Singapore Banks - Silver Lining; U/G Sector to NEUTRAL
Some +ve signs; Top Pick now DBS in place of UOB
- There are some positive signs emerging:
- the rate of new NPL formation and provisions related to the O&G sector are likely to ease in 2017; and
- the outlook for the domestic economy could improve. Banks will focus on revenue growth and cost management to offset provisions.
- We think DBS could be a key beneficiary on this front and we switch to DBS from UOB as our preferred pick. We upgrade Singapore banks to NEUTRAL from NEGATIVE.
1. 4Q16 results: Lacklustre
- Banks’ 4Q16 results reflected weaker profits due to higher specific provisions (SP), which surged by more than 100% YoY, largely for the O&G sector. Banks agree that the worst is not over for the O&G sector, and more provisions are likely to come through over the next few quarters.
- ROEs fell mainly due to higher provisions, which reduced net profits. 4Q SP is now 44-76bps of average gross loans across the banks. However, asset quality for the broader portfolio (excl O&G) continues to hold up relatively well.
- We saw:
- higher loans growth as banks now defend market share in domestic loans and source high-quality loans;
- lower customer spreads, which compressed margins;
- outperformance of net trading income and better cost management by DBS partly contributed to a decent 10% YoY increase in its pre-provision profit (PPoP).
2. Loans growth
2.1 Where are the lending opportunities?
- FY16 loans grew 4-9% YoY, which was better than our expectation. Loan growth was broad-based across countries and sectors. Amid an uncertain environment, banks are now being selective in choosing better quality credit in corporate and wholesale banking. Fully-loaded CET1 ratio is now 12-13%, which is not too far off from banks’ comfortable levels of c.11.5%. Banks will be careful with their lending and will not be inclined to take on higher risks.
- Comparing YoY, the largest increase in loan growth came from “Others” region (Australia, UK, USA etc), which rose 20-40% YoY. These can be attributed to both Singapore companies and those overseas looking to expand, making investments and acquisitions. By tapping their franchise in the region, Singapore banks also saw demand in Indonesia, Thailand and Greater China. Banks have guided for mid-single digit loan growth in FY17.
- We expect banks to grow by 2-4% in FY17 due to increased competition, especially in wholesale banking and consumer loans.
2.2 Loan growth in Singapore
- Our Singapore economist forecasts 2017 Singapore GDP growth of 2.5% (link) and looks for a domestic export recovery (link). Some positive signs may be emerging in the domestic economy. Using data from 2Q09 onwards, the multiplier between system loans growth and Singapore GDP growth is 2.0x on average, while the multiplier between banks’ loan growth in Singapore and GDP growth is 2.2x on average.
- We currently assume FY17 total loan growth of 2-4% YoY for Singapore banks, as mentioned earlier. This assumption could be conservative if growth in Singapore’s domestic economy improves in 2017. We estimate every 1% increase in our loan growth assumption could raise net interest income by c.1%, ceteris paribus.
- Banks’ loans growth in Singapore is now 7-8%, which is faster than system loan growth at 0.5% YoY. Banks are now defending their market share in Singapore housing loans, which grew 7-10% YoY, faster than the system’s 4%. UOB had 31% market share for new housing loans in 4Q; DBS’s market share rose to 29% (3Q16: 28%). As housing loans form 21-27% of the banks’ total loans, it is a competitive business.
- Notably, foreign banks in Singapore are reducing their loan sizes, suggesting that they are unwilling to take on higher risks amid reduced profits. For instance, HSBC (5 HK, Not Rated) reduced its housing loans by 20% YoY in 2016 to curb the size of this portfolio. Standard Chartered Bank (2888 HK, Not Rated) also reported lower new bookings for housing loans and business banking in Singapore. These made way for Singapore banks to gain market share and to outpace the growth in system loans.
- Aside from housing, loan growth could come from building and construction, especially for public infrastructure projects. The Building and Construction Authority expects construction demand (i.e. value of construction contracts to be awarded) in FY17 to be SGD28-35b, with demand from the public sector of SGD20-24b (i.e ~70% of the total demand).
