SARS Impact on Banking Systems in Greater China and Singapore

Moody''s has a stable ratings outlook for banks in Greater China - Hong Kong, the Mainland and Taiwan - as well as those in Singapore, and while the impact of the Severe Acute Respiratory Syndrome (SARS) outbreak on the banking systems of all four may prov

However, concerns about potentially deeper impacts are evident, should the illness continue to spread and its presence prove protracted. At the same time, SARS is likely to materially impact the region's economies, as evidenced by the already significant disruptions to business and investment.

In all the above systems, bank profitability and asset quality are expected to deteriorate in the coming months - albeit to varying degrees - as a result of SARS. On the other hand, liquidity should strengthen due to the uncertainties the illness is generating and the resultant fall in consumption. But again the extent of the negative impact depends on the pneumonia's severity and duration.

Given current information and the assumption that SARS can be largely contained - for example, WHO declared Vietnam SARS-free on April 28 - Moody's concludes the impact on the region's banks will be evident, but temporary.

Global economic conditions, in particular, the US recovery, will also play a crucial as Asia's economies are heavily export-reliant.

Furthermore, Moody's will continue monitoring the situation closely to assess potential impacts, if any, to the credit quality of banks in Hong Kong, Singapore, the Mainland and Taiwan.

Hong Kong

Average ratings A3/C+ (foreign currency deposit/bank financial strength), with stable outlook

Banking system resilient, but to suffer some disruptions

SARS - which first surfaced in the territory in March - is weakening consumer sentiment as the local economy continues to reel from several years of deflation. It is too early to say when normalcy will return and whether any serious effects will remain.

At the same time, Hong Kong's banks are well-capitalised, liquid institutions which have successfully managed themselves through previous downturns. Moody's believes that SARS is likely to exert a noticeable - albeit minor impact - on bank earnings and asset quality. The exact extent of the impact will differ from institution to institution, but ultimately, the situation will prove recoverable, assuming the disease can be controlled. Furthermore, the pace of recovery will depend on the progress of economic re-structuring, the global economy and growth in China.

Consumer credit most susceptible to SARS

As far as the wider economy is concerned, the most significant near-term impact has been the disruption to business and consumer demand, and the subsequent rise in unemployment. Fear of SARS has kept people at home and tourists away. Public transportation, hotels and restaurants have been hit hard. Real estate is another problem area, as SARS adds to downward pressure on an already depressed housing market.

But, as we have already indicated, the overall impact on Hong Kong's banks won't be severe. They generally have little direct exposure to retailing and catering, the hardest hit sectors. Most hotels, property investment and retail chains are owned by conglomerates with diversified cash flows. Overall corporate credits should keep performing as they benefit from past cost-cutting efforts. But banks with large hire purchase portfolios could suffer more asset quality problems, should the downturn prove protracted.

The credit card business is expected to suffer most as fewer transactions will reduce fee income. Consequently, those banks with large credit card portfolios will see further declines in asset quality and greater provisions. But after the rise in bankruptcies in 2002, banks have generally been more cautious towards credit cards and have reduced their exposures. Their outstanding balance in credit cards fell to 2.5% of total loans in 2002. And we expect more credit card charge-offs, since joblessness should jump in coming months.

Mortgage asset quality - with a delinquency ratio of only 1.1% in February 2003 - held up well through the downturn of the past few years. But in 2003, more provisions will be required due to revaluations in real estate collateral after price declines, as well as additional SARS-inspired defaults. Nevertheless, overall mortgage quality should not deteriorate substantially.

Fee income to be subdued

To offset an onerous decline in their interest margins, Hong Kong's banks have pursued fee income businesses in a big way. Low deposit rates have also prompted savers to seek more profitable income sources. The banks substantially bolstered their non-interest income in 2002, offering wealth management and insurance products to deposit customers.

But because of SARS and the reluctance of customers to visit banks, fee income generation will be curtailed. Furthermore, the banks have reduced promotional activities, but whether they can recoup lost business will depend on promotions and investor confidence after SARS. We believe that those institutions with higher telephone and internet banking customer bases are better positioned to minimize the impact of negative earnings.

Hunkering down to fight SARS

Hong Kong's banks have dealt remarkably well with SARS, implementing contingency plans to avoid service disruptions.

