MAS flags risks of financial stress ahead amid uneven economic recovery in 2021

CORPORATES, households and banks in Singapore have held steady and resilient amid the outbreak of the Covid-19 pandemic, with relatively healthy balance sheets and for lenders, strong capital positions.

But the uneven trajectory of economic recovery next year will impinge on jobs and corporate profits in Singapore. The risk of financial stresses remains during this protracted recovery period, said the annual Financial Stability Review of the Monetary Authority of Singapore (MAS) released on Tuesday.

While the Singapore economy has rebounded strongly in Q3 this year, growth is expected to slow in Q4 and remain modest in 2021. Some pockets of the economy are not expected to recover to pre-pandemic levels even by the end of 2021, said MAS.

Within the corporate sector, smaller firms that tend to be financially weaker, and those in the domestically-oriented and travel-related services impacted by the pandemic remain vulnerable.

Banks will likely face challenging operating conditions in the near term. The prolonged low-interest rate environment and asset quality deterioration amid global uncertainty will exert pressure on banks' profitability, even as they continue to maintain strong underwriting standards and healthy capital buffers, said MAS.

Households should be prudent in taking up new debt and in committing to property purchases as the labour market recovery is expected to be protracted. They should also continue serving or consolidating their existing obligations to buffer against unexpected shocks, said MAS.

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Leverage risk has worsened for corporates as earnings fell and debt rose

Fresh trends suggest that firms are at greater risk of not meeting their debt obligations from earnings, said MAS.

Debt ratios have risen and reached 163 per cent in Q2 2020, reflecting both a pick-up in corporate debt as well as a fall in gross domestic product (GDP).

Deteriorating corporate profits amid the Covid-19 shock and increasing leverage have weighed on debt servicing ratios, with the median interest coverage ratio (ICR) of Singapore-listed firms falling from 2.0 in Q2 2019 to 1.1 in Q2 2020.

But firms' debt servicing ability remains sufficient in the immediate term, said MAS. The median ICR of SGX-listed firms remains above one, and cashflows are expected to recover after Q2 2020.

As earnings declined, the banking system's corporate non-performing loan (NPL) ratio rose to 3.4 per cent in Q3 2020, from 2.5 per cent in the year-ago period. Higher NPL ratios reflect the prevalence of firms in sectors adversely affected by the pandemic - wholesale trade, retail, food and beverage, tourism-related industries - and oil-related industries impacted by the collapse of oil prices earlier in the year.

With economic recovery expected to be gradual and uneven, loan asset quality is expected to deteriorate, particularly in sectors with prolonged earnings weakness, said MAS.

Firms' efforts to ease short-term cashflows through higher cash holdings have also increased short-term debt and maturity risks.

Maturity risk, measured by the proportion of short-term debt to total debt, rose from 40 per cent in Q2 2019 to 42 per cent in Q2 2020, remaining below the historical average. But bond maturity profile of Singapore firms remains well termed out, with bonds due by 2021 making up about 15 per cent of outstanding bonds.

Overall, MAS's simulations suggest that Singapore's corporate sector remains largely resilient to cashflow shocks. The test showed 57 per cent of SGX-listed firms having cash coverage ratios above 1.5 at end-2021, suggesting they have enough cash to repay their short-term debt.

Under an adverse scenario where 2021 revenues decline by 20 per cent below the baseline, the majority of SGX-listed firms would still have resilient cash buffers. Most firms with more vulnerable cash buffers at end-2021 are small with annual revenues below S$100 million.

Small and medium-sized enterprises (SMEs) could be less able to weather the pandemic's impact with their smaller size and limited access to capital markets, said MAS. The proportion of vulnerable small and medium-sized enterprises was estimated to be about 30 percentage points higher than that of vulnerable large firms.

Households' debt serving burden manageable

The household sector's financial vulnerability index increased in Q3 on a year-on-year basis, alongside leverage risk. This comes as a sharply-lower GDP this year resulted in a rise in household debt-to-GDP, reversing the pre-pandemic decline.

Aggregate household debt was trending downwards since the last round of property market cooling measures in July 2018 as borrowers turned more cautious in taking on leverage.

As housing loans account for three quarters of total household debt, falling debt levels reflect in part the effectiveness of the cooling measures in moderating private residential property market transactions and in bringing prices closer to economic fundamentals, MAS said.

But since the circuit-breaker period, household debt-to-GDP rose 1.9 percentage points to 65 per cent in Q2, and a further 2.1 percentage points to 67.1 per cent in Q3, even though outstanding overall household debt fell.

Household debt as a percentage of income, which has remained stable at two times since 2015, is expected to rise slightly in the near term as accumulated labour market slack weighs on wages, said MAS.

Maturity risk has decreased, alongside reduced outstanding unsecured debt. However, the asset quality of both secured and unsecured debt weakened slightly, although MAS said it remains manageable at this juncture.

The credit risk profile of housing loans remains sound for now, but as household resilience is ultimately tied to employment and income, credit risk for housing loans could increase further in the period ahead if the economic downturn persists, said MAS.

The unsecured credit charge-off rate - a leading indicator for credit quality of housing loans - has crept up in Q3, suggesting that more vulnerable households could face difficulties in their housing payments.

But overall, MAS's simulations indicate that households' mortgage servicing ratios (MSR) remain manageable. Median MSR is less than 60 per cent in the current baseline scenario, and remains so even when further income shocks are applied.

But where possible, MAS noted that households should continue consolidating existing obligations and enhance resilience against unexpected shock.

Private residential property market remains resilient

Prices returned to pre-Covid-19 levels in Q3 2020 following an initial decline in Q1 2020. The cumulative price increase over the first three quarters of the year of 0.1 per cent, against the fall in real GDP (average y-o-y) of -6.4 per cent, as well as the less pronounced volatility in overall prices compared to the Global Financial Crisis period, points to some degree of underlying support and resilience in the market, MAS said.

Near-term pressure on banks' profits

Banks continued to maintain strong capital and liquidity positions amid the crisis, contributed by high deposit growth.

Credit growth has remained firm and NPL ratio continues to be low despite some deterioration in asset quality. Local banks' net profit remains healthy, averaging S$2.8 billion per quarter over the first three quarters of the year.

That said, lenders are likely to face downside pressure on profitability in the near term amid the prolonged low interest rate environment, deterioration of asset quality, and the possible need to further increase provisions in view of potential credit losses. This comes even as they continue to ensure strong underwriting standards and healthy capital buffers, said MAS.

The regulator added that banks should also actively monitor and manage their foreign currency risk prudently.

A sharp tightening in global financial conditions in March showed that banks remain vulnerable to fluctuations in short-term funding sources. Banks could also amplify the impact of turbulence in international financial markets by constraining credit provision to the economy as they face liquidity shortfalls.

Over the longer term, MAS's stress test results showed that key banks in Singapore have the capacity to withstand further negative shocks.

Total provisioning coverage in the banking system rose to 103.1 per cent in Q3 while specific provisioning coverage grew to 65 per cent. These buffers are further augmented by general provisions held at the head offices of foreign bank branches.

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