Singapore Banks (DBS vs OCBC vs UOB) - Maybank Kim Eng 2018-03-20: Clear Skies

Singapore Banks - Maybank Kim Eng 2018-03-20: Clear Skies Singapore Banking Stocks DBS vs OCBC vs UOB DBS GROUP HOLDINGS LTD D05.SI OVERSEA-CHINESE BANKING CORP O39.SI UNITED OVERSEAS BANK LTD U11.SI

Singapore Banks - Clear Skies

ROE recovery to sustain; Upgrade sector to POSITIVE 

  • Stronger loan growth, NIM improvement from higher rates, higher non-interest income and lower provisions are positives for Singapore banks.
  • Post 4Q17 results notes, we revisit our assumptions and turn more positive on OCBC and upgrade it to BUY. We changed our FY18-20E profit estimates for UOB and OCBC by +2-5%/+4-12% (OCBC and UOB attached to this report). 
  • We upgrade the sector to POSITIVE from NEUTRAL as we believe Singapore banks’ sustainable ROEs can recover to ~13-14%.
  • Our pecking order: UOB, OCBC and DBS 

1. Clear Skies: Riding on cyclical upturn 

  • We forecast ROEs to trend higher and earnings momentum to sustain into FY18-20E as banks stand to benefit in a cyclical upturn. 
    1. Maintain BUY on UOB with a higher Target Price of SGD31.08 (from SGD29.33). 
    2. We upgrade OCBC to BUY from HOLD with Target Price of SGD14.83 (from SGD13.50). 
    3. We retain HOLD for DBS (Target Price SGD29.66) as we think the positives have been priced in. 
  • We upgrade to POSITIVE for Singapore banks. Our assumptions are centered on the following: 
    1. Loan growth to remain robust: Lending opportunities and momentum could sustain into FY18-20E. We estimate the multiplier between Singapore banks’ overall loan growth and Singapore GDP growth is 2.7x on average since 2Q09, with OCBC and UOB to be more sensitive. We raised our loan growth assumptions for OCBC to ~10% and UOB to ~9-10% from ~9% and 9-9.5%, respectively.
    2. NIM upside from higher rates: With higher fed funds rate expectations with a 40-50% pass-through rate to 3M SIBOR and 3M SOR, banks stand to benefit in a rising interest rate environment. We retain our assumptions for 3M SIBOR to increase by 35bps/20bps/25bps respectively for FY18/19/20E.
    3. Higher non-interest income: Singapore banks’ wealth franchise could benefit as Asia Pacific will be one of the fastest-growing regions for wealth. In addition, we think OCBC could benefit from higher insurance earnings from its insurance arm Great Eastern (GEH) due to resilience in its operational performance with higher total weighted new sales (TWNS) and new business embedded value (NBEV).
    4. Cost: Banks’ cost-to-income ratios will improve from higher revenues. We expect DBS to be the key beneficiary here with cost efficiency gains to be reaped from its digitalisation efforts.
    5. Capital: UOB has the strongest CET1 capital position at 14.7%. As such, we see more upside to dividends. We further raise our DPS for UOB to SGD1.20-1.40/sh (from SGD1/sh) across FY18-20E. 
    6. No major asset quality deterioration: With sanguine economic prospects, improvement in corporate FCF and barring any significant deterioration in asset quality, we expect credit costs to remain benign at between 18-22bps across the banks for FY18-20E.

2. Where is loan growth coming from? 

  • In this section, we take a closer look to analyse where loan growth is coming from.
  • As Singapore is an open economy, we estimate the multiplier between Singapore banks’ overall loan growth and Singapore GDP growth is 2.7x on average since 2Q09. While it is not straightforward, we attempt to quantify the impact of a rebound in Singapore’s property market from housing and building and construction (B&C) loans from improved buying sentiment, enbloc deals and high land bidding prices.
  • Combing through the current key residential, mixed use and commercial land deals, our analysis show that the recovery in Singapore’s property market will increase housing and B&C loans by ~8% and ~4% respectively across the years until 2021E and 2022E. This implies ~2% y-o-y and ~1% y-o-y each year. Therefore, we do not expect banks to post very strong double digit loan growth over our forecast horizon.

