Singapore Banks - Maybank Kim Eng 2016-11-07: Post-3Q16 ~ Focus On Revenue

Singapore Banks - Maybank Kim Eng 2016-11-07: Post-3Q16 ~ Focus On Revenue DBS GROUP HOLDINGS LTD D05.SI

Singapore Banks - Post-3Q16 ~ Focus On Revenue

Driving topline growth 

  • Singapore banks are now driving topline growth to offset more provisions that need to be set aside in the face of worsening asset quality. 
  • Post- 3Q16, aside from asset quality deterioration, we saw: 
    1. banks gaining market share in domestic loans/finding new sources of loan growth; 
    2. falling customer spreads; and 
    3. higher non-interest income (non-II) and better cost management can cushion overall impact to earnings. 
  • We want to assess the drivers of topline growth for 3Q16.

1. 3Q16 results: Driving topline/better cost management to offset higher provisions 

  • Singapore banks are now driving topline growth, particularly non-interest income, and better cost management to compensate for higher provisions required in the face of worsening asset quality.
  • Aside from asset quality deterioration, 3Q16 results as a whole reflected: 
    1. gain market share in domestic loans or find new sources of growth; 
    2. lower customer spreads from lower SGD/regional rates and lack of repricing from credit spreads in a heightened risk environment; 
    3. higher non-interest income for DBS and OCBC; and 
    4. better cost management at DBS.
  • DBS’s and OCBC’s outperformance in non-interest income, rose 24% and 25% YoY, respectively, helped to offset flat and declining growth in net interest income and higher provisions. 
  • On the whole, large increases were in WM fees (DBS: 47% YoY, OCBC: 12% YoY) and net trading income (DBS: 18% YoY, UOB: 39% YoY). Higher life assurance profits from Great Eastern (GEH) partly resulted in a 48% YoY increase in other fees for OCBC, which was led by unrealised mark-to-market gains in GEH’s equity and bond investment portfolio. 
  • The other components that contributed to increases in OCBC’s other fees were dividend income (+112% YoY) and net gain from disposal of properties (+238% YoY). 
  • UOB’s non-interest income was down 5% YoY due to a gain from the sale of investment securities in 3Q15.
  • DBS’s significant 19% YoY increase in pre-provision profit (PPoP) was also partly due to its better cost management than peers, as expenses were down 5% YoY vs peers’ 1-6% increase. DBS attributed this to its digitalization efforts that resulted in productivity gains and strategic cost management. 
  • All three banks reported higher provisions YoY (DBS: >100%, OCBC: 11%, UOB: 16%) on the back of worsening asset quality deterioration especially in the O&G sector.

2. Finding lending opportunities 

2.1 Reduced trade loans meant growth elsewhere 

  • We highlighted in “Six Smoking Guns, 7 Sep 2016” that shrinking China’s trade loans from more attractive onshore borrowing rates would result in a retreat of capital back into Singapore or banks would have to find new sources of growth to fill the vacuum. This will affect DBS and OCBC more so than UOB as UOB has the smallest China exposure. For loans growth in constant currency terms for this quarter, UOB did the best at 7% vs DBS’s 5% and OCBC’s 0%. OCBC’s flat growth also underlies its more cautious stance in this landscape to enter new relationships with new clients.
  • Based on the loan composition by geography between 2014 vs 3Q16, loans in Singapore have now risen by 1-2% for DBS and OCBC. However, subdued economic prospects in Singapore are pushing banks to seek growth in other countries. For DBS and UOB, lending to “Others” by region rose from 8-9% in 2014 to 10-12% of total loans currently.
  • This quarter, the lending by DBS to “Others” in the region increased 32% YoY was broad-based across geographies/industries. Similarly, OCBC’s lending to the “Rest of the World” increased 7% YoY across broad-based industries. For UOB, loans in “Others” region increased 16% YoY mainly due to financial institutions (FI) lending in Australia, which also explained the 25% QoQ/4% YoY increase in FI loans.

2.2 Loan growth in Singapore 

  • Banks may have to either compromise on loan pricing or undertake higher risks to pursue loans growth. As of Sep 2016, system (DBU+ACU) loans contracted 5% YoY vs Jun’s contraction of 3.6%.
  • Despite the deceleration in system loans, Singapore banks have been lending out faster at 4-5% compared to the system. This reflected banks’ appetite to gain market share, as shown in housing loans where the main bulk is in Singapore. Housing loans grew by 6-10% YoY this quarter across the banks, higher than the 3% growth for the system.
  • DBS gained 2% market share in Singapore housing loans over the past 12 months to 28% now. During the quarter, banks offered promotional rates on housing loans. For example, DBS had a National Day promotional mortgage rate of only 1% in the first year (i.e. margin of 0.4% above current 18-month fixed deposit rate of 0.6%). Since 3Q15, DBS’s housing loans have increased between 10-12% YoY as compared to OCBC’s 3-6% and UOB’s 2-9%. We do not rule out the possibility that banks may undercut each other in the pricing for housing loans.

