Saturday, October 1, 2016

Singapore Banks: Part 4: Returns and Valuations


So far we've been looking at different aspects of the business separately.  All these parts operate together to generate a return.  How do we measure the returns generated?

The most common measure is ROE:

This doesn't account for differing leverage that different banks may have, so its used in conjunction with ROA:

ROA doesn't take into account the quality of assets.  To do this, we would look at Returns over Risk-Weighted-Assets:

Finally, we can use Revenue over Risk-Weighted-Assets, for cases where the banks have a lot of one-off expenses that affect their returns1:

Why the spike in OCBC's in 2012?  They had an one off $1.3bn sale of securities2.


We use book value to value banking stocks for two reasons.  Firstly, because earnings are highly cyclical.  Secondly, because for a financial business, accounting rules require the assets (i.e.: loans) on the balance sheet to be constantly updated to reflect future earnings3.

Specifically, we use Tangible Book Value (Book Value minus Intangible Assets):

How are the banks valued compared to the past?  I have to use simple book value to compare this, since I can't find any past P/TBV values4.  Price/BVs over recent downturns were:

                (Source: Share Investment: Ernest Lim: Singapore Banks Trading at near Global Financial Crisis Low Valuations).

Current Price/BVs are close to 1:


I would buy either UOB or OCBC, because of their historically high returns and lower write offs.

Would I buy now?  Banks stocks have been grinding lower for the last year.  They are fairly cheap, though not at crisis levels.  If I bought, I would only buy half a position now.  No telling when the next recession or crisis will come.

1 Not for these 3 S'pore banks, but may be used when comparing them to other countries' banks.
2 Note 7 in 2015 AR.   1.35bn "Disposal of securities classified as availiable-for-sale", which is 27% of PBT. 
3 Unlike other businesses where where the amount recorded on the balance sheet is the amount paid minus depreciation.
4 To calculate them I would need past stock prices un-adjusted for dividends/splits.

Friday, September 30, 2016

Singapore Banks: Part 3: Deposits


A low-cost deposit base is a competitive advantage for a bank.  If the cost of a bank's deposits - both interest and non-interest costs - is less than the AAA corporate bond yield for example, then they could simply buy the bonds and get free money off the spread.

This article gives an example of working through a bank's numbers to determine its cost of deposits.  Unfortunately, we can't do this for Singapore banks because:
  • 30-40% of their income is non-interest income, and we can't really apportion the costs between the segments.
  • And their deposits are in different currencies.  Non-interest costs are broken down between countries, but interest costs are not.
The best we can do is look at their non-interest rate costs, while accepting that some of it accounts for the non-interest income too.  And try to find some proxy for interest costs.

Non Interest Costs

For Singapore dollar deposits, non-interest operating costs as a percentage of deposits were:

In other words, they paid this percentage in non-interest operating costs (e.g.: rent, staff) in Singapore, for their SGD deposits.

No real difference between the banks, but at around 1%, these costs are extremely low.  And remember, this includes the cost of generating the 30-40% of non-interest income1 .

Their costs for deposits in other countries will be higher, since they lack scale.

Interest Costs

None of the banks break down their total interest costs by the different currencies they hold.  We can't just look at the total when dealing with such disparate currencies such as the SGD (interest rate 0.4%) and Malaysian Ringgit (interest rate 3%).

The CASA ratio is the ratio of (current plus savings) accounts to total deposits.  Since current and savings accounts usually have low interest, a higher ratio means a cheaper source of deposits.  

DBS has a consistently higher ratio of deposits from savings and current accounts.


Buffet's "weapons of mass destruction".  Here we compare the notional amounts of all derivatives on the balance sheet to total assets:

DBS stands out.  The large notional amounts are larger than bank's assets. They are not as scary as they seem - when buying or selling futures, its normal to have 10X leverage2.  You are betting/hedging on the change in price, not the absolute price itself.   Still, a couple of things strike me:
  • For all 3 banks the vast majority of their derivatives are for trading, not hedging.3
  • For the derivatives held for trading: for both OCBC and UOB, over 90% of them are OTC4. For DBS around half5 are. If you are trading, shouldn't you be using exchange-traded securities?
The banks' derivative disclosure is too complex for me to understand.  Probably for anyone else too.  But I just use the notional amount divided by total assets to get a rough idea of derivatives exposure.  Not sure if it means anything.

