Singapore Banking - Upside From Rate Hikes, Limited Downside From O&G
- The banking sector is lifted by tailwinds from higher interest rates and bond yields while headwinds from the O&G sector have diminished.
- DBS and OCBC trade at 2017F P/B of 0.99x and 1.03x, at a discount of 26% and 38% below their long-term mean respectively. These discounts should shrink as the equity market regains its composure.
- Maintain OVERWEIGHT.
- Our top pick is DBS due to its high-beta to rising interest rates, followed by OCBC.
Positive upside from higher interest rates.
- The US economy expanded at a rapid 3.5% yoy in 3Q16. The labour market has also strengthened with unemployment rate (seasonally adjusted) dropping 0.3% mom to a 9-year low of 4.6% in November. Thus, the FOMC’s decision to hike the federal funds rate by 25bp to 0.50-0.75% in December was unanimous.
- According to the Fed chairwoman Janet Yellen, FOMC members projected the federal funds rate would increase to 1.4% by end-17, indicating expectations of three hikes in 2017 instead of two.
SIBOR and SOR: On the march again.
- President-Elect Donald Trump’s intention to boost infrastructure spending, cut taxes and reduce regulations has rekindled expectations of stronger economic growth and higher inflation, which had a profound impact on money markets and bond yields around the globe.
- In Singapore, the 3-month SIBOR and SOR have bottomed in October and rebounded by 10bp and 40bp to 0.97% and 1.01% currently respectively. The yield curve has also steepened with yield spread between 10-year and 2-year government bonds widening from 0.9% to 1.2%.
Limited downside from O&G.
- We believe Singapore banks have already recognised the larger troubled accounts from the oil & gas (O&G) sector as NPLs. Assuming all NPLs in the O&G sector occur in the offshore support services (OSS) segment, we estimate DBS, OCBC and UOB have recognised 15.1% (2Q16: 10.1%), 21.5% (2Q16: 16.4%) and 31.1% (2Q16: 17.1%) respectively of loans extended to the OSS segment as NPLs. The damage appears to be already done.
- Oil prices have firmed up to US$56.89/bbl and US$53.78/bbl respectively for Brent crude and WTI crude, which could potentially provide some uplift to exploration activities and charter rates over time. We expect new NPLs from the O&G sector should normalise and taper off in subsequent quarters.
Help on the way.
- The Ministry of Trade & Industry has announced two measures to help marine and offshore engineering (M&OE) companies.
- First, the Internationalisation Finance Scheme has been enhanced to increase loan quantum from S$30m to S$70m per borrower group. The funds could be utilised for the purchase of assets, project financing or M&As.
- Second, bridging loans for working capital have been re-introduced with maximum loan quantum set at S$5m for each eligible company and S$15m for each borrower group, with loan tenure of up to six years. The government will assume 70% of the risk-share for both loan assistance schemes.
- The two schemes started in Dec 16 and loans of S$1.6b are expected to be disbursed in 2017. SMEs would benefit the most from these loan schemes.
Maintain OVERWEIGHT. Higher interest rates and bond yields are positive for banks.
- We believe current share prices have already built in expectations of further credit losses from the O&G sector.
- DBS and OCBC trade at 2017F P/B of 0.99x and 1.03x, which is near 1SD and 2SD below their long-term mean respectively. They also provide decent dividend yields of 3.4% and 3.9% respectively.
Positive impact on banks.
- UOB Global Economics & Markets Research forecasts the 3- month SIBOR to reach 1.35% by end-17:
DBS Group Holdings (BUY/S$17.80/Target: S$21.20)
- We estimate DBS’ NIM would expand by 4bp from 1.76% in 4Q16 to 1.80% in 4Q17. We raise our 2017 net profit forecast by 0.5%.
- Our target price of S$21.20 is based on 1.17x 2017F P/B, derived from the Gordon Growth Model (ROE: 9.3%, COE: 8.0% (Beta: 1.1x) and Growth: 0.5%).
Oversea-Chinese Banking Corp (BUY/S$9.18/Target: S$10.65)
- We estimate OCBC’ NIM would expand by 2bp from 1.62% in 4Q16 to 1.64% in 4Q17.
- We raise our 2017 net profit forecast by 0.3%.
- Our target price of S$10.65 is based on 1.20x 2017F P/B, derived from the Gordon Growth Model (ROE: 9.1%, COE: 7.75% (Beta: 1.05x) and Growth: 1.0%).
United Overseas Bank (NOT RATED/S$20.88)
- UOB has the least exposure to the O&G sector. Loans extended to the O&G sector amounted to S$9.2b, or 4.2% of total loans, compared with DBS’ S$16b (5.4% of total loans) and OCBC’s $12.2b (5.9% of total loans).
- UOB is more resilient and well positioned to weather the current credit cycle.
- Rising interest rates and bond yields.
- Easing of pressure on asset quality from the O&G sector.
- Decent 2017F dividend yields of 3.4% for DBS and 3.9% for OCBC.
- As mentioned above.
- Outbreak of trade war between China and the US.
- Further economic slowdown and political risks in regional countries.