Most of us would have at some point in time, being in contact with banks to process some important financial transactions. And in Singapore, it?ll probably not be too far-fetched to say that the local banks, DBS Group Holdings (SGX: D05), United Overseas Bank (SGX: U11) and Overseas-Chinese Banking Corporation (SGX: O39) would be among the most familiar banks that we go to for our banking needs.
On the outset, those three banks have operations that look awfully similar. After all, the most…
Most of us would have at some point in time, being in contact with banks to process some important financial transactions. And in Singapore, it’ll probably not be too far-fetched to say that the local banks, DBS Group Holdings (SGX: D05), United Overseas Bank (SGX: U11) and Overseas-Chinese Banking Corporation (SGX: O39) would be among the most familiar banks that we go to for our banking needs.
On the outset, those three banks have operations that look awfully similar. After all, the most basic banking operation involves taking in deposits from customers, loaning those deposits out and then trying to make a profit by charging interest on the loans that’s higher compared to the interest paid out on deposits.
That’s true as a generalisation, but as they say, the devil lies in the details. If we look beneath the hood, a different picture emerges.
The chart below shows the composition of the bank’s assets, split into Loans; Investments (consists of securities like government bonds); Cash & Equivalents; and Other Assets.
Source: Banks’ 2012 Annual Reports
At first glance, what’s striking is the difference between the amounts of loans that OCBC makes – as a percentage of its assets – compared to the other two banks.
With loans only taking up less than half of OCBC’s assets, it’s a lot less dependent on loans as compared to the other two banks for business.
A bank usually splits its income streams into two: Net Interest Income and Non-Interest Income. Put those two together and we obtain a bank’s Total Income (the rough equivalent of ‘revenue’ for companies in other industries).
Net-Interest Income is the difference between the interest a bank collects from the loans it makes and the interest it pays out on the liabilities it had incurred to enable it to make those loans (with the bulk of those liabilities typically being customers’ deposits).
Meanwhile, Non-Interest Income is the income that a bank derives from all other activities besides making loans. These activities can include the provision of wealth management services and trading of securities among others.
In 2012, OCBC’s Non-Interest Income made up 53% of its Total Income, in contrast to DBS and UOB’s corresponding ratio of 38% and 40% respectively, further showcasing OCBC’s smaller dependence on loans.
Ratings agency Moody’s recently downgraded its outlook for the local banks because of rapid loan growth and rising real estate prices here. Moody’s feared that the banks’ loan-asset-quality “has potentially peaked both at home and in many of the regional markets in which these banks operate.”
But with the chart above, the difference in asset-mix for the three banks would likely mean that they’ll react differently should their loan portfolios deteriorate. All things equal, OCBC might even seem to be the one that’s going to be less affected given that loans make up a much smaller percentage of its asset-base compared to DBS and UOB.
Foolish Bottom Line
With every company that’s being considered for investment, it pays to look behind the scenes to determine what drives the company’s revenue. In the case of the banks, superficial similarities actually mask large underlying-differences. Investors should always get to know a bank before investing in it.
For instance, how many bank investors actually know that OCBC has a thriving insurance operation under its majority owned Great Eastern Holdings subsidiary? The insurance operations made up 19% of OCBC’s Total Income for 2012, which helps explain why OCBC’s so much less dependent on loans for its income.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chong Ser Jing doesn’t own shares in any companies mentioned.