Are Singapore bank bonds close to risk free?

One explanation for the low LTD ratios among local banks is the provision of deposit insurance by the Singapore Deposit Insurance Corporation for up to S$75,000 per bank per person. The insurance coverage was in fact lifted to S$75,000 from S$50,000 in April 2019, which was a positive development for bank bondholders. These insured domestic deposits could be regarded as a stable source of funding for domestic banks as insured depositors will probably not withdraw their money at the first sign of bank distress.

The overall LTD ratio for the banking system was residing at a seemingly high level of 105% in September, but remained healthy in our opinion. Although banks with high LTD ratios were perceived to possess a high risk of a bank run in the past, a LTD ratio of more than 100% is the norm among large foreign banks now.

For one, many foreign banks have easy access to funds from multiple non-deposit sources such as their own central banks, and money market instruments such as commercial papers and other short-term funding notes. Secondly, customers, especially in Europe, are more incentivized to move their savings away from banks and into higher yielding securities with the low interest rate environment.

Domestic systemically important banks, resolution planning and their implications for bondholders

In response to the Basel Committee’s recommendations for creating rules for domestic systemically important banks (“D-SIBs”), MAS published the framework for identifying and supervising of banks regarded as too-big-to-fail in 2015. Seven D-SIBs, namely DBS, OCBC, UOB, Malayan Banking Berhad, Citibank, Standard Chartered Bank and The Hong Kong and Shanghai Banking Corporation (“HSBC”), were “assessed to have a significant impact on the stability of the financial system.” The latter four are foreign banking groups and have locally incorporated subsidiaries in Singapore. Among them, Standard Chartered Bank, Citibank and HSBC are also classified as global systemically important banks by the Financial Stability Board.

Locally incorporated D-SIBs are subjected to the resolution regime of MAS. According to the 2017 and 2018 documents on the resolution of financial institutions, the central bank has the right to bail-in the liabilities of both locally-incorporated banks and holding companies that have at least one bank subsidiary. Filtering through the list of details in the documents, we think these are the few important points for bondholders.

1)     The definition of bail-in-able instruments refers to: (a) any equity security that represents a legal or beneficial ownership in the issuer but excludes ordinary shares; (b) an unsecured debt that is subordinated to unsecured creditors’ claims of the issuer that are not so subordinated; or (c) any type of security that provides the right to be written down, cancelled, modified, converted into shares or other types of ownership in specific circumstances.

2)     If a bail-in-able bond is partially secured, only the unsecured portion will fall within the scope of MAS’s bail-in powers.

3)     Derivatives, vanilla senior perpetual securities, senior convertible bonds and senior exchangeable bonds, options and warrants are not bail-in-able.

4)     The bail-in provisions apply to securities issued on or after 29 Nov 18.

5)     MAS has implemented a no creditor worse-off than in liquidation compensation framework that provides creditors the right to compensation if they receive less in resolution than what they would have received in liquidation.

6)     In the event of a resolution of a financial institution, it is projected that losses will be imposed on its shareholders and unsecured subordinated creditors to the fullest extent possible. 

Even though it is the MAS’s intention to rely on the banks’ regulatory capital instruments (such as contingent convertibles) as the primary form of loss-absorbing capacity for the banks, the central bank may still provide temporary liquidity to support the banks in the event of a bank resolution. A resolution fund could be set up to facilitate the resolution process and the initial cost in resolving the financial institution will be recovered later from the financial sector. With this in mind, we think it is likely that there will be sovereign support for Singapore banks at the point where their viability is threatened.

The provision of emergency liquidity assistance (“ELA”) is an extension of this extraordinary support. Under the Monetary Authority of Singapore Act (Cap 186), MAS is able to offer loans or advances to banks in the context of restoring stability and public confidence in the financial system. This assistance may come in the form of a liquidity facility to specific groups of banks or, bespoke loans to troubled D-SIBs so that lenders may obtain funding in distressed situations. The establishments of the resolution planning regime and ELA frameworks are credit positive for bondholders in our view.    

