Analyst warns Singapore banks to beware the liquidity squeeze

Downgrade sector to Neutral (from Overweight) on growing signs of liquidity tightness. While Singapore banks do not have a valuation premium or a capital problem to deal with, our new concern is a liquidity squeeze, which could develop globally and cause Financials as an asset class to Underperform across the board.

What started out as a European capital threat is gradually morphing into a global liquidity threat. We make no changes to our target prices or stock ratings for DBS, OCBC and UOB for now but would be very watchful of liquidity. DBS remains our top pick for now.

Tight US$ liquidity seems to be developing in Singapore as well. In Singapore, the S$ 3-month SIBOR tends to be about 50% the rate of the US$ 3-month SIBOR, during normal times. However, since 2Q09, when Fed Fund rates brought down interest rates to almost zero, the relationship broke. While the US$ SIBOR went to 25-30bp, the S$ SIBOR hit an initial floor of 75bp because local banks were simply unwilling to lend at any lower rates.

SIBOR subsequently sank to 45bp and 35bp when the MAS’s strong S$ policy attracted more flows. Basically, US$ liquidity should not be a problem these days since QE1 and QE2 have been flooding the world with dollars. The only reason US$ SIBOR goes up is a greater reluctance to lend, as could be seen in mid-2010 when the euro crisis first surfaced.

In recent days, such a situation appears to be developing. The US$ SIBOR has started creeping up again, now matching S$ SIBOR. We interpret this as the market’s fears that US$ funding is getting tighter.

Implications for local banks
Europe’s capital problem becoming a global liquidity problem. What started out as fears that European banks have insufficient capital to cope with sovereign defaults have evolved into nascent distrust among financial institutions and a budding liquidity problem for the world. Signs of growing liquidity constraints are aplenty. Sure, the current situation is still far from Lehman days, but one should be aware that it is no longer just about European banks’ capital problems.

Fight for deposits + attempts to re-price loan yields upwards. In recent weeks, the Street has been focusing on abnormally low S$ SOR and highlighted how that would affect floating-rate loan pricing. Certainly, the collapse of SOR would add margin pressure to 3Q11 results, but we believe that is not the main source of margin pressure. We are actually more concerned about S$ deposit competition simmering in recent days.

The price war started with HSBC offering 0.72% time-deposit rates, before ANZ came up with a 1.00% promotion for time deposits and Maybank Singapore, a 1.35% promotion. Yesterday, what was even more alarming was Standard Chartered’s new offer of 0.908% for savings deposits. In comparison, the 3-month S$ SIBOR is only 0.34%.

We highlight that deposit competition is heating up, and no longer confined to the high-net-worth space. Clearly, banks across the world are trying to shore up their deposit funding. Although local banks do have a deposit franchise and might not necessarily need to compete as aggressively on deposits. Current short-term trends certainly bode ill for margins but it does not equate to structurally lower margins further ahead.

If rising US$ SIBOR sustains, we believe banks will start to push up lending yields soon. We believe that the banks will be trying to push up lending spreads soon. After all, all three Singapore banks did enjoy some of their best lending spreads during 4Q08-2009, when foreign banks became risk-averse and cut their lending activities.