Singapore Banking Outlook 2014: Robust Fundamentals Should Enable Banks To Ride Out Testing Times

Primary Credit Analyst: Ivan Tan, Singapore (65) 6239-6335; ivan.tan@standardandpoors.com Secondary Contact: Amit Pandey, Singapore (65) 6239 6344; amit.pandey@standardandpoors.com

Table Of Contents
Higher Household And Corporate Leverage Could Increase The Debt Servicing Burden Property Prices Are Already High And Interest Rates Are Set To Increase Gradually Low Margins Will Continue To Drive Overseas Expansion Overseas Expansion Will Become More Muted Sound Fundamentals Underpin Our Ratings On Singapore Banks Related Criteria And Research

WWW.STANDARDANDPOORS.COM/RATINGSDIRECT

FEBRUARY 11, 2014 1

1257270 | 301447691

Singapore Banking Outlook 2014: Robust Fundamentals Should Enable Banks To Ride Out Testing Times
Banks in Singapore will likely maintain their robust financial profiles in 2014 despite a slowing economy and rising interest rates. Standard & Poor's Ratings Services' base-case scenario for Singapore banks is one of stability. In our opinion, Singapore banks have sufficient buffers against downside risks if the credit cycle turns. We expect Singapore banks to maintain their adequate capitalization, strong liquidity, and good asset quality in 2014. Some deterioration in asset quality is likely because of lower economic growth prospects and rising interest rates amid higher household and corporate debt. But indicators of unemployment and bankruptcy are likely to remain low and supportive of strong household and corporate balance sheets. Overview Singapore banks' financial strength is likely to stay solid in 2014. Household and corporate debt has been trending upward while interest rates are set to increase, but we believe banks have sufficient capital buffer against these headwinds. Standard & Poor's maintains its stable outlook on Singapore's banking sector.

Sluggish economic growth and skittish financial markets could make for a more difficult operating environment for Singapore banks in 2014. We expect Singapore's GDP growth to decline to 3.4% in 2014, from 3.7% in 2013. At the same time, corporate and household indebtedness has been rising (see tables 1 and 2). We believe Singapore banks could face tighter credit conditions, especially if the U.S. Federal Reserve's tapering of its bond purchase program leads to an increase in interest rates and a higher debt servicing burden for the corporate and household sectors. However, the potential for a disorderly market response to tapering has subsided, following clarity that the tapering will be gradual and measured.
Table 1

Increasing Household Debt Burden*

2008 66.7% 2009 70.5% 2010 68.3% 2011 72.7% 2012 76.8% Q3 2013 77.5%

*As measured by a ratio of household debt to GDP. Source: S&P estimates.

Table 2

Rising Corporate Sector Leverage*

(%) Transport, storage, and communication Property Multi-industry Manufacturing H2 2009 H1 2010 H2 2010 H1 2011 H2 2011 H1 2012 H2 2012 H1 2013 35.0 51.7 32.3 21.3 26.8 51.6 35.5 16.2 41.3 51.8 34.5 19.4 45.0 51.2 42.4 19.9 43.9 48.3 41.1 22.0 56.2 49.0 43.7 25.0 49.4 50.6 51.5 25.0 55.5 52.1 34.1 26.4

WWW.STANDARDANDPOORS.COM/RATINGSDIRECT

FEBRUARY 11, 2014 2

1257270 | 301447691

Singapore Banking Outlook 2014: Robust Fundamentals Should Enable Banks To Ride Out Testing Times

Table 2

Rising Corporate Sector Leverage* (cont.)

Hotels and restaurants Construction Commerce 23.1 42.7 31.1 24.5 34.1 30.9 25.5 28.2 25.4 39.8 34.1 29.4 31.6 35.3 33.1 32.1 48.4 34.7 62.4 41.1 34.5 67.9 49.1 27.6

*As measured by a ratio of median total debt to equity. Source: Monetary Authority of Singapore.

Higher Household And Corporate Leverage Could Increase The Debt Servicing Burden
The increase in household debt and corporate sector leverage reflects the prevailing low interest rates and availability of easy financing, in our opinion. The multi-industry and commerce sectors are the only segments where leverage has not gone up. Supportive economic conditions also spur the demand for debt, and banks are happy to lend because they are flush with funds from easy monetary conditions. Singapore has one of the highest household indebtedness in Asia. In addition, high property prices have been leading to poor housing affordability. This can undermine the credit quality of mortgages, which form the largest industry exposure for Singapore banks at about 25% of total loans. The mortgages are predominantly floating-rate and are vulnerable to rising interest rates. Despite increasing leverage, credit costs have declined substantially since 2009 because of low real interest rates and tight labor market conditions (see table 3). However, an economic slowdown, less favorable labor market conditions, and a property price correction could erode household net wealth and corporate sector financial resilience. Households and corporate entities with heavier debt-servicing burdens are more vulnerable to such shocks.
Table 3

NPLs And Credit Costs Of Singapore Banks Near Historical Lows

Q3 2013 Gross NPL ratio (%) Credit losses as a % of gross loans 1.1 0.2 2012 1.2 0.2 2011 1.2 0.3 2010 1.6 0.4 2009 2.4 1.0 2008 1.7 0.6

NPLs--Nonperforming loans. Sources: Standard & Poor's calculations, and banks' financial statements.

