ and StanChart among the hardest hit as slump in crude oil and copper prices impacts Asia banks with loans backed by commodities
By Chim Sau-wai 25 Jan 2015
Sinking commodity prices have cast a shadow over asset quality in banks as at least US$23 billion of loan commitments in eight banks were backed by commodity plays in the Asia-Pacific region, data showed.
Commodity prices have taken a beating, with crude values dropping to a 51/2 year low due to a glut in supply and copper diving more than 20 per cent over the same period, as a slowing economy in top commodity consumer China affected prices of iron and base metals among others.
Banks with the biggest exposure to commodities financing are ANZ, Bank of Tokyo-Mitsubishi UFJ, Bank of China, Standard Chartered, Sumitomo Mitsui Banking Corp, HSBC, State Bank of India and DBS, according to the data from Thomson Reuters. The commodity plays are up from the US$21 billion seen in 2013.
Among the eight banks, ANZ had the biggest exposure of US$3.38 billion in loans to commodity plays. Bank of China's was US$2.8 billion, DBS had US$2.77 billion while Standard Chartered had US$2.1 billion in exposure last year.
Standard Chartered is a glaring example, with analysts growing increasingly concerned about the asset quality of the lender's loan exposure to commodity-related firms. Credit Suisse said in a recent report that Standard Chartered's US$61 billion global commodities exposure may require additional provisioning.
"In an adverse scenario, Standard Chartered would need US$2.6 billion of provisions and US$24 billion of risk-weighted asset increases as the riskiest of the commodities portfolio is re-assessed, resulting in an additional capital demand of US$4.4 billion in financial year 2015, just to maintain the base-case capital ratio," said Carla Antunes-Silva, one of the analysts who wrote the report.
According to Credit Suisse, among Standard Chartered's US$61 billion commodity exposure, US$32.6 billion is direct exposure to commodity traders with a further US$28.1 billion of exposure to energy, agriculture, metals and mining firms. This is in comparison to the bank's total assets of US$690 billion and shareholder funds of US$48.3 billion in the first half of 2014.
"We believe the last two years of de-rating have been driven largely by weaker revenue, and that the asset quality deteriorating leg is now setting in," said Antunes-Silva.
Standard Chartered stunned investors in August last year with a 20 per cent tumble in first half pre-tax profits. Ratings agency Standard & Poor's cut its credit rating on the bank for the first time in 20 years in response and said the resulting A-rating had a negative outlook - a signal that another downgrade could come.
Chief executive Peter Sands promised a better performance in the second half of the year.
Analysts expect full year earnings per share - due to be revealed in early March - to fall 17.3 per cent versus 2013, according to Bloomberg consensus estimates. Some 25 of the 38 analysts who cover the bank rate it a hold or a sell, with 13 ranking it as a buy.
Standard Chartered was exposed to a commodities financing fraud uncovered in Qingdao last year. It sued the owner of the metals trading firm at the centre of the case.
The bank had US$175 million in impairments from China commodities in the first half of last year, and its total loan impairments stood at US$846 million, which was 16 per cent higher than the same period a year ago. Falling commodity prices have already triggered debt repayment woes for the banking industry.
China Nickel Resources, a speciality steel producer in China, defaulted on HK$580 million worth of bonds in December. It failed to pay bank loan interest charges this month and faces demands from Citic Bank and Shanghai Commercial Bank to settle HK$320 million in loans, according to company filings to the Hong Kong stock exchange.
KGI Fraser Securities on Wednesday initiated a coverage on the Singapore banking sector with an overweight rating.
Its top pick is DBS (buy; target price S$22.38), which it said is the main beneficiary of rising interest rates.
Net interest margin (NIM) is expected to go up gradually on the possibility of a rate hike by the US Federal Reserve this year.
"Besides potential NIM upside, DBS's strong private banking business and solid investment banking arm should strengthen its non-interest income revenue streams," KGI said in a report.
It also likes OCBC (buy; target price S$11.63) for the bank's potential synergies and cross-selling opportunities after its acquisition of Wing Hang Bank.
"We are also positive on the potential synergies from integration of OCBC Wing Hang, which will be OCBC's main focus as the bank expands its footprint in Greater China," it said.
However, it initiated a "hold" on UOB with target price of S$23.04, saying a lack of near-term catalyst and possible funding pressure make UOB "unattractive".
It added that potential upswing in non-interest income will be another positive re-rating catalyst for the banks.
Slow deposits growth and increased funding competition may put pressure on banks' funding costs as interest rates move upwards, it said.
As Singapore's economy is expected to slow, banks will need to shift their focus on overseas expansion as they seek to grow their loan book.
Meanwhile, credit costs are expected to increase on the back of higher interest rates, even though all three local banks have relatively strong balance sheet and no systemic issues with current loan books.
The report added that Singapore banks continue to have adequate capital buffer for now.
“The problem for Singaporean banks is that weakness in other Asian currencies affects the Singaporean banks in two ways. Firstly, weaker currencies in the countries that Singaporean banks have lent to would lead to expectations of weaker loan growth and potential loan quality issues.” Singapore acts as an international finance centre for much of Asia. Singaporean bank assets have grown significantly to become close to 300% of GDP.