## Sunday, 27 March 2016

### Does Aspial's 5.30% Bond Have Sufficient Margin of Safety?

7 months ago, I blogged about whether Aspial's 5-year, 5.25% bond has sufficient margin of safety. 7 months later, Aspial has launched a new 4-year, 5.30% bond. Since the last blog post 7 months ago, has Aspial's financial strength improved based on the 2 criteria that Benjamin Graham used to analyse bonds, namely, the minimum average earnings coverage and the minimum current stock value ratio? Using Aspial's latest Financial Year's results, the computation of the 2 ratios are as follow.

Earnings Coverage

 Profit before tax = \$13.0M Adjusted for: - Deduct: Share of results of associates = \$1.8M - Add: Non-recurring forex loss = \$10.0M - Add: Finance cost = \$20.4M Total earnings available for covering fixed charges = \$41.5M Current finance cost = \$20.4M Add: Interest of proposed bond = 5.30% x \$75.0M = \$4.0M Total finance cost = \$24.3M Earnings Coverage = \$41.5M / \$24.3M = 1.71

The earnings coverage of 1.71 times is below the minimum average earnings coverage of 3 times for industrial companies.

Stock Value Ratio

 No. of shares = 1,891.6M Share price = \$0.275 Market value of shares = \$520.2M Current amount of borrowings = \$1,305.2M - Add: Proposed bond size = \$75.0M Total bond value = \$1,380.2M Stock value ratio = \$520.2M / \$1,380.2M = 0.377

The stock value ratio of 0.377 is lower than the minimum stock value ratio of 1 for industrial companies.

Thus, based on the above figures, the proposed Aspial's 5.30% bond does not pass both the earnings coverage and stock value ratio criteria. Hence, based on Benjamin Graham's criteria, the bond does not have sufficient margin of safety.

Compared to the figures in the previous blog post (based on 2014 financial statements), both earnings coverage and stock value ratio has dropped. The earnings coverage has reduced from 2.50 times to 1.71 times while the stock value ratio has reduced from 0.548 to 0.377. In fact, all key measures for computing the above 2 figures have weakened.

 2014 2015 Earnings Coverage Total available earnings \$52.6M \$41.5M Total finance cost \$21.0M \$24.3M Earnings Coverage 2.50 1.71 Stock Value Ratio Market value of shares \$   651.9M \$   520.2M Total bond value \$1,190.4M \$1,380.2M Stock Value Ratio 0.548 0.377

This reduction in margin of safety affects not just the newer 5.30% bond, but also the older 5.25% bond.

In conclusion, Aspial's 5.30% bond does not have sufficient margin of safety. The margin of safety of Aspial's 2 retail bonds has reduced since the last blog post 7 months ago.

## Sunday, 20 March 2016

### Behind Fixed Deposit Home Loan Rates

Fixed Deposit Home Rate (FHR) loans are loans with interest rates tied to fixed deposit interest rates. Recently, such loans have become quite popular among property owners looking to finance their properties. They like such loans because the interest rates are much more stable than those of the Singapore Interbank Offered Rate (SIBOR) loans. In addition, it is perceived that if banks were to raise the FHR rates, they would also incur higher interest costs for their source of funds, thus making such moves unlikely. However, is that really the case?

Currently, the FHR loans available in the market are DBS' 18-month FHR and OCBC's 36-month FHR loans. The figure below shows the breakdown of bank deposits by maturity, using OCBC's latest financial statements, which have a more detailed breakdown of bank deposits than DBS'.

 Fig. 1: Bank Deposits by Maturity

As shown above, a great majority of bank deposits have maturity of less than 1 year. Deposits with maturity of 1-3 years, which form the basis of FHR loans, constitutes only 1% of all bank deposits. Thus, by tying FHR rates to that of fixed deposits with maturity greater than 1 year, banks will actually not feel the pinch should they raise the FHR rates.

The reason for the short maturity of bank deposits is shown in Fig. 2 below.

 Fig. 2: Bank Deposits by Type

Among the bank deposits, current accounts constitute 31% of all deposits while savings deposits constitute another 18%. Together, such short-term on-demand deposits make up 49% of all bank deposits. Fixed deposits constitute 43% while other types of deposits make up the remaining 8%. Thus, although fixed deposits represent the largest source of funds for the banks, they do not form the bulk of the funds.

In conclusion, banks still come up tops by offering home loans with rates that are tied to fixed deposit rates.