Housing loans in Singapore 

  • With ~40-50% of Singapore banks’ loans extended to the housing, and B&C sectors, the recovery in Singapore’s property market will boost loan volumes. In this section, our analysis to ascertain housing loan growth is centred on:
    1. housing sales volume in FY18E; and
    2. key private residential projects and enbloc deals.
  • Our Singapore property analyst estimates FY18E private home sales (excluding executive condominiums (ECs)) to be 24k units (link). Including ECs, our base scenario assumes that the transaction volume would be 24.8k units. We estimate the net loan per private residential unit is about SGD700k on average since 2010. With sales of 24,800 units as our base case, we estimate ~SGD17b of lending opportunities, with loan repayments for the system estimated to be ~SGD9b. 
  • Over the past seven years, system housing loans grew by close to 2x from SGD115b in Dec 2010 to SGD205b now. While there will be repayment for the loans, we believe housing loan growth is likely to improve from current levels of 4%.

B&C loans in Singapore System 

  • B&C loan growth tapered off from double-digit growth since May 2016. Since then, B&C loan growth is ~3-4% on average. The Building and Construction Authority (BCA) expects SGD26-31b of construction demand for 2018 and SGD26-33b for 2019-2020. 60% of construction demand in 2018 will come from the public sector (2018: SGD19b vs 2017: SGD15.5b), which includes civil engineering projects such as the North-South Corridor.
  • Our property analyst expects the office supply pipeline in Singapore to come down for FY18-20E. Therefore, we think B&C loan growth from Singapore office space in the next few years is likely to be capped.
  • With B&C projects likely to come from the public sector over the next few years (such as the Thomson-East Coast Line, Deep Tunnel Sewerage System phase 2), we expect growth to at least maintain or improve from current levels of 4.2%.
  • For the three key upcoming large mixed use developments/commercial projects such as Central Boulevard and Beach Road, we estimate ~SGD6b of B&C loans will come through, which would help support ~1% of system B&C loan growth each year from FY18-22E.

Loan growth from which sectors and countries? 

  • There was broad-based growth in lending to different sectors for Singapore banks. Robust y-o-y increases were seen in almost every industry between 2016 and 2017 except for Transport and Others sectors. Lending to the FI sector rose the most for UOB and OCBC at 23-24% y-o-y due to more opportunistic growth for trade and investment flows.
  • Singapore banks’ loan growth mirrors Singapore’s and HK’s GDP growth more so than Malaysia and Indonesia’s. To analyse the relationship between loan growth and GDP growth, we estimate that the multiplier between Singapore banks’ overall loan growth and Singapore’s GDP growth was 2.7x on average based on historical quarterly data since 2Q09. 
  • Our Singapore economist estimates Singapore’s GDP growth to be 2.8% and 2.5% in FY18E and FY19E. This roughly implies that loan growth could be 8% and 7% respectively.
  • We estimate OCBC’s multiplier to be more sensitive at 2.9x on average, followed by UOB at 2.6x and DBS at 2.4x. OCBC also saw a higher multiplier in recent quarters, which we believe could be due to lending being extended to more Singapore-based corporates for trade and investment flows. 
  • Loan growth guidance from banks’ management was either 7-8% or a high single digit. As Singapore banks will benefit from broad-based economic recovery, we think there is further upside from here for lending opportunities. With OCBC and UOB being more sensitive in their multipliers, we raised our loan growth estimates slightly to ~10% for OCBC and ~9-10% for UOB across FY18-20E.

3. NIM upside from higher rates 

  • MKE’s Singapore economist expects 3M SIBOR to be 1.55% in FY18E and 1.75% in FY19E. In-line with our economist expectations, we have already factored in an increase in 3M SIBOR of 35bps/20bps/25bps respectively for FY18/19/20E into our forecasts.
  • Based on our linear regression analysis using historical quarterly data from 1Q00-3Q17, we estimate that the 3M SIBOR and 3M SOR will increase by 44bps and 48bps respectively for every 100bps increase in Fed funds rate. This implies a pass-through effect of 40-50%.
  • The slope of the yield curve (rate differential between 2-year Singapore Government Securities (SGS) and 3M SIBOR) has also been rising since 4Q16. Given the rebound in economic recovery and as our economist also sees higher inflation in 2018 for Singapore, we believe there is some scope for yield curve steepening, providing avenue for widening NIMs.
  • Comparing between 2016 and 2017, Singapore banks’ customer lending yields have been compressed for UOB and OCBC, which saw a 6bps and 12bps decline respectively, while DBS saw an increase of 6bps. 
  • Cost of funds for customer deposits have largely remained flat y-o-y for UOB and OCBC but rose 8bps for DBS. Between 2014 and 2017, CASA mix improved across the banks by 3-4ppt -- DBS from 57% to 62%, OCBC from 45% to 49% and UOB from 42% to 45%. Singapore banks have been paring down their proportion of fixed deposits.
  • Comparing the correlation coefficient on the q-o-q changes in 3M SIBOR and 2-year SGS to changes in asset and liability yields, Singapore banks are more correlated to changes in short rates than changes in long rates.
  • OCBC’s and UOB’s liabilities are more sensitive than assets, implying that their cost of funds may react faster than lending yields in a rising rate environment. This could be attributed partly to their higher mix of fixed deposits, which usually bears a higher cost than CASA. Fixed deposits form 51%/42% of total deposits for UOB/OCBC vs 37% for DBS in FY17.