Market and trading risk

The ratio of the banks’ market risk-weighted assets (“RWA”) to Common Equity Tier 1 (“CET 1”) capital forms part of our assessment of the banks’ solvency risk. As a general rule, the bank’s solvency profile is threatened if the positions in its portfolio lead to large losses arising from movements in market prices. According to the Basel Committee on Banking Supervision, high market risk is typical of investment banks and commercial banks with trading activities.

A volatile or an elevated level in the market RWA-to-CET 1 ratio represents significant trading risk. Comparing the three lenders (Figure 8), we observed that the ratios were less than 100%, meaning the banks have low trading risk. The ratios have been on a downtrend, with OCBC and UOB witnessing a marked drop in their RWA-to-CET 1 ratio between 2Q17 and 4Q17.

The denominator of the ratio — the amount of CET 1 capital — has largely been on an uptrend during this period, while its numerator — market RWAs — has gone in the opposite direction, resulting in overall lower market RWA-to-CET 1 ratios. We suspect that the lower market RWAs are a result of lower interest rate risk. Nonetheless, DBS retained the highest trading risk with a market RWA-to-CET 1 ratio in excess of 70% as at 3Q19.

The high trading activity of DBS was also reflected in its income statements, as net trading income for the bank climbed from S$354m in 3Q18 to S$431m in 3Q19. The bank’s net trading income represented 11% of DBS’s total income in the recent quarter, which was the highest among the three lenders. In comparison, OCBC’s and UOB’s net trading incomes made up 7% and 8% of their respective total income in 3Q19.

An additional measure of market risk is the percentage of derivatives exposure over CET 1 capital. Comparing the three banks, DBS again had the highest derivative exposure among Singapore banks. As of 3Q19, total derivative exposures were equivalent to 74% of DBS’s CET 1 capital, exceeding that of OCBC (43%) and nearly twice as high as UOB (40%).

Figure 8: Market risk-weighted assets over CET 1 capital

Singapore banks have high capital adequacy ratios

The Singapore banks’ capital adequacy ratios were well above regulatory requirements. With effect from 1 Jan 19, Singapore banks have to keep their ratio of CET 1 capital to risk-weighted assets above 11.5% (assuming the highest countercyclical buffer is applied at both the group and bank level). CET 1 capital, which consists mostly of common equity, is the highest quality of regulatory capital as it absorbs losses immediately when they occur.

As of 3Q19, DBS, UOB and OCBC had CET 1 ratios of 13.8%, 13.7% and 14.4% respectively (see Table 1). All their capital ratios topped MAS requirements, including other Basel III capital and liquidity measures. For example, the banks’ liquidity coverage ratio (“LCR”) and net stable funding ratio (“NSFR”) were comfortably higher than regulatory minimums.  Even the capital ratios of the foreign subsidiaries of OCBC exceeded MAS requirements, although the bank pointed out that these ratios were calculated in accordance with banking rules in other jurisdictions.

Table 1: Key prudential regulatory metrics as of 3Q19

Singapore lenders have maintained their CET 1 ratios above 12.5% between 1Q13 and 3Q19. It is evident from Figure 9a that the ratios appeared to exhibit a modest uptrend when they are benchmarked against risk-weighted assets. However, Figure 9b showed that the banks’ ratios of CET 1 capital to tangible assets have dropped since 3Q16, suggesting that the banks’ capital position actually weakened since 2016.

The tangible asset ratio is an unweighted perspective of capital adequacy that is not subject to regulatory adjustments. Tangible assets do not take into account off-balance sheet items that could include higher risk derivatives, but (as compared to RWA) they place more weight on safer instruments such as government bonds. Unlike risk-weighted assets, tangible assets do not factor in risk adjustments that are reliant on the bank’s internal models and assumptions.

