What is the cost of a recession to Banks?

In a downturn, the main issue for banks is the cost of the recession—the level of provisioning necessary, and whether the banks can cope with that level. We studied 753 companies for this report. Our findings suggest upside risk to consensus earnings estimates, as provisioning is likely to be significantly lower than it was during the 1998 Asian financial crisis, despite this being a global recession. We believe this is a potential catalyst for further rerating.

To estimate the level of provisioning, we compared the 2008 balance sheets of companies listed on the Singapore stock exchange with 1996. We identified the stronger companies and the weaker ones using a scorecard we designed based on net debt-to-equity and interest coverage ratios.

We found that only 4% of companies were in the ‘stressed’ category in 2008 and 29% were in the ‘strong’ category. This contrasts with 7% and 16%, respectively in 1996. We believe the significantly smaller percentage of stressed companies, plus the current low interest rates, will cap provisioning to only 2.6% of loans. This compares with 5.2% during the 1998 recession. However, as in 1998, we expect the most stressed companies to be SMEs.

We expect all the Singapore banks to comfortably absorb the provisioning, but our top pick is DBS Group Holdings (DBS) as: 1) it offers exposure to the more dynamic Greater China region; 2) we expect it to take market share by using its new capital; and 3) it trades at only 1.11x P/BV.

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