Warren Buffett’s No.1 rule
- The Singapore banks’ attraction is likely to be their resilient loan books.
- We are not hopeful of the banks showing much asset growth for 2015.
- Non-interest income growth rates should also slow down yoy, as trade and domestic business expansion activity slows.
- As the economy slows, the main worries are the degree to which NPLs will pick up and how much of a drag will rising credit costs be for each of the banks.
- Regionally, Thai and Indo banks have already guided for higher NPLs.
- In such an environment, Warren Buffett’s number one rule is also applicable to banks, i.e. never lose money.
- To ensure that their share prices perform well, we believe that the banks need to manage credit costs better than peers or take a harder look at operating cost control.
ECONOMY SLOWS, SYSTEM SHOW NO GROWTH
Singapore’s slowdown reflecting the external slowdown
- Singapore's 2Q15 GDP sharply missed expectations, contracting by a sharp 4.6% qoq, reversing 1Q15's +4.2% growth.
- Overall, with no growth for 1H15, GDP growth for the full-year looks likely to come in at the lower end of the government’s 2-4% growth forecasts. While the 2Q contraction was exaggerated by pharma swings, we do see a slowdown on the ground nevertheless.
- Business hiring expectations have been pulled back. Businesses are reconsidering their investment plans for Singapore on a mix of high cost, lack of labour availability and a general slowdown in neighbouring economies.
- From the office landlords, we understand that office demand has been lacklustre.
- Retail sales have been muted. The lack of business expansion means that wage growth expectations are rather muted, even if Singapore’s unemployment rate is low.
- The lack of wage growth plus restrictive policies to prevent households from leveraging up, and gradually sliding property prices, all conspire to keep consumption growth down.
System loan and deposit growth flatlined in 2015
- The lack of credit demand from both the business side and the consumer side, is reflected in system loans numbers. Based on MAS banking data, system loans were +0.3% YTD (in the period of Jan-May) vs. +5.8% in the same period in 2014.
- The reason for the slowest system loan growth for some time, was a sharp fall in business loans across the board in Apr, most notably manufacturing, non-bank financial institutions, commerce, and transport, storage and communications.
- Property loans growth, while muted (+1.1% YTD), at least still provided a positive contribution to overall loan growth.
- We believe that the bulk of the loans are drawdowns from earlier mortgage applications; with new mortgage applications declining 40-45% last year. Hence, we will not be surprised if system home loans start to contract (from net repayments) by end-2015 or 2016.
- Correspondingly, we think that it is quite plausible to see Singapore system loan growth start to turn negative at some point in the next 12 months.
- Deposits fared better, with YTD system deposit growth of 1.0% in 2015 vs. -0.2% over the same period in 2014. As loans faltered, the system LDR of 11% (as at end-14) is starting to fall back (end-May 15: 107%), which is a positive development.
- Browsing through system deposit data, we find that while 1Q15 deposit growth was more CASA-oriented (current account, savings account), 2Q15 deposit growth seemed to have had a heavier reliance on fixed deposits. This could be due to a series of re-pricing of fixed deposits offered at promotional rates, after the SIBOR moved up in 1Q.
Currency effects
- Another reason why we are pessimistic about 2Q asset growth is the impact of currency movements. In 1Q15, although the dollar strengthened against the S$, a big fall in commodity prices and trade volumes saw the value of Singapore banks’ trade book evaporate.
- We think that the effect of a falling trade book is over. Instead, for 2Q15, currency headwinds should come from the strengthening S$ vs. US$, RM and Rp.
- The S$ has strengthened 1-2% vs. the dollar, so US$ and HK$ loans will see some negative translation impact (thus affecting DBS and OCBC). Likewise, the S$ has strengthened 3-4% vs. the RM and 4-5% for the Rp, over 2Q15, so the ASEAN loan book will see quite a bit of negative translation effects (thus impacting OCBC and UOB).
- Clearly, there are a lot of headwinds for asset growth this year.
Non-interest income should also slow
- We believe that the non-interest income trends seen in 1Q15 should carry over into 2Q.