Despite the deterioration in the CET 1-to-tangible assets ratio, we do not feel that there is a need for concern as the banks’ capital adequacy ratios are higher than many of their international peers (see Table 2). Within the Singapore banking sector, we think that DBS has the weakest capital position as it has the lowest proportion of CET 1 capital.

Figure 9: CET 1 ratios using risk-weighted and unweighted methods

Singapore banks have met the minimum leverage ratio

Over in the US, bankers have lobbied for easier capital regulations, especially with regard to the Basel III leverage ratio — a measure of tier 1 capital relative to total leverage exposure on the balance sheet and certain off-balance sheet exposures. The banks argued that the capital standards were too onerous for them to conduct certain activities like lending in key markets performed at the subsidiaries. Lenders in Singapore, on the other hand, have little difficulty meeting regulatory standards with leverage ratios reaching more than twice the 3% minimum set by the MAS.

Among the global systemically important banks (“G-SIBs”) in Table 2, leverage ratios among Singapore, Chinese and US banks were distinctly higher than European banks, although individual banks may not be perfectly comparable due to the different banking rules in various jurisdictions. If we examined lenders that were supervised under the same regulator, for instance by just comparing European banks, we infer that Deutsche Bank was likely the weakest capitalized bank among its peers.

Access to capital remains healthy

Beyond relying on the ELA framework and resolution regime for capital support while in distress, the banks’ ability to attract capital on a continual basis is a testament of a healthy credit profile. Quite instinctively, the bank’s credit quality is likely to weaken if it is unable to source for new capital. For a publicly listed bank, we can look at its market capitalization over book value as a proxy for its capital-raising ability. The higher the bank’s market capitalization relative to its book value (or the price-to-book ratio), the easier it is for the lender to secure external funding.

Referring back to Table 2, the price-to-book ratios of Singapore banks are modestly higher than most other G-SIBs. As a matter of fact, the book values of many publicly listed G-SIBs surprisingly exceeded their market capitalizations. The few exceptions are JP Morgan Chase, Bank of America, Wells Fargo, RBC, BNY Mellon and State Street, with the latter two being large providers of custody and trustee services.

Table 2: Selected financial ratios for Singapore banks and G-SIBs

Observed spreads on credit default swaps (“CDS”) also provide a good indication of market appetite for a bank’s paper. Demand for a bank’s debt may be proxied by the 5-year CDS bid-ask spread, which is simply the difference between the ask and bid prices of the CDS contract. It is observed in Figure 10 that the CDS bid-ask spreads of Singapore banks widened considerably in 2008, but declined over the years since then, partially due to the improved credit quality and liquidity of bank subordinated debt. In 2008, the collapse of Lehman Brothers resulted in an uncertain outlook for the banking sector, creating a liquidity crunch.

Figure 10: Bid-ask spreads on 5-year credit default swaps  

Singapore lenders have good liquidity profile

With the advent of the Global Financial Crisis, the failure of banks to control and manage their liquidity profiles has led to the introduction of two liquidity standards — the NSFR and LCR. The liquidity profiles of banks have since improved with the enforcements of these standards. Also, monetary policies around the world are easing and well supportive of increasing credit growth in the economies.

A bank’s liquidity profile is evaluated according to the group’s ability to access cash and whether if it is able to receive cash inflows from its liquid banking assets. The liquidity coverage ratio is a Basel III Pillar disclosure that computes the amount of high quality liquid assets (“HQLA”) over total net cash outflows over a 30-day period under a predetermined stress scenario. As of end-September, the LCR ratios of UOB (146%) and OCBC (152%) both surpassed DBS (131%).

Cash flows in the LCR denominator are adjusted for risk weights before final net outflows are calculated. These risk weights are assigned at the bank’s discretion, which is why we would like to supplement the LCR reading with another assessment of liquidity, namely the ratio of HQLA to tangible banking assets (“HQLA/TBA”). With this in mind, the HQLA/TBA ratios of all three Singapore banks showed an improvement from 3Q18 to 3Q19. The HQLA/TBA ratios of DBS, UOB, OCBC were 16.0% (3Q18: 15.0%), 15.1% (3Q18: 12.1%) and 12.4% (3Q18: 10.4%), all higher from the third quarter last year.  