Property Prices Are Already High And Interest Rates Are Set To Increase Gradually
Our ratings on banks in Singapore already factor in the effects of high property prices and rising interest rates. Our base-case scenario for Singapore's banking sector incorporates: An elevated risk of economic imbalances from high property prices into our Banking Industry Country Risk Assessment of Singapore. Stabilization of property prices reflecting government measures to address over-exuberance in residential property investments. Gradual increases in interest rates in 2014, reflecting the tapering of monetary policies in advanced economies, as they achieve broad-based recovery.

WWW.STANDARDANDPOORS.COM/RATINGSDIRECT

FEBRUARY 11, 2014 3

1257270 | 301447691

Singapore Banking Outlook 2014: Robust Fundamentals Should Enable Banks To Ride Out Testing Times Slower but still positive economic growth of 3.4% in 2014. Singapore's government has taken measures to rein in the rapid rise in household debt, through several rounds of cooling measures since 2009. Key changes include a higher stamp duty (a tax on the property's purchase price) for buyers of up to 18%, a lower loan-to-value ratio of 50%, and a cash down payment of 25%. Most of these measures apply to loans for second homes and generally don't affect Singaporean first-time home buyers and buyers of government-built flats. On June 28, 2013, the regulator introduced a total debt servicing ratio framework under which a borrower's total loan repayments, including all property-related loans and non-property-related loans (such as student loans, credit cards, auto etc.), cannot exceed 60% of the individual's income. In our view, these measures have dampened momentum in the market, with the private residential property price index showing signs of stabilizing (see chart 1). We believe the government could implement more measures to meet its price stabilization objectives if needed.
Chart 1

Interest rates in Singapore are set to rise from their current low levels (see chart 2) as the Federal Reserve begins tapering its quantitative easing program. Higher borrowing costs amid rising leverage could weaken the asset quality of Singapore banks, in our view. The days of declining nonperforming loans and extremely low credit costs might be over, and the credit cycle is likely to turn. We expect credit costs to increase 25-30 basis points in 2014. Highly

WWW.STANDARDANDPOORS.COM/RATINGSDIRECT

FEBRUARY 11, 2014 4

1257270 | 301447691

Singapore Banking Outlook 2014: Robust Fundamentals Should Enable Banks To Ride Out Testing Times

leveraged entities, especially small and midsize enterprises in emerging markets, are particularly vulnerable to higher borrowing costs amid rising leverage and higher interest rates. In our base-case, we expect the Singapore banking sector's asset quality to remain resilient. Singapore banks have sufficient buffer against a gradual rise in interest rates, in our view.
Chart 2

Low Margins Will Continue To Drive Overseas Expansion

We believe interest margins for Singapore banks will remain low in 2014, but begin to stabilize. Interest margins have been declining over the past several years because of low interest rates and price competition (see chart 3). Singapore banks have more than two-thirds of their loans in the domestic market or in relatively developed banking systems, including Hong Kong and Malaysia, where they have been operating for a long time. Competition for loans and customer deposits in these matured markets is steep, and negatively impacts interest spreads. We believe rising interest rates from policy tightening can offset pricing pressure leading to stabilization of margins in 2014.

WWW.STANDARDANDPOORS.COM/RATINGSDIRECT

FEBRUARY 11, 2014 5

1257270 | 301447691

Singapore Banking Outlook 2014: Robust Fundamentals Should Enable Banks To Ride Out Testing Times

Chart 3

Price competition in matured markets has prompted Singapore banks to expand into emerging markets. Emerging markets offer notably higher growth potential and better margins, often at the cost of heightened credit risks emanating from lower per capita incomes and weaker payment cultures. Singapore banks have positioned themselves as regional banks, initially with the aim of servicing their customers overseas, but increasingly to take advantage of greater integration and opportunities in the ASEAN (Association of South East Asian Nations). The region's economic and population growth potential vis-a-vis that of developed countries makes it an attractive proposition, especially for Singapore banks looking for higher yields.

Overseas Expansion Will Become More Muted

Economic woes and political uncertainties in regional economies such as India and Thailand are likely to dampen Singapore banks' acquisition appetite. Foreign ownership restrictions are also common in most emerging economies, and some are becoming more protective of their banking systems. Indonesia provides a case in point. The country is an appealing investment destination reflecting its large economy, attractive margins, and consistently high loan growth of over 20%. It also had one of the most liberal regimes in Asia until mid-2012; foreign investors could purchase 99% of an Indonesian bank.

