Two weeks ago DBS has increased the spread of their FHR-pegged home loans across the board and re-introduced sibor-based packages to the market, something which they stopped with the launch of FHR about 6 months ago. DBS remains the first and only bank to have introduced this innovative feature.

What should one make of this latest move by DBS? First let us understand what is FHR. It stands for Fixed Deposit Home Rate which is basically the average of DBS’s prevailing 12-month and 24-month time deposits rate for the deposits band of S$1,000 to S$10,000. These two rates have remained constant ever since FHR was launched in Jun 2014 at 0.25% p.a. and 0.55% p.a. respectively leading to an average of 0.40% p.a. for FHR, whilst 3-month sibor has been on an uptrend since Nov 2014 from 0.42% all the way up to 0.67% in the span of 2 short months.

At MortgageWise we have been recommending clients who were looking for floating rate mortgage to consider FHR-pegged loans as we think it is a superior and innovative peg for borrowers. Our reasoning is simple. FHR will eventually rise when banks in Singapore lift their deposit rates across the board, however we believe FHR increments will always lag behind sibor increases, and the reverse will happen when rates start trending down in the next down cycle.

First understand that the three local banks are net lenders in the Singapore interbank market, ie. they lend more than they borrow. You can appreciate this simply by looking at their vast retail network on the island and the huge base of depositors who parked money in savings and time deposit accounts with local banks. What this means is that for the banks to make more money, or increase their spread in banking lingo, they will try to lend higher in the interbank market and hold back raising their “costs of funds” for as long as they can, ie. deposit rates that they pay to attract you and me to park money with them. It makes commercial sense then that they will wait for sibor rates to trend up further, signaling liquidity drying up in the market, before increasing their deposit rates to attract more funds. In a way when sibor goes up, foreign banks will start to run more fixed deposit promotions (you see that happening already now) and raise funds through deposit base rather than relying solely on interbank borrowing. When that happens local banks will eventually be forced to raise their deposit rates as well in order to avoid exodus of funds. However there will be a time lag for them to do this for commercial reasons as explained earlier.

In a reverse situation when the cycle turns and sibor rates start trending down, local banks will quickly lower their deposit rates in order to maintain the same spread or profit. Hence we predict FHR will drop much faster then sibor rates in an environment when rates start to fall for example due to another financial crisis. Borrowers will benefit immediately with reduction in FHR.

In conclusion we think FHR is indeed a better peg than sibor in both a rate hawkish as well as a rate dovish environment, and it retains the same transparent nature of a money market peg like sibor as opposed to bank’s internal board rate for mortgage loans.

We suspect DBS probably realized as much. So instead of raising their FHR which means raising their costs of funds immediately, they now increase the spread of their FHR-pegged loans to 1.05% for the initial 3 years, as well as the “thereafter” spread from year 4 onwards from the previous 1.25% to 1.45%. Even at this new spread, their FHR package rates remain highly competitive at only 1.45% p.a. and ranks top lowest for our floating rate comparison, as sibor has moved up even more over the same period. The bank has since re-introduced sibor packages to the market in a bid to diversify their loan portfolio away from FHR pegs, which reinforces our view that FHR is indeed a superior peg and first choice home loans for borrowers in the long term.

Lastly, there is one caveat. Our argument above might not hold true if the 12-month and 24-month fixed deposits for the lowest deposits band of S$1,000-S$10,000 forms only a small percentage of the bank’s total deposits, which is likely the case going by Pareto’s 80/20 rule which suggests that 80% of the banks’ deposits probably come from 20% of the bank’s clients, the HNWI (high net-worth individual). Conversely although fixed deposits of $10,000 and below might form 80% of all the fixed deposit accounts, collectively they only contribute to 20% of the deposits which the bank can always choose to ignore and raise the deposit rates (hence FHR) in exchange for a much higher loan interest revenue from FHR-pegged DBS home loans.

At MortgageWise.sg, we seek to provide thought leadership in the area of mortgage planning in Singapore, taking deep dive into developments and news on mortgages & helping clients track interest rate movements.  We do not just go for one-time business with clients but rather choose to build long trusting relationships by giving truly independent advice to the extent of losing the deal.  We strive to become the first-choice mortgage partner for homeowners and the creditable distributor of mortgage products for banks and financial institutions in Singapore.