Most have segregated their key staff and staged staggered shifts. Staff must wear face masks to reduce contamination.

All this has occurred under the watchful eye of the Hong Kong Monetary Authority, the de facto central bank.

So far, SARS-prompted interruptions have been negligible, while the extra costs - due to the contingency plans - have been quite small.

Uncertain Impact from government rescue package

On April 23 2003, the Hong Kong government announced a SARS rescue package totaling HK$11.8 billion (US$1.51 billion), and designed to provide relief to SMEs through lower government rentals and fees as well as loan guarantees.

Individuals will receive tax rebates. The package will widen Hong Kong's budget deficit, but should help stimulate the economy. The banks may also enjoy some benefits. In particular, SME loan guarantees will shift some of the sector's risk to the government, but it is too early to determine the exact impact of these measures.


Average ratings Aa2/B, with stable outlook

Banks' strong financial fundamentals will continue to protect creditors

Strong capitalization and resilient underlying earnings power sustain the high ratings of Singapore's banks and their stable ratings outlooks. In Singapore, as in Hong Kong, Moody's believes that the banks are likely to see a minor, albeit noticeable, decline in earnings and asset quality. Again, our conclusion assumes the outbreak will not be prolonged due to continued medical progress and Singapore's strong containment methods.

While SARS is likely to push Singapore's already weak economy into temporary recession, the impact will be on banking profits and not banking solvency. Unemployment, already on the rise, will increase as the illness continues.

However, the global economy remains the key driver for Singapore's economy and its banks.

Fast, firm government action mitigates SARS fallout and bolsters confidence

The Singapore government's early response to SARS has helped curb the outbreak. The incidence of SARS within the population is about one-quarter of Hong Kong. Importantly for the economy, the early and extensive quarantining of suspected cases and their contacts bolstered public confidence and kept business life normal.

Nevertheless, Singaporeans continue to avoid crowds with obvious ramifications for the hospitality, entertainment, retail and transportation sectors. Travel and tourism, of course, have been badly hit, but successful containment should allow this sector to recover, assuming neighboring countries do not suffer serious outbreaks.

Recently announced government assistance for SARS-affected businesses and individuals should prove doubly beneficial for the banks. Help to businesses, especially smaller ones, will make loan defaults less likely. And aid for individuals, especially the self-employed, should reduce quarantine violations.

US/global economies continues to drive local bank and economic performances

The performance of Singapore's small open economy depends on global and regional economic activity. SARS caught Singapore just as it was recovering from the end of the tech bubble. Exports seem unaffected for now.

SARS has not spread significantly in the US, but if that changes and if US consumers respond as consumers in Hong Kong and Singapore have, then the damage to global growth, and therefore Singapore, could be serious. The US economy remains - directly and indirectly - the key driver of the performance of the local economy and banks.

Banks likely to suffer only slightly lower profits as credit costs rise

For Singapore's banks SARS has become a new test for business continuity planners, but Moody's believes the bottom line impact, while noticeable, will be minor. Wealth management fees, which have been growing, may slow as customers avoid face-to-face contact. Added expenses for multi-locations and shift management of key functions are immaterial.

But, credit costs, which would probably have fallen this year, are now likely to rise.

Consumer and small business credits will be the hardest hit. Small businesses - especially in hospitality, entertainment, tourism, and transportation (taxis) - are already suffering. Some, even with government assistance, will have difficulties meeting debt payments. Consumer credit quality will be affected. Higher unemployment will add to already growing credit card defaults, but such exposures remain small.

Car loans and mortgages will also weaken. Mortgages are the only significant bank portfolios, while temporary unemployment is likely to be managed through lengthening mortgage tenors. Low and declining property values could prompt some small losses flowing through to banks' bottom lines.

Major corporate borrowers are less leveraged after several years of poor economic growth and generally have sufficient internal resources to support operations in a temporary downturn. The ongoing significant presence of GLCs (Government Linked Corporations) in the economy adds resilience to this sector. For example, the government still owns over 56% of Singapore Airlines.

Singapore bank ratings are therefore well positioned

DBS, traditionally a large corporate lender, has little exposure to small businesses, but does have a large mortgage portfolio. Singapore's two other local banking groups, United Overseas Bank (UOB) and Oversea-Chinese Banking Corporation (OCBC), have smaller - but still substantial consumer portfolios - and significant small business exposures.