1 But wxcludes allowances & write offs.  
2 And even more for low volatility assets.  
3 From 2015 Annual report footnotes.  For OCBC: around 98% of derivatives are for trading (note 18); UOB does not give the breakdown of derivatives used for trading or hedging, but the amounts in note 37a suggest only a small amount is for hedging. For DBS, over 99% of derivatives are for trading (note 36.2 on p149).  
4 Forwards and swaps are OTC  
5 Not sure if their "FX Contracts" are OTC - if they are, the amount rises to 78%  

Wednesday, September 28, 2016

Singapore Banks: Part 2: Losses and Leverage


Allowances and write offs are a normal part of doing business for a bank.  Even for a successful one.  Write-offs are during a downturn are the biggest source of losses: from when people stop paying their loans or the securities held drop in value...permanently.

Over the long term, these can be measured by the allowances made for bad debt and investments.  General Allowances are made when loans are taken out, with the expectation that some will turn bad.  Specific Allowances are for individual loans or investment that have already turned bad.  If less loans turn bad then expected, or the debtors starts paying off bad loans, the allowances can be written back.  The graphs below show the sum of all allowances1.

Since loans are the largest part of the banks' business, lets look at the allowances for loans first:

Now lets look at all allowances - this includes the above loans, plus for investments, acquisitions, etc:

In both cases, OCBC has historically been more conservative in their lending and investments.

Due to the recent Oil & Gas Industry scare, lets look at more recent bad loans.  Non-Performing Loans are loans for which required payment has not been made - the criteria is objective.  I'm looking at Non Performing Assets here (which include NPLs), because I couldn't find NPL information for one of the banks:

Nothing conclusive.   Over the last 3 quarters, DBS is going up, the others going down.  Will be interesting to see if that becomes a trend.

Another chart showing how many of the NPAs are secured loans:

OCBC has a higher number of NPAs that are secured.  Meaning they have more chance of getting something back.

Does OCBC make less losses because it has a higher proportion of (safer) housing loans?  Not really:


Due to the possibility of a debt crisis in China: lets take a quick look at the Singapore banks' China exposure.  UOB has the least:
   (Source: Andy Mukherjee: China infects Singapore Banks)


Before looking at a business' profits, we look at its leverage to see how much risk it is taking to get those profits.

What does leverage mean for a business that lends out money?

The key requirement is shareholders equity: this is the money available under all circumstances for the bank to pay off any losses.  Leverage used to be measured by the the Shareholder Equity Ratio - the ratio of Shareholders Equity to Assets.  Most "assets" for a bank are loans, so this ratio roughly measures "How many loans have you made compared to shareholders equity?"  If you have 20X more assets than equity, then a 1% decrease in assets values reduces shareholder equity by 20%.  And a 5% decrease wipes you out.

Nowadays, leverage is measured by the under the Basel III capital adequacy ratios.  To understand these, we need to take a detour and look at:

  • Common Equity Tier 1 (CET1) is the highest quality of equity.  Roughly, it is Shareholders Equity minus Intangible Assets (p4). 
  • Risk Weighted Assets (RWA).  Banking profits are traditionally measured by "Return on Assets".  But this ignores how risky the assets on the balance sheet are.  The RWA calculation tries to account for this by adding up the weights of different types of assets based on their risk.  For example, safe assets like short term government bonds have a multiplier weight of zero.  Riskier assets, such as loans, are given higher scores, depending on the loans' terms and repayment records.  This adding process is done three times: for credit risk, market risk, and operational risk, as shown below:

          The final value is the sum of all three numbers.  A lower result is better, meaning less risk.

          RWA does not measure systematic risk.   For example, the Housing markets in Australia and Sweden are in a bubble likely to burst.  RWA calculations will not show this extra risk for Australian and Swedish banks.

