OCBC probably wishes it hadn’t put this picture on the first page of its 2014 annual report.
OCBC is known to be one of the best run banks in Asia. But much like the rest of the Singaporean banking system, it has been increasing its risk exposure over the past few years. And the biggest risk facing them is a slowdown of the Chinese economy.
Singapore is a stable, mature economy. If bank lending increases by 60 percentage points of GDP in 5 years, it is likely that some of these loans have been made to less creditworthy borrowers.
The net loan balance for OCBC itself has risen from SG$81 billion in 2009 to SG$208 billion in 2014. Part of this increase reflects the purchase of ING’s private banking business in Asia and the purchase of Wing Hang bank in Hong Kong. But the bank has also increased its loan book organically by ratching up its mortgage lending and general commerce loans.
If we look at the geographical breakdown of loans in the annual report, we see that 26% of gross loans were in Greater China in 2014. vs 9% in 2009. This is about the same ratio as Singaporean peer DBS, which many suspect have skeletons in the closet.
A lot of the increased exposure to Greater China is due to the acquisition of Wing Hang Bank in 2014. Wing Hang was acquired by OCBC for 1.77x tangible book by Samuel Tsien, who took up the role as CEO in 2012. He is an untested card, and the big question is if as conservative and sensible as previous CEO David Connor.
At the time of the acquisition, OCBC stated that:
“Apart from Shanghai, the Pearl River Delta including Hong Kong and Macau is our bread and butter, offering higher returns and risks simultaneously”.
They also stated that:
“We want to make Wing Hang a very attractive platform for yuan-related businesses for OCBC clients”
and that it was eyeing the:
“increasing investment and trade flows between Southeast Asia and China”
In other words, OCBC has sought out exposure towards yuan carry trade flows and mainland borrowers. Fitch followed up by putting OCBC on a negative watch due to higher credit and operating risks in China compared to Singapore.
Wing Hang has exposure to Hong Kong, Macau and China. Industry exposure on the mainland is not evident from its filings, but according to sell side “most [of Wing Hang’s] loans in southern China were related to property development”. Wing Hang’s classification of its loans are based on the “usage of its advances”, not necessarily the region where the ultimate parent of the borrower is located. This makes it more difficult to judge the credit risks Wing Hang has taken on. Mainland property developers such as China Overseas Land routinely borrow in USD/HKD from Hong Kong banks using their Hong Kong subsidiaries. Close to 40% of OCBC’s loan book are in US$ and HK$ loans. Even though direct currency exposures are hedged, credit risk is not. If China devalues its currency by a large amount, non-SOE credits will naturally suffer.
Now both OCBC and Wing Hang are well run banks. OCBC’s loan-to-deposit ratio is low at 85% so it is not dependent on wholesale funding. It is implicitly backed by the Singaporean government. But bad debts could weigh on the banks profits for a few years. Leverage ratios are not low either, compared to other banks in Asia. OCBC has an tangible equity/assets ratio of 7.2%. This may be enough for Singapore mortgage lending, but not necessarily when 26% of assets are in Greater China and it has significant exposure to a fragile mainland property market.
OCBC’s home market in Singapore may also be an issue from a bad debt perspective. While a rising SIBOR may benefit the net interest margin as mortgages are floating-rate, it will also lead to higher defaults.
In 2014, OCBC’s provisioning for loan losses was 17 basis points of gross loans. That’s not very high. As a comparison, one of the best run banks in the world Wells Fargo has had an average provisioning level of 30bps over the last couple of years. If the ratio goes up to 70bps, pretax profit will drop 30-40%. In reality, profits may drop more than that, given the cyclicality of fee & commission income.
The benefit of shorting Singaporean banks such as OCBC or DBS is that they have large exposure to mainland borrowers and that the Singaporean economy is weak. Singapore’s capital account is negative partly due to the strong US Dollar and partly due to Singapore’s exposure to the oil & gas industry.
Such outflows tend to contract the monetary base, which tightens the economy. And the economy is suffering indeed: Singapore’s CPI inflation rate has been negative 8 months in a row. An easing of monetary policy would require MAS to weaken its currency, which could happen after the elections in October. So shorting Singaporean banks and placing the proceeds in US Dollar provides a win-win: either the MAS weakens the currency or the banks suffer in a weak economy. A depreciation of the renminbi would be icing on the cake.
Other banks with mainland exposure include DBS, Bank of East Asia, BoC Hong Kong, ANZ and Standard Chartered. Given that banks to some extent are black boxes, I favour a basket approach to shorting them.