Singapore's three largest banks could see a possible uptick in bad loans and softer loan growth in 2023 after a strong showing in 2022, as macroeconomic conditions get more challenging.

DBS Group Holdings Ltd., Oversea-Chinese Banking Corp. Ltd., or OCBC, and United Overseas Bank Ltd., or UOB, are entering 2023 with strong profitability and asset quality metrics after logging hefty profits in the first three quarters of 2022, owing to higher interest income and improving margins. While the banks' net interest margins may rise further in 2023, they could face drag from an economic slowdown in key markets as nations focus on inflation control.

"Banks' gross nonperforming loan ratios could, however, weaken slightly over the next 12 to 18 months because of economic headwinds and increased vulnerability of small and midsize enterprises," said Ivan Tan, an analyst at S&P Global Ratings. "We have become more circumspect on mainland China and some regional economies to which Singapore banks are exposed."

Investors remain cautious about a possible recession in the U.S. and Europe and a slowdown in the Asia-Pacific region. In its December 2022 report, the Asian Development Bank, or ADB, cut its growth forecast for developing Asia to 4.6% in 2023 from 4.9% previously, citing recurrent lockdowns in China, the Russia-Ukraine war and slowing global growth. While the ADB raised its 2022 gross domestic product growth forecast for Southeast Asia to 5.5% from 5.1%, it lowered its growth expectation for 2023 to 4.7% from 5.0%, citing weakening global demand.

The ADB projects Singapore's GDP to grow 2.3% in 2023, down from its prior forecast of 3.0%. The Southeast Asian nation on Jan. 3 reported that GDP grew 3.8% in 2022, slowing from a 7.6% expansion in the previous year.

DBS Group, OCBC and UOB are all heavily focused on Southeast Asia and derive most of their earnings from the region. In 2021, DBS Group generated about 70% of its operating income from Singapore and South and Southeast Asia, according to S&P Global Market Intelligence data. OCBC and UOB derived around 80% of their operating income from the city-state and Southeast Asia.

While NPL ratios at Singaporean banks have improved throughout 2022, analysts say borrowers could face difficulties servicing their loans or repaying their debts. The NPL ratios of both DBS and OCBC improved to 1.20% as of Sept. 30 from 1.30% and 1.50%, respectively, at the end of 2021, while UOB's ratio improved to 1.50% from 1.60%.

Still, the banks expect any deterioration in asset quality to be manageable.

"We are not seeing signs of systemic stress in asset quality," UOB CFO Lee Wai Fai told Market Intelligence. "Any deterioration is expected to be manageable, with the nonperforming loans ratio to remain comfortably below 2%, as we foresee economic activities and the labor market to hold up within the region."

In addition, loan growth is expected to remain tepid in 2023. Lee said UOB expects some moderation in credit growth and consequently loan-related fees, especially in wholesale lending. On the retail side, though, he expects loan demand to remain supported by mortgage loans due to a healthy pipeline.

"Among our key assumptions is mid-single-digit loan growth and controlled credit costs," Ratings' Tan said. "Our base case assumes loan growth of 5% to 6% over the next 12 to 18 months, with credit costs in the pre-COVID range of 20 basis points to 25 bps."

Profitability, margin expansion

Profitability at Singaporean banks is expected to remain strong, as improving net interest margins would more than offset the expected decline in fee income due to weaker market sentiment. Banks have gained from margin expansion since late 2021 when central banks across the world started raising rates to fight inflation. Analysts expect further improvement in 2023 as rates continue to be transmitted through the banks' books.

CGS-CIMB Research forecasts Singaporean banks' net profit to rise between 20% and 37% year over year in 2023, driven by an expected 20- to 50-bps increase in NIM "as higher Fed rates continue to be transmitted through the banks' books," according to a Dec. 9 note. CGS-CIMB expects Singapore's banking sector to grow loans by 4% to 5% in 2023, compared with 6% to 7% in 2022.

The net profit of each of the three banks rose more than 30% year over year in the quarter ended Sept. 30, Market Intelligence data shows.

"The balance sheets of large Singapore banks are rate-sensitive and benefit from an extensive buffer of low-cost customer deposits," Ratings' Tan said. A NIM expansion of 15 bps to 20 bps is possible in 2022, which could grow by a further 10 bps to 15 bps in 2023 "after rate hikes are fully priced in," Tan added.

All the banks reported improvement in their NIMs in the first three quarters of 2022, compared with 2021, citing multiple rate hikes by the Monetary Authority of Singapore. DBS Group's NIM for the nine months to Sept. 30 improved to 1.65% from 1.45% in the prior year period. For the same period, OCBC's NIM rose to 1.78% from 1.55%, while UOB's rose to 1.74% from 1.56%.

Slower M&A

Amid an uncertain outlook, Singapore banks are likely to go slow on acquisitions after striking multiple deals in the past few years. The banks' executives have said they plan to focus on integrating their recent purchases instead of doing big deals.

"With the acquisition of Citigroup’s consumer banking business in [Malaysia, Thailand, Indonesia and Vietnam] and integration process still ongoing, we are not likely to actively pursue more M&A opportunities in the near future," UOB's Lee said in an email. The Singaporean bank, however, continues to be open to M&A opportunities, he added.

Similarly, DBS does not expect to do any big deals in the near future.

In a Nov. 3, 2022, conference call, DBS CEO Piyush Gupta said the bank is not looking at doing "an earth-shattering M&A of large scale" because such a deal would be distracting for the bank, which has announced at least four acquisitions overseas since November 2020, including the purchase of Citigroup Inc.'s consumer banking business in Taiwan in early 2022. Still, the bank is "open to bolt-ons," he added.

DBS Group did not offer a fresh comment and referenced comments from November 2022 in response to an email from Market Intelligence.