Banks 2016 Outlook - DBS Research 2015-12-17: Limited engines to fire

Banks 2016 Outlook - DBS Research 2015-12-17: Limited engines to fire UNITED OVERSEAS BANK LTD U11.SI  OVERSEA-CHINESE BANKING CORP O39.SI 

Banks 2016 Outlook - Limited engines to fire 

  • Rate hikes may not translate to significant NIM spike. 
  • Moderated earnings growth expected.
  • Expect higher credit costs as we reach the end of a benign credit cycle. 
  • OCBC remains our preferred pick over UOB. 


 Muted NIM impact despite rate hikes. 

  • Expectations are rife for the first Fed rate hike in years - 25bps by mid-Dec and another 25bps in 1Q16. This should push SIBOR further up to 1.4% by 1Q16. 
  • We have imputed slightly higher NIM in 2016 to account for the expected rate hike but we believe the NIM uptick may be muted as: 
    1. we expect funding costs to catch up, dampening the impact of loan yield increases on NIM; 
    2. in addition, with the S$ loan-to-deposit ratio now at a high of 87% from 79% two years ago, there may be little room left for banks to leverage on; and 
    3. the wildcard on whether Singapore banks still carry surplus US$ liquidity may dampen overall asset yields and hence NIM. 

 Moderated earnings growth. 

  • If the excitement of the NIM spike for the Singapore banks cools off, there leaves hardly any drivers for growth in 2016. Judging from the trends we have seen in 2015, we believe that even with the Fed rate hikes, there is not much room for NIM to rise significantly. 
  • With loan growth likely to stay in the low single digits, topline growth will be slower. 
  • Non-interest income is unlikely to excite as well and may be volatile depending on markets, and to some extent, be the wildcard to earnings. 
  • As we exit the benign credit cycle, credit costs will start to accelerate. 
  • We forecast 2016 earnings growth of 6%. Upside surprise could come from higher than expected NIM increase. Every 10bps increase in NIM translates to 4-7% rise in earnings. Elsewhere, there is little to worry about capital levels in our view, as Singapore banks are among the highest capitalised in the region. 

 Asset quality still relatively healthy. 

  • So far, an asset quality capitulation appears remote. But banks have been prudently setting aside additional provisions where required. Stress tests have been carried out on selected portfolios particularly the commodities and oil & gas sectors, but so far, there has been little stress. 
  • OCBC’s oil and gas exposures were at 6% of total loans while commodities were at 7% of total loans as at 3Q15. 
  • Meanwhile, UOB’s exposure to commodities is less than 8% of total loans while the sub-segment, oil & gas is c.5% of total loans. Stay watchful on unemployment trends; this would spell a change in asset quality direction should the labour market weaken. 


 Smaller NIM increase could dampen earnings growth. 

  • We have conservatively imputed 4bps increase in NIM for 2016. This is the key driver to earnings growth given that loan growth is expected to be sluggish, non-interest income likely to lose momentum, expenses to be high and credit costs to escalate. Thus, if the increase in NIM falls short of expectations, there would be risks to earnings. Note that every 10bps increase in NIM translates to a 4-7% rise in earnings and vice versa. 

 Asset quality capitulation. 

  • While we are expecting NPLs to remain fairly stable despite imputing higher credit costs as we reach the end of a benign credit cycle, a repeat of a GFC scenario could throw our forecasts out of the window, pushing credit costs up by an additional 10bps and NPL ratios up by almost 50bps from current levels. This could result in a 21-24% downside to our FY16F earnings. 

Valuation & Stock Picks 

 Trading at -1.5 SD of the 10-year mean PBV. 

  • Singapore banks have performed poorly vs ASEAN peers, with an 18% contraction in market cap YTD-2015. While share prices of the banks have rebounded from their lows in early October, this only reflected the good news that asset quality was unlikely to deteriorate significantly. 
  • Although we believe the banks remain fundamentally strong (no significant deterioration in asset quality, strong capital position), the market appears to be pricing in the slower loan growth and higher credit costs in the coming quarters and does not seem positive on any potential NIM spikes from rate hikes. 
  • Singapore banks are currently trading at 1.0x FY16 BV, which is at -1.5 SD of its 10-year mean P/BV multiple. 

 Still prefer OCBC to UOB.

  • OCBC remains a BUY on solid asset quality and Greater China traction. Our S$10.00 TP is derived from the Gordon Growth Model and implies 1.1x FY16F BV. The potential reach of its differentiated non-interest income franchise should support valuation. A turn in the interest rate cycle with minimal disruption to asset quality will be testimony of its robust credit position.

LIM Sue Lin DBS Vickers | http://www.dbsvickers.com/ 2015-12-17
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