3. No wider customer spreads
- Customer spreads fell across the banks to 1.99-2.09% in 4Q16 (3Q16: 2.01- 2.13%; 4Q15: 2.07-2.34%). This suggests:
- a lack of re-pricing interval as SGD rates are lower;
- lending yields not re-priced for risks in a heightened risk environment;
- competitive loan pricing;
- a drive for higher loan volume at the expense of lower loan pricing; and/or
- the chase for higher quality credit, which are lower yielding.
- Based on our linear regression analysis, we tested the Fed Funds rate (independent variable) against the 3M SIBOR (dependent variable) based on 16 years of quarterly historical data. If history is a guide, for every 100bps increase in the Fed fund rate, the 3M SIBOR will increase by 44bps. Similarly, the 3M SOR will increase by 48bps. Pass-through effect could be between 40-50%.
- We also tested our regression analysis on banks’ customer NIMs and 3M SIBOR. For every 100bps increase in the 3M SIBOR, our regression analysis shows that there will be a c.10-14bps increase in banks’ customer NIM.
- We expect slight improvement in NIM for FY17E across the banks on the back of a 20-25bps increase in SIBOR. Competitive loan pricing will offset some of the re-pricing benefits away.
- Loan-deposit ratios now range from c.83-87%, vs 2015’s range of c.85-89%. This may provide some headroom, albeit limited, to drive increases in revenue growth.
- The strategy of Singapore banks is to increase lending to large corporates and remain selective on loans. Corporate loan pricing is likely to come under pressure as banks compete in this space. Unless interest rates rise, customer spreads will continue to fall.
- Being the largest SME lender among Singapore banks, UOB’s customer spreads were higher than peers. However, its strategy to focus back on corporate lending in the wholesale banking/FI sectors this year resulted in lower lending yields and lack of pricing power. In 4Q16, the gap between UOB’s customer spreads versus DBS’s and OCBC’s further narrowed to 9bps and 10bps respectively (3Q16: 10 and 12 bps difference, respectively; 4Q15: 27 and 20bps difference, respectively). UOB’s gap with DBS is now at its lowest since 2008, and the gap with OCBC is at the lowest since 2004. Comparing between 4Q15 and 4Q16, UOB’s customer spreads fell by 25bps vs peers’ 7-15bps, and lending yields for customer loans fell by 20bps vs peers’ 6-16bps.
4. Non-interest income
- In 4Q16, non-interest income formed c.34-43% of total income for the banks.
- Non-interest income declined by 3-6% YoY for OCBC and UOB, but DBS’ grew 20% YoY in 4Q16. DBS’s outperformance was due to net trading income, which grew 37% YoY while peers’ fell by 20-25%.
4.1 Net trading income
- Outperformance in DBS’s non-interest income came from net trading income, which contributed 42% of its 4Q16 non-interest income (vs peers’ 13-22%) and 14% of its 4Q16 total income (vs peers’ 6-8%). DBS’s net trading income rose 37% YoY in 4Q16. For FY16, net trading income was 12% of total income (vs peers’ 6-10%).
- Despite volatile market conditions in 2016, DBS’s returns from net trading income held up better as compared to peers. Given its higher value-at-risk (VaR) of trading book, DBS’s larger trading position and bigger bets contributed to higher gains. However, there are risks as earnings can disappear in depressed market conditions, as was seen during GFC. Such earnings can be volatile by nature and considered to be of weaker quality
4.2 Wealth management (WM)
- For FY16, DBS’s WM fees rose 19% YoY (4Q16: 32% YoY), partly driven by the bancassurance contributions from Manulife. Amortized contributions from Manulife are SGD26.5m per quarter, or SGD106m per year. If we strip out the amortized quarterly contribution in 4Q16, WM fees grew by 10% YoY. WM fees grew c.2% YoY for FY16 after stripping out amortized contributions of SGD106m.
- In 2016, OCBC’s WM fees grew 3% YoY. 4Q WM fees rose 33% YoY as the quarter also marked the integration of Barclays’ Singapore and Hong Kong wealth units into Bank of Singapore (OCBC’s private banking arm).
- Stripping out the transfer in AUM of Barclays’ units of USD13b, AUM at Bank of Singapore grew 20% YoY to USD66b from USD55b a year ago.