          Like any metric, RWA can be gamed.

Basel III requires banks to have CET1 capital of at least 4.5% of RWA.  Singapore requires banks to have CET1 capital of between 9% to 11.5%3 by 2019.  All three look like they've already made it2:

OCBC has a lower ratio than the other banks because MAS ruled that its insurance subsidiary, Great Eastern Life, cannot be included in CET1 capital.


Historically, OCBC has made less bad loans and write-offs than UOB and DBS.  They have been more conservative in their lending and investments.

UOB has the lowest exposure to China.


1 General plus specific allowances, including write backs.
2 The graph shows the CET1 CAR for MAS Basel III rules, effective 1st Jan 2018.  These are not the 'headline' numbers presented in the 2015 Annual Reports - those are higher and computed using an older methodology.
3 Its a 9% CET1 CAR, plus a 0 to 2.5% 'Countercyclical Buffer', which MAS may adjust to slow down lending.

Sunday, September 25, 2016

Singapore Banks: Part 1


I'm looking at he local Singapore banks, as some are trading below book value and at single digit PEs, due to fallout from the local O&G industry and fears of a China slowdown.

I've always avoided banking and finance companies due to their performance in the 2008 crisis.  Basically I had the idea that they are all black boxes, stuffed full of derivatives, bad loans and 3-letter acronyms, who would report rising profits for years, before one-day turning around and writing them all off.   As shown in the chart below:

The counterpoints are that:
  • In many countries, banking is an oligopoly, with the top 3-4 players having 50-75% of the market.  They are still price competitive, but new entrants are limited.
  • Banks provide a large amount of detail about their loan book (aggregated by industry, country, percentage of loans secured, etc).  As well as Non-performing loans (NPLs) which are decided by objective criteria.
  • We can see their long-term history of write offs and NPLs - a bank that was conservative in the past is likely to be so in the future.  Corporate culture does not change quickly.
  • The cost of funding (deposits) is known and provides a distinct competitive advantage for some players.  Cheap money.

Learning about Banking

I haven't found any single, complete book on "Analysing bank stocks for idiots and value investors".  Rather there were many online sources and examples:
I'll start with the Singapore banks since I live there, but I want to use the same steps for other countries.

Market Share

Most countries have a "big four" handful of banks that dominate the local market and are backed by the government as 'too big to fail'.  Singapore has 3.  Before investing in a country's banks, we want to see how competitive the market is.  A simple measure of market competition is the market share that these banks have for:

  • Home loans.  Best I could find is a report showing the big 3 local banks had a 63% market share in 2013.  Standard Chartered and HSBC are the only other significant competitors.
  • Deposits.  A Moodys Report gives says the 3 major banks had 60% of deposits at end 2012  (p13).
What do I expect in the future?
  • I think that the Singapore banking market has become more competitive for deposits after it was liberalised in the 2000s.  But from the above chart, not yet for loans.  
  • I don't think it will become less competitive: I can't imagine any of the ten Qualifying Full Banks packing up and leaving in the future.  And if they do, they'll probably just be taken over.
  • Government savings schemes, such as Singapore Savings Bonds or CPF Life could provide competition for deposits.  Though Singapore Savings Bonds seem to be dying.
So going forward I expect either the same or more competition.  Especially if more of the Qualifying Full Banks can achieve scale.  I don't see less competition.

Non-interest Income

I start by looking at a bank's non-interest income, for two reasons:
  1. I am looking for banks that do 'traditional' banking: the simple collection of deposits and lending them out.  We don't want banks where the majority of income is from complex, risky activities like investment banking, or worse still - derivatives trading.
  2. Although banks try to generate fee-based income from other activities to 'smooth out' credit cycle fluctuations, these earnings are often still subject to the same cycle.  Or may be highly volatile, year-on-year.  So these earnings should be discounted a bit when looking at PEs.

