Singapore Banks - DBS Research 2018-04-27: The Quarter All Have Been Waiting For

Singapore Banks - DBS Vickers 2018-04-27: The Quarter All Have Been Waiting For Singapore Banks OVERSEA-CHINESE BANKING CORP O39.SI DBS GROUP HOLDINGS LTD D05.SI UNITED OVERSEAS BANK LTD U11.SI

Singapore Banks - The Quarter All Have Been Waiting For

  • Positive trends expected for NIM, loan growth and lower credit cost; typical seasonally strong quarter for wealth management; insurance is a wildcard
  • Sustained SIBOR/SOR rates will ensure NIM remains on an uptrend; lower credit cost back to pre-oil & gas crisis days is the trend going forward
  • BUY ratings maintained on OCBC and UOB; Target Prices raised on higher NIM; entering a new era of higher ROEs
  • Singapore banks releasing 1Q18 results starting from end April (DBS: 30 Apr, UOB: 3 May, OCBC: 7 May (GEH: 4 May))

The long awaited strong quarter.

  • Net interest margin (NIM) and credit cost will be the focus this quarter. The sustained SIBOR uplift since 4Q17 should be well reflected in 1Q18’s NIM. With the woes from oil & gas non-performing loans (NPL) largely taken care off, banks should be booking significantly lower provisions y-o-y. 
  • Loan growth is expected to hover around 2% q-o-q while fee income should be seasonally stronger supported by wealth management. OCBC may experience some volatility in its insurance contribution because of the new accounting standard. 
  • All in, this is the long awaited strong set of quarterly results we have been waiting for. After going through several years of NIM compression and two years of NPL woes, the Singapore banks are ready to shine.
  • Valuations are heading to +1SD of mean.

MAS’ stance seals interest rate upcycle; room for SOR/SIBOR to accelerate further.

  • The Monetary Authority of Singapore (MAS) had on 13 April slightly increased the slope of the nominal effective exchange rate policy (SGD NEER) band to an appreciation pace. 
  • Our strategists do not expect a follow through with another tightening at the next review in Oct 2018. In this respect, expectations of a sustained upward trend for SOR/SIBOR should persist, which is positive for the banks. Taking this stance into consideration, we have lifted our NIM projections for FY18-19F by an additional 2-3bps resulting in earnings upgrades of c.4%. This is the basis to our higher Target Prices.

BUYs maintained; Target Prices raised; heading to the next level.

  • We have BUYs on both OCBC and UOB with UOB as our preferred pick for
    1. lower credit costs vs historical levels providing better earnings uplift, and
    2. certainty of at least S$1.00 full year dividend.
  • Our Target Price for UOB is raised to S$33.20. 
  • We continue to hope for higher dividends for OCBC. We have raised our Target Price for OCBC to S$15.30. 
  • Sustainable deliveries could push banks’ valuations closer to +1SD of the 10-year mean.

Key risks.

  • While all the stars appear aligned for the Singapore banks, there are a couple of risk factors. If SIBOR/SOR starts to decline, the NIM story will be out of the window (some degree of probability); slower than expected loan growth (small probability), and another upset in asset quality (low probability) could derail earnings upside.

Reiterating Our 2018 View; Trends Expected In 1Q18

A recovery year with greater conviction.

  • In our 2018 Singapore Bank outlook report released on 23 Nov 2017 - Singapore Banks - A Year Of Greater Conviction, we highlighted three key trends to watch in 2018:
    1. SIBOR rally will kick-start; NIM momentum should pick up,
    2. pick up in loan growth, further supplementing top-line growth, and
    3. NPL issues largely over, resulting in significantly lower credit costs.
  • In 1Q18, we expect all these three trends to be visible.

NIM uplift story intact, should be clearly visible in 1Q18.

  • With rate hikes almost a certainty in the coming quarters, the 3M SIBOR/SOR have broken out of their trading range, reaching their highest levels so far; currently at 1.5%. With a greater pass-through expected from the USD rates to SIBOR/SOR, the Singapore banks are almost surely to deliver higher NIM. 
  • The expected sustained rise in SIBOR should see the Singapore banks' NIM on a firmer rise in 2018.

Singapore Banks: NIM forecasts; on an uptrend

Better than expected NIM uptrend; earnings raised.

  • With the MAS’s stance on the SGD NEER announced on 13 April and expectations that the SGD would appreciate at a slower pace vs the USD, there will still be room for SOR/SIBOR to continue to rise. Our interest rate strategist expects SOR/SIBOR to surpass 2% by the end of the year. 
  • With greater certainty of this trend, taking into account some elements of competition and rise in funding costs outside Singapore operations, we have further raised our NIM forecast by 2-3bps on average. We now expect OCBC to see NIM improve by 8bps (from 6bps) to 1.73% (FY17: 1.65%) and UOB to see NIM improve by 9bps (from 6bps) to 1.86% (FY17: 1.77%). 
  • Our sensitivity analysis shows that every 25 bps rise in interest rates that reprices the S$, HK$ and US$ books collectively will lift NIM by an average of 3bps (UOB: +1bp; OCBC: +3bps) with a corresponding 2% increase (UOB: +1%; OCBC: +2%) in sector earnings.

First time in years, net interest income driven by both NIM and loan growth.

  • The Singapore banks suffered from NIM compression during 2010-15, followed by several years of slow loan growth in 2015-16 with the slowest growth of 0% y-o-y in 2015. In 2017, loan growth picked up with a slight improvement in NIM. 
  • In 2018, both NIM and loan growth will drive net interest income.

Sustained loan growth trends.