WWW.STANDARDANDPOORS.COM/RATINGSDIRECT

FEBRUARY 11, 2014 6

1257270 | 301447691

Singapore Banking Outlook 2014: Robust Fundamentals Should Enable Banks To Ride Out Testing Times

However, Indonesia's introduction of more stringent bank ownership rules and the collapse of the DBS Bank Ltd./PT Bank Danamon Indonesia Tbk. deal in 2013 suggest that future expansion into the country will be difficult. The new rules restrict foreign investors' ownership stake to 40%, which they can increase if they demonstrate sufficient financial strength and good corporate governance during an 18-month review period. Bank Indonesia has retained that right to authorize a majority stake, but it's unclear how the bank would exercise this discretion. In respect to the DBS/Bank Danamon deal, it appears that Bank Indonesia would allow majority ownership only if the Monetary Authority of Singapore first shows equal treatment for Indonesian banks to operate in Singapore. In our view, the "reciprocity" arrangement introduces home-host regulator issues and political considerations that do not pertain to the financial soundness of the individual bank. Bank Indonesia's decision came against a backdrop of growing nationalistic sentiment, particularly in the resources sector, which has introduced several restrictions on foreign investments. In light of these developments, we believe Singapore bank's expansion into Indonesia will be organic. This lowers the event-driven risk of aggressive growth through acquisition. Banks will be reluctant to acquire a minority stake, which is capital-inefficient under Basel III regulations and does not offer direct control over the management and policy of the bank. Going forward, Singapore banks are likely to direct their attention toward other high-growth systems, such as China, as the Oversea-Chinese Banking Corp. Ltd.'s interest in Wing Hang Bank demonstrates. Overall, we believe Singapore banks' overseas expansion through acquisition will be subdued in 2014.

Sound Fundamentals Underpin Our Ratings On Singapore Banks

We believe Singapore banks are in a position of strength and have sufficient buffers against downside risks from a normalization of the credit cycle. In addition, leading indicators of unemployment and bankruptcy are likely to remain low in Singapore, which will support strong household and corporate balance sheets. That said, the potential for rating upgrades on Singapore banks appears limited because we believe the banks will find it difficult to significantly boost profitability and capitalization. Strategic missteps, such as overly aggressive loan growth and overseas expansion, would heighten the likelihood of losses and lead to significant capital impairment, in our opinion, which could trigger downgradesan unlikely scenario. Generally speaking, we believe banks' performance will remain healthy and that credit quality will hold firm.
Table 4

Key Indicators Of Selected Singapore Banks

Gross Net nonperforming nonperforming assets/customer assets/customer loans + other loans + other Tier 1 Total real estate real estate capital ratio loans/customer owned (%) owned (%) (%) deposits (%)

Return on average assets (%) Stand-alone credit profile 2013 a N.A.

Issuer rating DBS Bank Ltd. AA-/Stable/A-1+

2012 1.1

2013 N.A.

2012 1.2

2013 N.A.

2012 (0.3)

2013 N.A.

2012 14.0

2013 N.A.

2012 88.2

WWW.STANDARDANDPOORS.COM/RATINGSDIRECT

FEBRUARY 11, 2014 7

1257270 | 301447691

Singapore Banking Outlook 2014: Robust Fundamentals Should Enable Banks To Ride Out Testing Times

Table 4

Key Indicators Of Selected Singapore Banks (cont.)

DBS Group Holdings Ltd. Oversea-Chinese Banking Corp. Ltd. United Overseas Bank Ltd. Not rated AA-/Stable/A-1+ a 1.0 0.9 1.1 1.4 1.2 0.8 1.2 0.9 (0.3) (0.3) (0.3) (0.2) 12.9 14.9 14.0 16.6 90.7 90.1 87.6 93.3

AA-/Stable/A-1+

a-

1.1

1.1

1.2

1.5

(0.5)

(0.4)

13.6

14.7

91.5

85.6

Note: 2013 data is for the first half of the year; and 2012 data is for the full year. N.A.--Not available.

Table 5

Banking Industry Country Risk Assessment

Country Government support Singapore Highly supportive BICRA group Anchor rating Group 2 a-

Economic risk factors and descriptors Economic risk Economic resilience Economic imbalances 3 Very low risk High risk

Industry risk factors and descriptors Industry risk 2

Institutional framework Very low risk Competitive dynamics Systemwide funding Low risk Low risk

Credit risk in the economy Low risk

Related Criteria And Research

Related Criteria
Banks: Rating Methodology And Assumptions, Nov. 9, 2011 Banking Industry Country Risk Assessment Methodology And Assumptions, Nov. 9, 2011

WWW.STANDARDANDPOORS.COM/RATINGSDIRECT

FEBRUARY 11, 2014 8

1257270 | 301447691

Copyright 2014 Standard & Poor's Financial Services LLC, a part of McGraw Hill Financial. All rights reserved. No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor's Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an "as is" basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT'S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages. Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P's opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof. S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process. S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.standardandpoors.com (free of charge), and www.ratingsdirect.com and www.globalcreditportal.com (subscription) and www.spcapitaliq.com (subscription) and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.standardandpoors.com/usratingsfees.

WWW.STANDARDANDPOORS.COM/RATINGSDIRECT

FEBRUARY 11, 2014 9

1257270 | 301447691