Nevertheless, Moody's expects the credit costs of all three banks to remain well within their earnings. SARS is only delaying, for another year, a return to normality.


Average ratings Baa1/E+, with stable outlook

New administration faces tests

China has one of the world's fastest growing economies but also one of its weakest banking systems. If SARS is not contained, it will curtail growth and exacerbate structural deficiencies, such as unemployment and banking fragility.

Public and investor confidence are key to China's growth, and much will depend on how well China's new administration controls the illness. If SARS is contained within a short time, its impact on the banks should to be minor.

Admittedly, SARS is most difficult to control in China, given its size, its poor infrastructure and - until recently - its limited awareness. But the banking system is flushed with liquidity and less exposed to potentially troubling SME and consumer credits. It enjoys strong government support.

At the same time, the red-hot real estate sector may take a breather as consumer confidence weakens.

Problems seen as short term, assuming SARS is contained

The government is now trying to deal more forcefully with SARS to regain consumer and investor credibility. If it is effectively contained, the impact to the economy and bank credit quality would be minor. However, if it becomes a run-away problem, the impact could be significant, negatively affecting government finances, domestic demand and foreign investment. All this could mean slower economic growth and higher joblessness. Again, it is too early to say how much time the fight against SARS in China will require.

Bank ratings remain supported

Moody's average foreign currency deposit and debt ratings for Chinese banks are Baa1 - also the rating for the four state-owned commercial banks, which represent over 65% of the system's deposits and assets, and that of the two rated policy banks. The relatively high rating reflects our view that these banks are important to the country and will continue to enjoy strong support from the government, rated A3 with a positive outlook.


Average Ratings A3 / D+, with stable outlook

So far, the least affected of the four banking systems

SARS has so far not exerted as serious an impact on Taiwan as it has on Hong Kong, Singapore and China. The authorities acted relatively early and the number of reported SARS cases has been lower that of its neighbours to date.

However, Taiwan's economy is closely linked to the region, and will likely be affected by the situation of its neighbours.

Systemic support and liquidity strong

Taiwanese bank debt and deposit ratings widely reflect credit enhancement from the strongly supportive stance of the island's financial regulators. This support will likely continue to underpin the ratings of the banks at their current levels through any disruptions, even those from an extended SARS outbreak.

Banking system liquidity is relatively high, reflecting the paucity of lending opportunities - and could increase further if deposits rise as a result of falling consumer confidence and transaction volumes.

SARS could exacerbate structural issues

If SARS is contained in a relatively short time, its impact should be minimal. However, if it becomes a longer-term issue, it could exacerbate the banking system's negative structural issues - chiefly: low profitability, falling collateral values and rising system leverage. In particular, any diminution of earnings could delay the current efforts of Taiwanese banks to improve asset quality and economic capital.

At best, SARS may slow a recovery in bank financial fundamentals. At worst, it could contribute to the longerterm decline in Taiwanese bank financial strength ratings.

International conditions still key - especially US and China

Taiwan's economy is export-oriented and highly exposed to the impact of SARS on global economic conditions - particularly those of its major trading partners, the US and China. Furthermore, Taiwanese businesses have extensive investments in the Mainland. Business travel between China and Taiwan risks the importation of new SARS cases to Taiwan, but any travel restrictions could undermine the island's economic output.

Rising domestic consumer leverage presents challenge

Taiwan has experienced a boom in consumer finance, as banks refocused their efforts on this relatively under-served segment. In particular, credit cards, cash cards and unsecured personal lending volumes have risen rapidly. Although consumer leverage is below that in many Western economies, its relatively quick rise means that many such exposures remain untested.

Should SARS cause a rise in unemployment, a significant challenge to the risk management systems of those Taiwanese banks engaged in consumer lending could emerge. Counteracting this, falling consumer confidence may slow growth in consumer debt - reducing potential asset quality problems from this sector - but also leading to lower bank earnings.

Moody's Investor Services
Hong Kong Wei Yen
Thomas Keller
Singapore Deborah Schuler
Patrick Winsbury
Tokyo Brian Oak 81.3.5408.4100
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