Categorizing Non-Interest Income

The Singapore banks' non-interest income has been built up over the years and now accounts for 30-40% of their income.  Lets look at the different categories of non-interest income to see whether we can spot any long term trends, and check if they are cyclical.

Loan Income and Trade Related income have grown steadily, and were not affected by the 2008 downturn.  I would categorise this as "Steady Growth":

Credit Card income surprisingly grew steadily for DBS and UOB, only OCBC's dropped after the GFC.  I'll put this under the "Steady Growth" category too:

Trading Income1 has grown tremendously since the GFC, but is highly volatile - it can rise or fall 20-50% a year.  I've put OCBC's bancassurance income here too as it correlates so closely to the Trading income2 .

Fund management, Wealth Management and Investment Banking are less volatile, but highly cyclical, dropping 50% of more during the GFC:

"Services and Other Fees" is also quite cyclical, surprisingly:

For simplicity, I'll put the last last 3 items under a "Volatile or Cyclical" category.

So now we have 2 categories of non-interest income: "Steady Growth" and "Volatile or Cyclical".

Interest vs Non-Interest Income

Lets compare the interest income and categories of non-income for each bank:

As percentages:

30-40% of all 3 banks' income is from non-interest sources (red and blue above).  How did it fare during the financial crisis?

  • In 2009, UOB's non interest income dropped 20%.  
  • In 2008 and DBS' non-interest income dropped by 13%.   
  • In 2008, OCBC's non-interest income dropped by 42%.
BUT, interest income did not drop - it actually rose. The drop in profits came from write-offs, which are not included here.


  • 30-40% of all Singapore banks' income is from non-interest sources
  • Non-interest income for the Singapore banks has been cyclical and/or volatile.  More than interest income.  It fell 13 to 42% in the previous downturn.
  • So I'd factor in a 5 to 16% drop in total earnings (from non-interest earnings alone) if we were expecting a crisis.
  • Interest income - excluding write-offs - was pretty steady during the crisis. Maybe because the crisis was so short.
  • This is all excluding write-offs, which I'll look at next.
1 Mostly forex
2 Thats to be expected, as insurance makes money by investing their float. But, I think they would invest in stocks and bonds, not trade forex.

Bought Singapore Savings Bonds

Bought 50K of SSBs in July, held in my CDP acct, bought from UOB bank acct.
Security code: SBAUG16 GX16080S

Friday, July 29, 2016

Seaspan (NYSE:SSW)

Seaspan is a REIT-like company that leases out container ships.  Its business model is simple: borrow money, use it to buy ships which are leased out, and pay the difference between the lease payments and the operating/finance costs as dividends.  The key story here is that long lease periods on the majority of their fleet should allow them to ride out the next few years downturn.

Income Statement and Dividend payments

A quick look at its 2015 income statement shows what we'd expect - the biggest costs are depreciation, ship operating costs, and interest payments:

Theres a catch here: the "Change in fair value of financial instruments" (outlined in green).  This is normal for companies that hedge their debt through interest rate swaps1.  Usually the hedged rate of interest will be included in the interest expense, and the "Change in the value of the swaps" is just an accounting entry to be ignored2.  But Seaspan has recorded them differently: The interest expense records the unhedged (variable) rate of interest, and the "Change in fair value of financial instruments" includes the difference between the hedged (fixed) rate and unhedged (variable) on the interest payments3.  We want to include this as part of operating expenses, and ignore the 'accounting entry' part4.  After adjusting for this (all figures in USD 000's):

For REITs we need to check how much of earnings are paid out as dividends:

In 2014 and after, they have paid out more than 100% of their earnings.  This means they are paying out of their depreciation.

Debt structure

The table below shows all debt, including preferred shares, and when it is due:

Can repayments be covered?  All required payments are shown below: the minimum interest repayments, plus rolling over the loans/notes on maturity, plus operating leases:

How much is of the variable rate debt is hedged at fixed rates?  Not much.  And not for long.  Out of approximately 3.4bn floating rate debt:

On the bright side, most of their swaps require payment of LIBOR at 5%, so when they expire, these repayments drop. The 2015 interest payments would be 92m lower if there were no swaps.  On the other hand, finding long term projects - 8 to 17 year leases on assets with a 20 to 30 year lifespan - is a risky business in the long term.  A spike in interest rates could cause problems.  More on this below.