5. Asset-quality concerns
- Our credit cost estimate remains elevated, at 37–38bps on average for Singapore banks from FY17-18E. This is to factor in further asset quality deterioration, especially from O&G sector.
- Our estimate could be at risk should there be more recoveries, or if credit costs are more benign than what we expected as banks have varying standards in their loan-loss methodologies. For every 10bps decline in FY17E credit cost estimate, net profits will increase by 6-7%, ceteris paribus.
5.1 O&G woes not over
- Banks were hit by higher SP for O&G in 4Q16, and the increase in NPLs for the year largely came from this sector. Provisions for O&G are likely to remain elevated. However, the pace of acceleration of new NPL formation and provisions will ease in 2017 as the chunky exposures have been recognised as NPLs. Banks are also providing for decline in collateral values.
- Singapore banks have 1.6-2.4% of loan exposure to the support services sector. The NPL ratio for support services is now between 15% and 22%.
- DBS took proactive steps in 4Q16 to move four new names into NPAs. The total amount of NPLs (excl Swiber) is now SGD1b, with SGD0.8b from its portfolio of larger names and SGD0.2b from its portfolio of smaller names. However, the remaining c.SGD1.4b of its portfolio of smaller names showed weakness, and risk remains as these have yet to be classified as NPLs.
- Lowest O&G exposure and higher SP meant UOB will be relatively shielded from further deterioration. UOB’s provision coverage remains the highest among Singapore peers at 116% vs peers’ 97-100%. However, UOB’s writebacks in general provisions (GP) in FY16 reduced its GP buffer to 1.2%, narrowing its gap against peers’ 0.9-1.1%. As DBS will be set aside divestment gains from its sale of the PwC building of SGD350m as GP, this should ease some concerns about its provision adequacy.
- Despite its lower exposure to O&G among peers, UOB’s SP was 46bps of average net loans in 2016. 40% of its SP taken in 2016 was the result of sharp declines in collateral values. In contrast, OCBC’s and DBS’s SP were 23bps and 38bps of average net loans in 2016, respectively. That said, the write-downs in collateral values can vary across different types of vessels, which can affect the amount of provisions taken in by the banks. UOB remained confident that it has provided for most of the write-downs in collateral values and impact from higher specific provisions should ease in 2017. We currently factor in specific provisions over average net loans to be between 29-37bps across the banks for 2017.
- If we assume 2017 SP over average net loans rose to 46bps from our current estimation (i.e. this is also UOB’s SP over average net loans for 2016), we want to assess how this will affect banks’ 2017E net profits and book values, particularly for DBS and OCBC. OCBC could be more affected. Its SP may need to increase by 59%, reducing its FY17E net profits by 10%, ceteris paribus. DBS may need to increase SP by 33%, reducing its FY17E profits by 8%, ceteris paribus. Estimated book values will be reduced by c.1%.
5.2 Other sectors that may see weakness
- Aside from O&G, the broader sectors are holding up relatively well. We also sense more optimism from the banks on their loan exposure to SMEs as they do not see significant weakness/stress in this portfolio. This is in contrast to the cautious tone they had in 3Q16. OCBC shared that if the domestic economy slows down, sectors that may face pressure are retail, F&B and commodities processing.
- Having said that, if the domestic economy faces a prolonged downturn or growth is weak, cash flows for corporates will stay tight, particularly for SMEs. Default risks may trend higher if growth is weak amid the turning credit cycle. We believe UOB has the largest exposure to SMEs, at 20% of loans.
6. Upgrade to NEUTRAL; Top Pick DBS
- We upgrade Singapore banks sector to NEUTRAL from NEGATIVE, as we think the O&G deterioration is likely to ease this year. Banks will drive revenue growth and contain costs to offset high provisions. Improvements in domestic GDP growth may be underway. The challenge for banks going forward will be finding sources of revenue and opportunities amid a volatile environment and slower global growth.
- We value the banks at ~0.9-1.0x FY17E P/BV, to reflect our lower forecast ROEs compared to prior periods. We previously revised our estimates and target prices in our 4Q results notes (links to 4Q results: DBS, OCBC, UOB). We retain our recommendations.
- We now switch to DBS (HOLD, TP SGD18.13) from UOB (HOLD, TP SGD19.54) as our preferred pick given its better cost management and ability to drive revenue growth.