  • Loan growth surprised on the upside in 2017 with banks generally guiding for 7-8% loan growth. The momentum is expected to continue in 2018, still driven by property-related (mainly domestic) as well as domestic and regional corporate loans. 
  • Sensitivity of loan growth to earnings is marginal (every 1 ppt increase in loan growth leads to only less than 1% impact on earnings). It would be more important to watch the impact of NIM on earnings.

Lower credit costs in 2018, a certainty.

  • With NPL woes addressed in 2017, the banks should have a clean start in 2018 and credit costs should ease. We expect credit cost to drop by 12bps to 23bps (2017: 35bps). Based on our estimates, the through-the-cycle credit cost (2003-2016) stands at 35bps. 
  • With the implementation of IFRS9/SFAS109, banks are no longer allowed to buffer up general provisions. The SFAS109 requires banks to maintain a minimum of 1% collective impairment allowance and specific allowance to be set aside on a case-by- case basis (regulatory loss absorption reserves). The Expected Credit Loss (ECL) model includes more forward-looking information to assess credit quality of the bank’s underlying financial assets. 
  • With the current health operating environment and benign NPLs (now that the oil & gas issues have been sorted out), credit costs should reflect the pre-oil & gas crisis levels. The IFRS9/SFAS109 accounting rule will be tested in a crisis scenario.

Seasonally strong fee income in 1Q18.

  • 1Qs are typically strong for wealth management and market related activities. We expect fee income to be strong for the banks. OCBC may be an exception because of a change in accounting rules related to its insurance income contribution. 
  • While we expect Great Eastern Holdings (GEH) to post strong 1Q18 figures, its non-operational profit (from its non-par fund profit) could be stripped out and placed under other comprehensive income, under a new accounting rule (IFRS4 for insurance companies; which is equivalent to IFRS9 for banks).

Expenses would also be seasonally higher in 1Q.

  • It is also typical that personnel costs are loaded in 1Q but the impact should not be too far away from the full year guidance. Cost-to-income ratio would benefit from higher revenues.

Capital – the last round of deduction for Basel III.

  • We have reached the final year before the transitional period to fully loaded CET1. Banks have been well prepared for this. Over the past few years, the banks have been optimising capital utilisation and recalibrated their respective risk weighted assets. With clarity on the treatment of risk weighted assets for the Basel rules, banks started to raise dividends in 4Q17.
  • Only OCBC did not raise dividends significantly, although we believe there is room to do so.

Valuation & Recommendation

Back in the bull market zone.

  • The last time we saw banks valuations at such levels was 10 years ago. In 2007, SIBOR hit a high of 3.5% while NIM averaged 2.1%. Loan growth was at double digits driven by the Integrated Resorts (IR) loans.
  • Although NIM levels are lower now vs 10 years ago, we are nevertheless in a NIM uptrend era. With loan growth recovering, topline growth is a clear driver. Fee income has also changed structurally vs 10 years ago, with banks now relying more on wealth management income for growth. 
  • Expenses are well controlled and efficiency has improved, potentially bringing cost-to-income ratios to new lows. More importantly, credit costs are gradually shifting back to the pre-oil & gas NPL period. 
  • All these would seal expectations of strong 28% earnings growth for the banks in 2018 with ROEs heading to 11-12%. This clearly justifies higher valuations for the banks vs 5 years ago.

Trading slightly above10-year historical mean.

  • The Singapore banks had a fantastic rally in 2017, starting from the first rate hike at end-2016. The banks have collectively appreciated by > 30% over 2017, one of the best sector performances for the year. Sustained momentum of NIM, loan growth and lower credit costs with contained NPLs should lift valuations to at least to mean P/BV multiples. 
  • For a further re-rating, we would need to see stronger and sustainable revenue drivers and a clear path for asset quality improvement.

Second best performer among ASEAN peers.

  • Singapore banks emerged the second best performer vs its ASEAN peers, just after Malaysian banks. 
  • In our view, the rally for Singapore banks stems from improved expectations of better years ahead especially with the rate hike story intact and asset quality issues a thing of the past.

Prefer UOB.

  • The stars are all aligned for UOB, hence our shift in preference to UOB now from OCBC. 
  • UOB’s key catalysts are clearly entrenched in its NIM and loan growth, but more importantly, lower credit cost after years of hoarding a 32 bps credit cost level be it rain or shine. UOB has also raised its dividends and S$1.00 full year DPS is expected to be sustainable. 
  • While we expect OCBC to do well in 1Q18, it might see some volatility in its insurance income arising from the new accounting standard and it is still awaiting a higher dividend proposal. Elsewhere, we continue to wait for its decision on its insurance operations in Malaysia, where it is expected to lower its stake to 70% from 100%.

Key Risks

Relapse of oil & gas woes.

  • While the banks have articulated that the oil & gas NPL issues are largely behind them, risks of these companies running out of cash flow as their funding instruments (bonds) mature remain a risk. We understand that most of these have been restructured or are undergoing restructuring, which means these accounts would have been classified as NPLs. The remnants of these may still trickle into some NPL formation in 2018.

NIM and loan growth fail to deliver.

  • We have been positive on NIM uplift and new loan growth. A disappointment in macro indicators could temper the better loan growth expectations. 
  • Although loan growth is less sensitive to earnings, sentiment of loan deceleration could dent top-line prospects. A slower-than-expected pass-through of Fed rate hikes to SIBOR/SOR could also derail the NIM uptrend.
  • Competition in loan rates could be an added dent to NIM.

Sue Lin LIM DBS Vickers | Rui Wen LIM DBS Vickers | http://www.dbsvickers.com/ 2018-04-27
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