When their charter contracts expire?  They have some expirations in 2016/17, and more after 2020:

By 2018 they will have a number of ships with expired charters:
  • 25 panamax vessels (23 x 4250 TEUs and 2 x 4600 TEUs)
  • 2 X 8500 TEU ships
  • 2 x 1000 TEUS, expected delivery in 2017 which they have not charted out yet. May be deferred to 2018.
Assuming these are contracted out at today's market rates, I estimate 2018 'normalised' earnings to be 140m5, down 13% from 2015.  If dividends were maintained6, they'd be digging into 62m from depreciation - sustainable over a few years, since depreciation is around 220m.

Stress Test

3 ships are charted to Hanjin, at rates far above market.  Hanjin has requested a fee cut of 30%, Seaspan refused and said they'd rather take the ships back.  Unlikely, but what if it did happen? If they did take the ships back and re-lease them out at current market rates, I estimate revenue/earnings would drop by 33m7

What if the LIBOR rose to 5%? ...which last happened in 2007.  I estimate that 2015 interest and operating lease payments would raise by 56m if this happened:

If LIBOR rose to 2%, 2015 interest and operating lease payments would raise by about 15m.


Good way to play the container shipping cycle, while getting paid to wait out the downturn.

The main risks are:
  • The shipping cycle downturn may go on for more than 3-4 years, if demand decreases, or if more supply is bought onto the market.
  • Since 2014, Seaspan's dividends are greater than earnings.  Hopefully they are only doing this for a few years to ride out the cycle.  Management cannot lower dividends, as this would hammer the stock price, making equity raising difficult.  This is not a company that grows organically to build long term shareholder value. Think of it as a bond, paying out the difference between its lease rates and costs as a yield (with occasionally a bit of capital returned as well).
  • They are exposed to rising interest rates.
  • About 60% of their 2015 revenue came from China companies (YM, COSCO, CSCL, and COSCON).
Buying this stock is a bet that:
  • The container cycle will recover by 2020, when Seaspan has more vessels coming off fixed-rate charters, and,
  • Interest rates don't rise too much.
This is a cyclical stock.  But when the industry is under dark clouds, sell a few years later when the sun is shining.   Need to remember that it is not a 'buy-and-hold-forever' stock.

See "Illustration of an interest rate swap" here as an example.
This entry will be armortised away later if the swap is held until it ends.
Page 54 of the 2015 Annual report: "Although we have entered into fixed interest rate swaps for much of our variable rate debt, the difference between the variable interest rate and the swapped fixed-rate on operating debt is recorded in our change in fair value of financial instruments rather than in interest expense."  Why....? 
This is done in the press releases for their results, e.g.: see Section B "Normalised Net Earnings and Normalised Earnings per share" here.
Based on: a) 2018 minimum contracted revenue of 794m (2015 Annual Rpt footnote 14a), b) Revenue of USD 5.1K/day for a panamax and USD 10K/day for a 8500 TEU vessel, c) Utilization rate 97%, d) Operating cost for 10000 and 11000 TEU vessel of 15K/day, and for 14000 TEU vessel of 15k/day (from "Daily Operating Cost" graph, p23 here), and e) Excludes latest announcement of 2 11000 TEU craft bought from CGI. 

Assuming dividends of 202m, based on 1H 2016 annualised dividend for both common and preference shares
Assuming current charter rate of 10000 TEU vessel of USD 12K/day, and 97% utilization rate.

Bought Seaspan (NYSE:SSW)

Bought 1315 shares of Seaspan (NYSE:SSW) at USD 15.20 on 27th July 2016.  Total Cost is USD 19,987.09.

This is a cyclical play.  It pays almost a 10% dividend while we wait for the container shipping industry to recover.  I may be 1 or 2 years too early.

For Singapore residents, dividends are reduced by 30% due to withholding tax.