Our final liquidity measure is the NSFR, which expresses the bank’s available stable funding over its required stable funding. Put simply, the NSFR restricts lenders from relying excessively on unstable funding sources and incentivizes them to use more stable funding channels. As presented earlier in Table 1, the NSFRs of Singapore banks are above 100%, implying that the banks have more short-term stable funds relative to long-term illiquid assets. These ratios are above Basel and MAS minimums, reinforcing the fact that the liquidity profiles of UOB, OCBC and DBS are healthy.

Our thoughts about the issuer profiles at this juncture

Our discussion thus far leads us to have a slight preference towards UOB over OCBC and DBS in terms of its credit profile. Quite importantly, UOB has the smallest exposure to Hong Kong, a higher proportion of CET 1 capital to tangible banking assets and lower market risk exposure relative to CET 1 capital. Our top pick therefore is UOB among the three lenders, but considering the interconnectedness of the banking system and the equal likelihood of each lender receiving funding support from the central bank in times of need, we think there is very little difference that sets these banks apart at this point in time. We feel there is little default risk facing Singapore banks now so we would not have any qualms issuing a positive outlook for all three companies. Moreover, our comparison among G-SIBs and Singapore lenders in Table 2 shows that the domestic banks still have superior credit quality over some large systemically important banks.

Are Singapore bonds attractively priced?

In recommending the Singapore bank bonds, we looked primarily at their bond yields and key salient features. The number of outstanding Singapore bonds was estimated to exceed 340 but we narrowed our focus to the securities available on our platform, listed in Table 3 below. There are clearly various types of securities along the banks’ capital structure, ranging from additional tier 1 (“AT1”) perpetual bonds, covered bonds, preference shares, tier 2 instruments and senior unsecured debt. Senior unsecured debt are the highest ranked in the list, while AT1 bonds are becoming increasingly popular with bond investors due to their higher yield. 

Table 3: Singapore bank securities

In the context of subordinated notes, we prefer the GESP 4.600% 19Jan2026 Corp (SGD) and UOBSP 3.500% 16Sep2026 Corp (USD) over other local bank credits. Many of the instruments in Figure 13 are Tier 2 instruments, or part of gone-concern capital. In other words, Tier 2 instruments absorb losses in an insolvency situation before depositors and other more senior creditors, but after AT1 noteholders. In addition, the standards for Tier 2 eligibility are less stringent than those for AT1 as they allow bonds with a fixed maturity date to be included. In the Basel III framework, all AT1 notes must be perpetuals.

UOBSP 3.5% ’26s has a write-down clause where the loss absorption is conducted on a pro-rata and proportionate basis with all other Tier 2 capital securities. If the bank drops below the point of non-viability, MAS will notify UOB as a trigger for the write-down mechanism of the note. We also like the

GESP 4.600% 19Jan2026 Corp (SGD) (callable in January 2021) for its reasonable yield to next call of 1.68% on 3 Jan 20. The issuer Great Eastern Life Assurance Co Ltd (Singapore) is the insurance subsidiary of OCBC and we believe it will have strong parent support in the event of financial difficulty.

Figure 13: Callable subordinated Singapore bank debt

When viewed against other foreign issuers, the yield to next call of GESP 4.6% ’26s was comparatively lower than other European bank credits (Figure 14). Similar bonds such as  Standard Chartered’s 4.4% ’26s, BNP 4.3% ‘25s and BPCEGP 4.450% 17Dec2025 Corp (SGD) have bond yields in excess of 2% on 3 Jan 20. Standard Chartered Plc, or STANLN is an international, global systemically important bank with its headquarters in London; BNP Paribas is the biggest bank in France; and BPCE SA is part of the second largest French banking group, Groupe BPCE.

Figure 14: Subordinated SGD bank debt