Singapore is headed for a painful deleveraging cycle: Moody's

Bad loans are feared to spike.

Singapore's largest banks will see an increasing amount of problem loans and will have to hike loan loss provisions on back of the escalating regional headwinds, according to a report by Moody's.

Moody's has revised its rating outlook on DBS, OCBC and UOB from stable to negative, citing deteriorating credit conditions against a backdrop of slower economic and trade growth.

The ratings agency warned that Singapore's corporate sector is headed for a challenging deleveraging cycle, on back of weaker economic growth and banks' tighter credit underwriting.

"Domestic firms are affected by slowing economic and trade growth in Asia and the drop in oil and other commodity prices. This has led to deteriorating corporate profitability, and in turn to lower credit metrics for corporates across several industries, including manufacturing, oil and gas, shipping, ship and rig building, and metals and mining," Moody's said.

Although domestic credit growth moderated substantially in 2015, overall leverage in the economy remains elevated compared to that of the previous decade, Moody's said.

The banks also face escalating headwinds from slowing growth in regional economies, because foreign loans constitute around one-half of their gross loans.

Another looming risk for Singapore banks' asset quality is their large exposure to oil and gas borrowers, including services companies, which were the most affected by the collapse in oil prices. Singapore banks' exposures to oil and gas services firms are significant and ranged from 13% to 24% of their common equity Tier 1 capital as of the end of 2015.

Despite the headwinds, the three large Singapore banking groups maintain very strong buffers in terms of capital, loan loss provisions and pre-provision income, Moody's said. The banks also maintain solid funding and liquidity profiles. Although bad loans are expected to increase, asset quality remains solid.