- The latest China total trade figures show a 7% contraction for 1H15. Likewise, trade-related fees and customer-hedging activity (reflected in treasury profits) are both likely to slow sequentially for the Singapore banks.
- We are less certain on the direction of investment banking-related fees.
- 2Q15 witnessed a very buoyant China equity market and rather stable Asian bond-market activities, so we think that there is a fair chance that DBS (with its Greater China platform) might outperform the other two banks on IB fees this quarter.
- For the Singapore banks to show non-interest income growth, they must depend more on consumer-related fees streams such as wealth management and credit cards.
- The buoyant trend in wealth management was evident in 1Q15 and such trends should sustain.
- As wage growth in Singapore slows and rising cost-of-living starts to set in, the population is turning more and more to online shopping (as evidenced by SingPost’s fast-growing e-commerce and logistics revenues).
- Similarly, we think that this trend bodes well for banks with a strong credit card franchise (DBS and UOB).
Unlikely to have MTM losses
- We do not expect any fallout from the sideshow in Europe currently. Any marked-to-market losses on investment securities are likely to be extremely limited.
- The Singapore banks have had a dress rehearsal in 2011 and have pared down whatever European debt that they owned.
- The only links to Europe that we fear are counterparty exposures to healthier north Europe banks, should any contagion effects take root; we think that this is an overly pessimistic scenario.
2Q15 RESULTS EXPECTATIONS
DBS to report on 27 Jul, OCBC and UOB on 31 Jul
- The three Singapore banks report next week.
- We are expecting 2Q net profit of S$1,044m for DBS, S$985m for OCBC and S$844m for UOB.
- For all three banks, we expect the topline to be mostly driven by NIM improvements.
- We think that asset growth will be muted (~1% qoq).
- For DBS, we are expecting a relatively stronger non-interest income showing, as we think that it could surprise on IB and WM fees. The line to watch is once again total provisioning. With little asset growth this quarter, there is little reason for banks to pad up general allowances, which means that the differences with total provisioning could be all about the magnitude of specific allowances.
- We are most wary of UOB, followed by OCBC, mainly for their ASEAN exposure.
VALUATION AND RECOMMENDATION
Maintain Add rating on DBS and OCBC, Hold on UOB
- We swap our order of preference for Singapore banks to DBS, OCBC then UOB. Previously, we liked OCBC ahead of DBS.
- In the current environment of clear credit quality deterioration in ASEAN, we think that DBS has the least likelihood of springing any big negative surprise from provisioning.
We rate DBS an Add, with an unchanged target price of S$22.77, based on GGM (1.41x CY15 P/BV).
- At the turn of the year, the main reason for DBS being the consensus top pick was that it was the best interest-rate play among the three banks. With interest rate optimism dying down by now, we believe that DBS will still be appreciated if it beats estimates on strong non-interest income (wealth management, IB, credit cards), falling SPs, coupled with the potential of earnings tailwinds from Manulife in 2016.
- 2Q15 is a quarter where IB activity in Greater China markets shot up and we think that DBS could also likely be the bank among the trio that would have benefited the most from this.
We rate OCBC an Add, with an unchanged target price of S$11.85, based on GGM (1.4x CY15 P/BV).
- We are optimistic that OCBC has other levers to deliver earnings growth, besides that of rising interest rates. We believe that its wealth management fees and treasury activities will see upside from synergies reaped via Wing Hang Bank’s Hong Kong platforms.
- Associate earnings from a strong-performing Bank of Ningbo is also likely to give group earnings a small boost. That said, risks stem from its exposure to ASEAN.
We rate UOB a Hold.
- UOB’s 1Q15 margins surprised positively as it was not impacted by excess dollar funding. Likewise, as its two peers get rid of their excess dollar funding, their margin drag will also diminish, thus leaving UOB with less positive margin improvement to show (vs. peers) this quarter.
- UOB is actively pushing into the wholesale space and pursuing loans from MNCs investing in ASEAN. But with many of the ASEAN companies guiding less bullishly in 2015, we think that ASEAN may not provide the tailwind compared with previous years.
- Our main concern for UOB lies in its potentially rising NPLs from business loans in ASEAN.
Source: http://research.itradecimb.com/