4. Non-interest income 

  • Our base case assumes healthy earnings momentum from non-interest income into FY18-20E, mainly from higher fee and commission income, higher net trading income and higher insurance income (for OCBC).
  • For OCBC, its insurance arm Great Eastern Holdings (GEH) (GE SP, Not Rated) showed resilient underlying business momentum. New business embedded value (NBEV) and total weighted new sales (TWNS) rose +17% y-o-y and +23% y-o-y respectively in 2017, reflecting robust underlying operational business of its insurance franchise. In Singapore, TWNS grew 36% y-o-y. TWNS from agency and bancassurance channels for Singapore and Malaysia in FY17 also rose by 21% y-o-y and 26% y-o-y respectively (FY16: 17% and 11% respectively).
  • GEH is a dominant player in both Singapore and Malaysia, thus it is a key beneficiary of the under-penetrated insurance sector over the long term, as Singapore and Malaysia’s life penetrations levels are still low at 5.5% and 3.2%. Singapore and Malaysia contributed ~80% and ~20% of PBT in FY17. We turn more positive on GEH’s long-term growth story and factored in a 3-year CAGR of ~22% on GEH’s life profits for OCBC, as we think our previous estimates are too conservative. 
  • With Asia Pacific to be one of the fastest-growing regions for wealth management (WM), we see Singapore banks as key beneficiaries to increase their share and bolster earnings in WM.
  • Banks’ AUM have grown decently at a 7-year CAGR (between 2010-2017) of 12-22%, with the largest increase coming from OCBC followed by DBS, as these two banks are more aggressive for inorganic growth. Based on Asian Private Banker, Singapore banks were the top 20 largest private banks by AUM (ex-China onshore) in 2016. The risk-on environment in FY17 also partly contributed to the increase in AUM, as AUM grew 12-24% y-o-y across the banks.
  • We turn more positive on OCBC’s wealth franchise as we expect sustainable robust growth from:
    1. its cross-selling abilities across its wealth platform with WM income formed 34% of total income in FY17;
    2. tapping onshore private banking in Indonesia (through OCBC NISP private banking unit; AUM of conventional mutual funds in total rose 31% y-o-y to reach IDR3.4t); and
    3. sustainable increase in AUM for Bank of Singapore.
  • We raised OCBC’s WM fees by 8-16% across FY18-20E. UOB, albeit being seen as the least aggressive in the WM space, posted solid growth in AUM (+12% y-o-y) in FY17. Although UOB has been growing organically, its AUM has been growing decently at a 7-year CAGR of 12%.
  • We think the growth should sustain as it continues to expand its WM platform. We are positive it has the capacity to steadily increase its WM fees, and raise WM fees by 6-12%.
  • Against a positive macro backdrop, we expect Singapore banks’ WM fees to grow by double digits over FY18-20E, with a 3-year CAGR of 24-29% respectively.

5. Costs 

  • Singapore banks’ 7-year CAGR (from 2010-2017) for expenses was between 4-9%, with OCBC the highest and DBS the lowest. Staff costs saw 7-year CAGR of 8-10% across the banks, partly due to consolidation of the acquisitions they did in the past few years.
  • To compete against disruptors from FinTech/e-commerce competitors, we believe IT-related expenses will continue to rise and banks are more likely to invest more in technology. Potential disruption in the payments space can have wider negative implications (Cashing In On Cashless Payments?).
  • We retain our overall cost estimates and expect it to increase by a 3-year CAGR (between 2017-2020) of 4%/7%/6% for DBS/UOB/OCBC. We expect DBS to be the key beneficiary from cost efficiency gains to be reaped due to its digitalisation efforts, as digital customers can be acquired at lower unit costs and lower cost-to-serve through digital channels. UOB will continue to invest the most in IT as it builds its regional franchise.
  • With higher revenues, we expect Singapore banks to have lower cost-toincome ratios at 41%/39%/37% on average for FY18E/19E/20E respectively, with UOB to have the highest cost—to-income ratio among peers.