3. Fall in customer spreads 

  • Customer spreads fell across the banks to 2.01-2.13% in 3Q16 (2Q16: 2.10- 2.23%; 3Q15: 1.99-2.27%). We think lower spreads reflected the following: 
    1. lack repricing interval as rates are now lower; 
    2. lack signs of wider credit spreads/risk premium in a heightened risk environment; and/or 
    3. higher loan volume being driven at the expense of lower loan pricing.
  • UOB saw a steeper decline in customer spreads at -10bps QoQ/-14bps YoY vs DBS -7bps QoQ/+4bps YoY and OCBC’s -10bps QoQ/-3bps YoY. UOB’s average lending yields for customer loans fell 13bps QoQ and 6bps YoY, marking its sensitivity to repricing intervals (DBS: -9bps QoQ/ -2bps YoY, OCBC: -14bps QoQ/ -1bp YoY).
  • This also leads us to wonder if there is a lack of repricing in its lending yields for credit spreads, given that it is the largest SME bank among peers. In 3Q16, the gap between UOB’s customer spreads versus DBS’s and OCBC’s narrowed significantly to 10bps and 12bps, respectively (3Q15: 28bps and 23bps difference, respectively). We think this can be partly attributed to management’s intention to focus back to corporate lending in the wholesale banking or FI sectors, which resulted in lower-yielding margins. As of 1H16, wholesale banking loans grew by 5% YoY. UOB’s 3Q16 NIM rose 1bp QoQ to 1.69%, as the decline in lending yields was partially offset by higher loan volume.
  • Lending to larger corporates could be a strategy that UOB wants to undertake in an uncertain environment. We think this is an appropriate move by management. Unlike SME loans, the risks will be lower as larger corporates will have more cashflow and thus less likely to incur bad debts.
  • We now sense a more cautious tone as all banks cited challenges in their SME book, which could be more affected in a prolonged downturn. If banks are not willing to undertake more risks, we may see corporate loan pricing under pressure as they compete for market share. If there is no repricing interval and/or no repricing for credit spreads, NIMs are likely to head lower. For now, we expect stable NIMs for FY16-17E across the banks, at 1.67-1.78% on the assumption of higher rates.

4. Non-interest income to drive topline 

  • Fee and commission income and net trading income formed the bulk of non-interest income. Non-interest income as a percentage of total income is now 38-44% across the banks. In 3Q16, fee and commission income and net trading income formed ~19-24% and ~7-12% of total income across the banks, respectively.
  • In 3Q16, higher non-interest income for DBS and OCBC helped to cushion the overall adverse impact to net profits from flat or declining net interest income and higher provisions. Some of the larger increases can be seen in WM fees for DBS and OCBC, net trading income for DBS and UOB, and GEH’s profits from life assurance for OCBC.

4.1 WM fees 

  • DBS’s WM fees rose 12% QoQ/47% YoY from higher bancassurance contributions with Manulife, which started this year. Amortized quarterly contributions from this partnership work out to be SGD26.5m per quarter (or SGD106m per year). Stripping out the amortized quarterly contribution in 3Q16, WM fees grew by a commendable 27% YoY; we think some of the increases can be attributed to performance-related income from bancassurance. If we strip out the amortized quarterly contributions of ~SGD80m for 9M16, WM fees would be flat YoY.
  • For OCBC, outperformance in WM came from: 
    1. higher AuM from its private banking arm, Bank of Singapore (+20% YoY); and 
    2. higher margins from cross-selling of products. 
  • DBS and OCBC have been scaling up this business from acquisitions of foreign banks’ private banking businesses.
  • However, this business is not without risks, as private banks are now facing higher regulatory and compliance costs due to more stringent requirements and global crackdown on tax evasion from regulators.

4.2 Net trading income 

  • UOB’s net trading income this quarter (+39% YoY) reflects gains in treasury customer flows, which comprise 70-80% of its trading income. This is considered to be more recurring in nature as compared to proprietary trading. Proprietary trading formed the remaining 20%, reflecting its low risk appetite. 
  • On the other hand, OCBC’s net trading income, which was mainly related to treasury customer flows, fell 17% YoY.
  • DBS’s net trading income rose 18% YoY this quarter. Based on Figure 16, DBS has a much higher value-at-risk (VaR) of its trading book than peers, reflecting its bigger proprietary position. Its higher VaR has contributed to higher trading gains. Volatile market conditions can shrink returns from this component.

4.3 GEH’s contribution 

  • Higher profits from life assurance from GEH this quarter, led by unrealised mark-to-market gains in its equity and bond investment portfolio, partly contributed to OCBC’s 48% YoY increase in other fees. Volatile markets can swing this contribution. GEH’s profits from life assurance ranged between 3-10% of OCBC’s total income over the past four quarters.

5. UOB most preferred 

  • Fundamentally, we maintain our NEGATIVE sector view from further asset quality deterioration, especially in the O&G sector.
  • We value the banks at ~0.8-0.9x FY17E P/BV, to reflect our lower forecast ROEs compared to prior periods. We had revised our estimates, target prices and recommendation in our 3Q results notes. 
  • We upgraded DBS from SELL to HOLD as we believe its negatives are largely priced in. 
  • We prefer UOB (HOLD, TP SGD18.36) in this cycle as it is the least exposed to the beleaguered O&G sector and China.


Ng Li Hiang Maybank Kim Eng | http://www.maybank-ke.com.sg/ 2016-11-07
Maybank Kim Eng SGX Stock Analyst Report HOLD Maintain HOLD 14.55 Same 14.55
SELL Maintain SELL 7.40 Same 7.40
HOLD Maintain HOLD 18.36 Same 18.36