Local banks should sustain their capital ratios at around 14 per cent over the next few years or they could risk triggering a rating downgrade, said Fitch Ratings.
The warning comes as deteriorating asset quality and profitability are likely to hit capital ratios at a time when there is "limited rating headroom", the credit ratings agency said on Sunday.
The three banks are rated AA-and have been put on rating watch negative by Fitch Ratings to reflect the weakening operating environment.
All three have targeted for common equity Tier 1 (CET1) ratios between 12.5 per cent and 13.5 per cent. DBS Bank's CET1 ratio stood at 13.7 per cent as of the second quarter, OCBC Bank at 14.2 per cent and United Overseas Bank (UOB) at 14 per cent.
Fitch Ratings said such targets will be "inconsistent with current scoring" if there is no credible plan to restore them "within a reasonable horizon".
"The capital score is likely to be lowered should the banks sustain CET1 ratios well below 14 per cent without a credible plan to rebuild them to around 14 per cent within the next couple of years."
It did note that the Monetary Authority of Singapore's call for banks to cap dividends for this year will "go some way" in helping them maintain capital ratios at a level "commensurate with risk" for the year.
Fitch Ratings added that this has saved the banks up to 40 basis points of capital each.
Overall, the agency has a negative outlook on the banks' earnings and profitability scores, which implies a risk to profitability mainly due to impairments that are "larger than currently expected".
Fitch Ratings expects the lenders' earnings this year to fall by about a third from the end of last year. In turn, credit migration is likely to have an impact on their capital ratios.
In the second quarter, all three banks recorded a sharp dive in earnings as benchmark rates collapsed and the trio lifted provisions. DBS' net profit fell 22 per cent to $1.2 billion, OCBC's slumped 40 per cent to $730 million, while UOB's tumbled 40 per cent to $703 million.
Net interest margin (NIM) compression started late last year, with a big drop in the second quarter as the Singapore Interbank Offered Rate (Sibor) fell significantly.
"We expect continued margin compression due to the lag effect of Sibor reduction, which will pressure revenues for 2020. We believe margins are likely to be flat in 2021," said Fitch Ratings.
NIM in the second quarter stood at 1.62 per cent for DBS, 1.6 per cent for OCBC and 1.48 per cent for UOB.
The agency said there may be some residual lag from falling benchmark rates, although banks are likely to price new loans higher, given the potentially higher incremental risk, less competition in the market and potentially tighter liquidity. Banks have also been cutting deposit rates to lift margins.
Fitch Ratings has projected for non-performing loan (NPL) ratios to peak at a little over 3 per cent next year for the trio. As they continue to build buffers in the second quarter, all three have kept to their earlier guidance from the first quarter. Second-quarter NPL ratios remained steady at 1.6 per cent for OCBC and UOB, and at 1.5 per cent for DBS.
"Regulatory relief has generally held NPLs stable (so far this year)," said the agency.
But it warned that the full extent of the pandemic's impact may be reflected only in next year's NPL ratios, as debt repayment moratoria offered to borrowers will delay much impaired-loans recognition.
That said, the banks are expected to continue to book significant general provisions this year. "We give the Singapore banks benefit for their high leverage ratios," Fitch Ratings said.
"We expect all three... to continue to generate profits throughout the downturn, with the trough being in 2020."
THE BUSINESS TIMES