6. Capital 

  • Singapore banks have strong capital positions. UOB is now the best capitalised among Singapore banks, with fully-loaded CET1 ratio at 14.7%, followed by DBS at 13.9% and OCBC at 13.1%. These levels are now above management’s comfort level of ~12.5-13%.
  • CET1 ratios rose in FY17 due to:
    1. higher capital from higher retained earnings;
    2. reduction in RWAs for UOB (-7.5% y-o-y) and OCBC (-2.4% y-o-y).
  • The reduction in both UOB’s and OCBC’s RWAs are attributed to a decline in both credit RWAs (OCBC: -0.6% y-o-y, UOB: -1.6% y-o-y) and market RWAs (OCBC: -20.1% y-o-y, UOB: -59.3% y-o-y).
  • RWAs are likely to trend higher from higher loan growth. Banks will continue to:
    1. optimise RWA efficiency; and
    2. find growth segments to pay for higher RWAs. 
  • OCBC performs best in its balance sheet efficiency, with returns on risk-weighted assets (RoRWA) at ~2.1% vs peers’ ~1.4-1.7%.
  • We think there will be dividend upside from UOB given its strong CET1 position and consistent RoRWA improvements in the past year. We further raised our DPS for UOB to SGD1.20-1.40/sh (from SGD1/sh) across FY18- 20E.

7. No significant asset quality deterioration 

  • In view of IFRS9 rule, UOB and OCBC also took the opportunity to use their surplus GPs to clean up their loan book and accelerate their NPL recognition for their O&G exposures. This is similar to what DBS did in 3Q17. 
  • Since the oil rout, Singapore banks have been paring down their exposure to the O&G support services sector, reflecting their reduced appetite. We think tail risks from O&G exposure should be largely over and specific provisions have peaked. With asset quality concerns on O&G exposure out of the way, coupled with sanguine economic outlook and improvement in corporates’ FCF, we think provisions will come down into FY18E. 
  • Our base case assumes no significant asset quality deterioration in a benign credit environment, with rate hikes to be on a gradual path of steepening. We estimate credit costs to normalise to 18-22bps on average for Singapore banks into FY18-20E. For every 10bps increase in credit cost, we estimate that FY18-20E net profits will be reduced by 4-6% across the banks, ceteris paribus.
  • Provisions under IFRS 9 rule are considered to be pro-cyclical and will result in earnings volatility. It could come in lower/higher than provisions under the current accounting treatment in a cyclical upturn/downturn. Our current forecasts have not factored in IFRS 9. It is possible for credit costs to come in higher/lower than our current expectations.

8. Upgrade sector to POSITIVE; OCBC to BUY 

  • We are POSITIVE on Singapore banks. We now value the banks at ~1.4-1.6x FY18E P/BV (from ~1.3-1.6x previously), to reflect higher forecast ROEs going forward. We revised our estimates and Target Prices for the OCBC and UOB in this note, and retain our estimates and Target Price for DBS. See 
  • We upgrade OCBC to BUY with new Target Price of SGD14.83. We value OCBC at 1.5x, 1SD above its historical mean of 1.3x. We believe the premium can be sustained as we expect 2.8ppt of ROE improvement in FY20E from current levels. We think OCBC’s valuation multiple deserves to go up in view of its ability to expand ROEs from non-II growth.
  • We value DBS at 1.6x, close to 1.5SD above its historical mean of 1.2x. We believe a higher multiple for DBS is warranted as we see double-digit income growth and cost efficiency gains vis-à-vis peers. However, we think the positives have been priced in for now. DBS' share price has been the best performing over the past 12 months. Maintain HOLD at Target Price SGD29.66 and await a lower entry level.
  • We value UOB at 1.4x FY18E P/B, close to 0.5SD above its historical mean of 1.3x. We value UOB on a lower P/BV multiple as it has lower forecast ROEs. That said, we prefer UOB (BUY, Target Price SGD31.08) as we like its disciplined pricing strategy and its sensitivity to re-pricing intervals. Maintain BUY.

Ng Li Hiang Maybank Kim Eng | 2018-03-20
Maybank Kim Eng SGX Stock Analyst Report HOLD Maintain HOLD 29.660 Same 29.660
BUY Upgrade HOLD 14.830 Up 13.50
BUY Maintain BUY 31.080 Up 29.33