Singapore Banks - Maybank Kim Eng 2015-10-14: The NIM Enigma.

Singapore Banks - Maybank Kim Eng 2015-10-14: The NIM Enigma. Singapore Banks DBS GROUP HOLDINGS LTD D05.SI  OVERSEA-CHINESE BANKING CORP O39.SI  UNITED OVERSEAS BANK LTD U11.SI 

Singapore Banks - The NIM Enigma 

  • Our quantitative tests of Singapore banks’ NIM sensitivity to SIBOR largely validate conventional thinking that firmer rates tend to fatten NIMs. 
  • Rising rates benefit NIMs through the repricing interval, risk premium & yield curve. In Singapore, repricing and risk premium have stronger influence. But as delinquencies accompany higher credit risks, the incremental income from NIM expansion may be attenuated by credit costs.  
  • Cut sector rating to Underweight from Overweight. Downgrade DBS & OCBC to Sell. Downgrade UOB to Hold but our preferred exposure to the sector. 

Dissecting NIMs: More Than Meets the Eye 

  • Banks’ net interest margins (NIMs) essentially comprise two components: customer margins and interbank margins. In our quantitative analysis, we tested the sensitivity of their customer NIMs to repricing risks, credit risks and yield-curve risks from firmer interest rates. We tested their interbank NIMs against the spread between SIBOR and LIBOR. 
  • Conclusion: banks’ asset-liability structures are sensitive to rate increases. Repricing assets/liabilities to a 50 bps rise in SIBOR would broaden group NIMs by 4.6-7.2 bps, ceteris paribus. And as credit spreads are volatile, NIMs could widen more if rate increases are driven by the risk premium ie an expansion of the credit-risk spread. For every 50 bps, NIMs could be widen 3.4-6.6 bps. But higher delinquencies could dilute any positive EPS impact. 

Debunking the Myth: Is DBS the Biggest Beneficiary? 

  • Contrary to market expectations, DBS may not be the biggest beneficiary of a rate hike in uncertain economic times. Rather we believe it to be UOB. We downgrade our sector rating to Underweight from Overweight. 
  • On this set of findings, we are reordering our recommendations. DBS and OCBC have been downgraded to SELLs from BUYs. UOB remains a HOLD; it is our preferred exposure to the sector. 

Important Corollary On Disintermediation 

  • A relevant corollary from our tests is that Singapore banks are facing serious disintermediation pressures. The evidence? The gap between their group NIMs and customer NIMs has been narrowing, suggesting that the banks are lowering their credit spreads to customers. This shrinks their returns from financial intermediation and marks a structural change for the sector. We believe this should be priced into the sector’s long-term valuations. 

Investment Summary 

Rate hikes = wider margins? 

  • In our quantitative study, we tested Singapore banks’ NIM sensitivity to types of interest-rate risks that we deem relevant: repricing, credit, yield curve and the SIBOR-LIBOR spread. For simplicity, we use a multi-step multi-variable linear regression model based on historical data as a guide. 

Yes, better NIMs … but only modestly. 

  • Banks’ asset and liability structures are sensitive to rate changes, facilitating NIM expansion. But from our test results, the impact is modest. Both assets and liabilities are parked at the short end, almost evenly matched in their sensitivity to rate changes. This implies that gaps in repricing intervals are small. While NIMs should expand because of higher returns from capital funds, the improvements may be limited. 

Overlooked credit spreads an important determinant of NIMs. 

  • We proxy credit spreads using the differential between US Baa bonds and SIBOR. OCBC and UOB showed a higher propensity to pass on higher risk premiums in an unfavourable lending environment. Between 4Q07 and 3Q09, OCBC/UOB customer NIMs were up an estimated 47bps to 2.66% and 38bps to 2.91% respectively, largely driven by heightened risk premiums. Customer NIMs were compressed to a low of ~1.68%-1.79% in 2014. But we note that a higher risk premium may also be accompanied by asset delinquencies. 

NIMs inversely correlated with yield curve; not many opportunities to ride the curve. 

  • Singapore’s inverted yield curve for most periods between 2Q04 and 2Q15 (see Figure 19) was inversely correlated with NIMs. We think this triggered severe margin compression and historically low NIMs. Although the yield curve has normalised, it is rather flat. An anaemic macro outlook implies that the slope is unlikely to steepen soon. We are not optimistic that there are many opportunities to ride the curve. 

True to its reputed franchise, UOB has better pricing power. 

  • From our study, UOB appears best positioned to sit out macroeconomic uncertainties. Its assets and liabilities appear to be the most prudently managed, allowing it to book the highest NIM among the three banks. Its ability to pass on pricing increases in an adverse lending environment is an important element of its franchise, in our view. Financial disintermediation has been more brutal than envisaged, especially for DBS and OCBC. 
  • The gap between banks’ group NIMs and customer NIMs has been narrowing. In other words, the banks are lowering their credit spreads to customers, which seem to confirm our suspicion that their returns from financial intermediation are shrinking. This marks a key structural change for the sector. 
  • The structural challenges, unless reversed, should be priced into valuations. We wonder if Singapore banks could have mis-priced risks in their asset books, lured by the low credit costs of recent years.

Ng Li Hiang Maybank Kim Eng | http://www.maybank-ke.com.sg/ 2015-10-14
Maybank Kim Eng SGX Stock Analyst Report SELL Downgrade BUY 15.90 Same 15.90
SELL Downgrade BUY 8.50 Same 8.50
HOLD Maintain HOLD 21.00 Same 21.00