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Will investors’ confidence in bank stocks improve this year?

Developments and results in next few weeks will be closely tracked

WITH 2007 behind them, investors in the Singapore-listed banks will be closely watching developments in the next few weeks to see what 2008 has in store.

Analysts expect core lending to continue to do well, given strong loans growth so far. But the banks are unlikely to be spared if economic growth here slows in the year ahead.

One of the questions expected to be answered soon is who will take the helm of DBS Group as chief executive to replace outgoing CEO Jackson Tai.

The banks’ fourth-quarter results, expected in February, will also play a crucial role in restoring – or further denting – investor confidence in their shares.

Top of the list of things to look for in their earnings reports will be any further write-downs in the value of their collateralised debt obligation or CDO holdings.

In early November last year, OCBC Bank stunned shareholders when it slashed the value of its portfolio of CDOs, comprising pools of asset-backed securities (ABS), by $221 million to just $48 million – less than a fifth of the original value.

OCBC chief executive David Conner said at the time that the move was intended to ‘prepare for the worst’ after it became clear that the market for such debt securities had dried up amid the financial market turmoil.

OCBC’s write-down of its ABS CDO holdings against its earnings was the most aggressive so far among the three banks listed here, although it has another $372 million invested in corporate CDOs – those backed by corporate bonds – that could still see a fall in value.

United Overseas Bank (UOB) has charged $55 million so far against its earnings for its CDO investments of $388 million, of which some $90 million are in ABS CDOs.

And DBS took an $85 million charge against its third-quarter earnings for its CDO exposure, including a $70 million write-down of its $275 million investment in ABS CDOs. It has total CDO exposure of $2.36 billion – including $1.1 billion held by a special purpose vehicle.

The possibility of further writedowns has kept the banks’ share prices depressed in the weeks since they announced their Q3 earnings.

DBS and UOB have been buying back their own shares, which may suggest the banks believe their stocks are undervalued.

Equally important to watch out for will be signs of any weakening in the banks’ core revenue, operating profit and interest margins that would suggest they are in for a rougher ride in 2008.

In recent months the banks have benefited from the surge of activity in the property market and broader economic growth.

Overall bank lending to the property sector – including home loans to individuals and commercial loans to property developers and other businesses in the building and construction industry – has climbed steadily since January and reached an all-time high of $107.2 billion at end-November, according to the most recent estimates from the Monetary Authority of Singapore.

So far then, the impact of the global financial market turmoil that began in late July has been limited to writedowns in the value of the banks’ CDO holdings, losses suffered on trading securities and derivatives from widening credit spreads and – less directly – from lower interest margins resulting from a defensive shift of funds into lower yield short-term assets in the face of volatile financial markets.

These effects – while significant enough to drag the banks’ profits down for the second half of 2007 – are unlikely to last into 2008 and are relatively easy for the banks to manage.

Of greater concern is whether the malaise will affect the banks’ core lending business. That could happen if, as widely expected, broader economic growth worldwide slows and companies here – squeezed by higher costs and lower demand – start cutting back on expansion plans and new investments.

Slower loans growth – particularly to property developers, home-buyers and small businesses – would be one of the first signs of this.

Other symptoms of longer-lasting effects of the financial storm on the banks would be a rise in the proportion of bad loans if the businesses they lend to run into financial trouble, or a decline in fee and commission income from investment banking and wealth management, if the appetite for such services wanes.

In Singapore, the banks’ retail business will likely face greater competition from Citigroup’s consumer subsidiary Citibank Singapore, which has been expanding rapidly into the heartland through its tie-up with transport operator SMRT Corp.

With stiff competition at home, it will also be important to see how well the banks fare in new markets, particularly China. All three Singapore banks have now received approval from Chinese regulators to set up local subsidiaries and are expected to expand their operations there.

But other overseas ventures have proved difficult. Over the past year, Thailand’s banking sector has been particularly troublesome for DBS and UOB.

The value of DBS’s 16 per cent stake in Thailand’s TMB Bank plummeted some 40 per cent in 2007. In July, DBS took a $159 million charge against its Q2 earnings. And in Q3 it wrote down the investment by another $38 million to $270 million.

Since the end of September, TMB’s share price has dropped a further 20 per cent. At a rough estimate, that would make a $50 million dent in DBS’s Q4 earnings if it decides to write down the value of the investment a third time.

Meanwhile, sharply higher charges for bad loans led UOB to a pre-tax loss of $25 million for its Thai operations in the first half of 2007 – the most recent published figures for the group’s business there – reversing a $19 million profit a year earlier.

Also from Jan 1, 2008, the three Singapore-listed banks and Citibank Singapore will be subject to the new Basel II rules governing how much capital banks need to set aside based on the risks they face.

That will put to the test the millions of dollars the banks have poured into new computer systems and staff training over the last two years. Among other things, the international guidelines are supposed to help banks deploy their capital more efficiently while guarding against the risk of collapse.

But events in recent months – especially the reluctance of large banks in the US and Europe to lend to one another at prevailing interest rates – have revived old criticism that the Basel II framework puts too much emphasis on how to measure the credit risk on loans, even though the collapse of British bank Northern Rock suggests a lack of ready funds – liquidity risk – can ruin a bank just as easily as a mountain of bad debt.


Source: Busines Times 2 Jan 08

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