See related blog posts:

## Sunday, 13 March 2016

### Will Bank Deposits Pay Negative Interest Rates?

Negative interest rates have been the rage with central banks around the world, with Bank of Japan being the latest one to join the bandwagon in an attempt to stimulate their economy. Will negative interest rates come to Singapore and will banks pay negative interest rates on our bank deposits?

Just to bring everyone on the same page before I answer the 2 questions, central banks are banks for consumer banks operating in the country. Consumer banks like DBS collect deposits from companies and individuals with excess funds, loan out the majority to other companies and individuals to fund their investments and purchases, and deposit a small portion with the central banks. It is a requirement for consumer banks to set aside some money with the central banks to ensure they have adequate resources to handle bad loans and stay solvent in times of crisis. Under the normal scenario of positive interest rates, central banks pay interest on these deposits to consumer banks. Consumer banks also collect interest on loans to debtors and pay depositors interest on their savings deposits. Thus, when central banks pay negative interest rates to consumer banks, will consumer banks pass on this cost and also pay negative interest rates on depositors' bank accounts?

The probability of this happening is almost zero. Assuming consumer banks really were to pay negative interest rates to depositors, it would mean that depositors lose money parking their funds in the banks. Likely, depositors would respond by pulling money out of consumer banks and keeping in their houses and safes. How are the consumer banks going to recall the loans from debtors to pay off depositors withdrawing money from them? Most of these money are tied up in debtors' long-term investment projects and 20- to 30-year housing loans. It is not possible to liquidate these investments quickly and return money to the bank. The consequence is a bank run that is certain to bring down the consumer banks and the economy. Thus, consumer banks will avoid paying negative interest rates to depositors. The most likely scenario is to pay a low but still positive interest rates, like the 0.05% today. Depositors do value the convenience of bank accounts and are willing to tolerate near-zero interest rates.

Having said the above, depositors may still be affected by negative interest rates in some other ways. It is, after all, a cost to consumer banks that they need to recover from somewhere, either from depositors or debtors, or both. While this would not manifest as negative interest rates on bank deposits, it is likely to manifest as higher bank fees, such as the monthly account maintenance fee on current accounts and savings accounts that have balances below a certain threshold, cheque cancellation fees, etc.

On the debtor side, consumer banks are also likely to charge higher interest rates to recover some of the negative interest paid to central banks. However, this is not likely to be significant. Consider the case of DBS, which has \$283 billion in customer loans and \$19 billion with central banks. Assuming central banks charge -1% on DBS' deposits with them and DBS passes on the cost fully to debtors, the net increment in interest rate on customer loans is only 0.07%.

There is still one more avenue for consumer banks to recover the negative interest. Besides deposits with central banks and customer loans, consumer banks also purchase government bonds issued by central banks. So, if negative interest rates were to happen, consumer banks will attempt to reduce the amount placed with central banks (but no less than the statutory minimum) and shift some of it into government bonds that still pay positive interest rates. It is still placing money with the central banks, just a different avenue and with positive interest rates. This is why when central banks lower interest rates into negative territory, government bonds will rise and their yields will lower. In layman terms, assuming DBS were to pay negative interest rates on consumer deposits, I would withdraw my money and buy the DBS preference shares that have a coupon rate of 4.7%. Either way, I am still lending money to DBS, just that one is called a deposit (with negative interest rate) and another is called a preference share (with positive interest rate). Thus, an important consequence of negative interest rates is asset inflation in government bonds due to consumer banks buying them.

Let us now tackle the other question, which is whether negative interest rates will come to Singapore. As shown above, negative interest rates will actually lead to a slightly higher loan interest rate for debtors and higher bank fees for depositors. It is not as if central banks cannot afford to pay positive interest rates on deposits with them, because, central banks have the authority to print money. Paying positive interest rates on deposits with them is just a matter of allocating more or less of the money they are printing anyway to the consumer banks. So why are central banks willing to adopt such a desperate measure?

The 2 big regions that have implemented negative interest rates are Europe and Japan (the other countries being Denmark, Sweden and Switzerland), which, not coincidentally, are also implementing Quantitative Easing to inject more money into their banking systems. The negative interest rate policy is another measure to prod consumer banks into lending more money to the public rather than hoarding up cash in risk-free deposits with the central banks. In Singapore's case, the loan-to-deposit ratio is very high (DBS' ratio is 88%). Practically all the money collected by consumer banks is put to good use. There is thus no impetus to introduce negative interest rates in Singapore.

Secondly, negative interest rates will lead to a lower exchange rate of their currencies, thus boosting the competitiveness of their export industries. This is possibly another reason why some central banks are willing to adopt negative interest rates. In Singapore's case, the exchange rate of SGD is managed directly rather than indirectly through the setting of interest rates. Thus, this reason will not lead to negative interest rates in Singapore.

In conclusion, unless things change in future, negative interest rates are unlikely to come to Singapore. Individual depositors will also not need to worry about consumer banks paying negative interest rates on their bank deposits.

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## Sunday, 6 March 2016

### Do Properties or Shares Make Better Investments?

Singaporeans have a penchant for properties. It is not difficult to understand this, because, land is scarce in Singapore and we often hear stories about people making a lot of money from properties. However, are properties really better investments than shares?

A week ago, Today published an article by OrangeTee titled ECs: Gaining Value Over the Long Term, which shows the gains by Executive Condominiums (ECs) at the end of the Minimum Occupation Period (MOP) and upon privatisation. The results are reproduced below for easy reference.

 Fig. 1: Gain by ECs at End of MOP & Upon Privatisation (Source: Today)

The results show that at the end of MOP, which is approximately 7 years from the launch of the EC, not all ECs make money. The average gain from the 21 ECs listed in the study is 5.9%, while the median gain is -13.0%. As Today pointed out, at the end of MOP, ECs are not "sure-win" investments. However, upon privatisation, which is another 5 years from the end of MOP, the average gain of ECs improves to 64.2% while the median gain improves to 43.0%.

How do the above gains compare to that of the Straits Times Index (STI) over the same period, assuming that an investor chooses not to invest in an EC but wait until the end of the year and buy the STI? The results for each batch of ECs and the corresponding returns from STI at the end of MOP are shown below.

 Fig. 2: Performance of ECs vs Shares at end of MOP

In the figure above, all ECs having the same year of launch and MOP completion are grouped together. Using the first batch "1996 - 2004" as an example, the first figure (i.e. 1994) shows the year of launch while the second figure (i.e. 2004) shows the year of MOP completion. Together, they show the holding period from launch till end of MOP.

From the figure above, not all ECs make money at the end of MOP. Those launched before 1999 lost money while those launched after 1999 made money. Compared to shares, all batches of ECs underperformed the STI except for the batch launched in 2001 and MOP completed in 2008. Overall, for the 21 ECs studied, ECs returned an average of 5.9% while the STI returned an average of 50.8% over the 7-year holding period. Shares outperformed ECs by 44.8%.

 Fig. 3: Performance of ECs vs Shares upon Privatisation

Fig. 3 above shows the performance of ECs and shares at the end of privatisation, which is approximately 12 years from the launch of the EC. The performance of ECs upon privatisation improved significantly compared to that at the end of MOP. Compared to shares, there are 3 batches of ECs that outperformed the STI, namely, the 1999-2010, 2001-2013 and 2001-2014 batches. However, overall for the 21 ECs studied, ECs still underperformed the STI. The average return by ECs is 64.2% while the average return by STI is 101.5% over the 12-year holding period. Shares outperformed ECs by 37.2%.

The above comparison involves only ECs and not other condominiums. However, according to the study reported by Today, new ECs have an average discount of about 20% compared to new condominiums. This discount reduces to 9% at the end of MOP and 5% upon privatisation. Thus, if ECs, with their price advantage over mass market condominiums, already underperform shares, it can be inferred that mass market condomiuniums will also underperform shares.

It should be noted that the above comparison does not include rental yields by ECs and dividend yield of STI. The average rental yield is around 3-4% while the average dividend yield is 3%. Thus, the exclusion of rental yield and dividend yield does not significantly affect the outcome of the comparison.

Having said the above, although properties generally underperform shares, there are vintages for both properties and shares. Properties bought in certain years tend to perform better than properties bought in other years. Shares have the same characteristics. Thus, there will be periods when properties will outperform shares. It is therefore important to be selective and buy properties and shares when they are undervalued.

In conclusion, the comparison shows that, contrary to popular perceptions, properties are, in general, not better investments than shares. The main reason for the popular perception is likely because properties are usually bought with bank loans, thus magnifying the gains on the downpayment. On an unleveraged basis, properties are not better investments than shares.