Banking – Singapore - UOB Kay Hian 2018-06-08: Risk On The Upside For Domestic Interest Rates

Banking – Singapore - UOB Kay Hian 2018-06-08: Risk On The Upside For Domestic Interest Rates Singapore Banking Stocks SIBOR DBS GROUP HOLDINGS LTD SGX:D05 OVERSEA-CHINESE BANKING CORP SGX:O39 UNITED OVERSEAS BANK LTD SGX:U11

Banking – Singapore - Risk On The Upside For Domestic Interest Rates

  • The correction in the bond market and the resultant higher yields for government bonds and corporate bonds would have a positive impact on pricing for corporate loans.
  • Recent strength in the US dollar, if sustained, should also be a booster for SOR and SIBOR. We believe the risk for domestic interest rates is on the upside.
  • Maintain OVERWEIGHT. BUY DBS and OCBC.



WHAT’S NEW


  • We believe the risk for domestic interest rates is on the upside:

Sovereign debts not spared.

  • The recent rise in government bond yields around the world is a US-centric phenomenon, which we attribute to the following factors:
    1. The record issuance of US treasury bills and government bonds to finance the enlarged budget deficit post-Trump inspired cut in corporate tax rate from 35% to 21%.
    2. Concerns that trade conflicts would reduce China’s trade surplus with the US, thus reducing demand for US treasury bills and government bonds from China.
    3. Future hikes in US interest rates would increase the burden for the US to service its national debt.
    As a result, yield for 10-year US government bond spiked by 58bp ytd to 2.99%.

Corporate bonds suffered as well.

  • The turmoil for US government bonds was transmitted to the corporate bond market. Based on Bloomberg Barclays Total Return Index, yields for investment grade and high-yield US corporate bonds increased 77bp and 63bp ytd to 4.02% and 6.35% respectively.

Contagion spilled over to Southeast Asia.

  • Singapore was not left unscathed. Yield for 10-year Singapore government bond jumped 58bp ytd to 2.58%. Yield for the Bloomberg Barclays Singapore Total Return Index, encompassing both government bonds and corporate bonds, increased 47bp ytd to 2.45%. 
  • Higher yields for corporate bonds would have a positive impact on pricing for corporate loans.

Strength of US dollar correlated with higher SOR.

  • While the Fed Chairman Jerome Powell maintained that he sees “no evidence that the US economy is overheating”, there are quarters within the Fed concerned that the labour market is tight and wage inflation could pick up, necessitating a faster pace of hikes for the Fed funds rate going forward. There are widespread expectations of rapid and successive hikes in US interest rates, driving strength in the US dollar.
  • We have witnessed a concurrent sell-down of regional currencies across emerging markets since mid-April, similar in direction but smaller in magnitude compared to the taper tantrum in 2013. In Singapore, strength of the US dollar is usually a booster for higher swap offer rate (SOR), which has a positive knock-on impact on Singapore interbank offer rate (SIBOR). 
  • The strengthening US dollar caused steep rise in both the SOR and SIBOR during 2H14 and 2015. Recent strength in the US dollar, if sustained, should also be a booster for the SOR and SIBOR.


ACTION


Maintain OVERWEIGHT.

  • We believe the risk for domestic interest rates is on the upside. Higher yields for corporate bonds provide support for high loan yields. The recent strength in US dollar against the Singapore dollar, if continued, also augurs well for higher SOR and SIBOR. 
  • UOB Global Economics & Markets Research expects 3-month SIBOR and 3-month SOR to reach 1.85% and 1.65% by end-18 respectively.

DBS Group (Rating: BUY/ Target Price: S$35.50)

  • Management is confident of achieving ROE of 12.5% for 2018. ROE could reach as high as 13% if specific provisions fall below guidance of 20-25bp.
  • DBS is the prime beneficiary of higher interest rates due to its high S$-CASA ratio of 90.2% (savings accounts: 73.2%, current accounts: 17%). Its deposit franchise in Hong Kong has improved with HK$ current accounts expanding 26% y-o-y.
  • DBS provides attractive dividend yield of 4.2%, based on DPS of S$1.20 for 2018.

OCBC Bank (Rating: BUY/ Target Price: S$16.50)

  • We expect OCBC to recognise divestment gains of S$608m from the divestment of its 30% stake in Great Eastern Life (Malaysia) through IPO/trade sale in 4Q18 (total proceeds: S$760m). The divestment of a 33.3% stake in Hong Kong Life Insurance for HK$2,366.7m (S$425.9m) is waiting regulatory clearance and should be completed by end-18.
  • OCBC plans to implement internal ratings-based approach (IRBA) to compute risk- weighted assets for OCBC Wing Hang in 2019.
  • OCBC will evaluate reinstating its scrip dividend scheme as a tool for capital management, which could support a higher dividend payout ratio.


SECTOR CATALYSTS

  • Rising interest rates and bond yields.
  • Moderation of credit costs.


ASSUMPTION CHANGES

  • We maintain our earnings forecasts.


RISKS

  • Rapid increase in the federal funds target rate (steep rate hikes) that may trigger capital countries in Southeast Asia.







Jonathan Koh CFA UOB Kay Hian | https://research.uobkayhian.com/ 2018-06-08
SGX Stock Analyst Report BUY Maintain BUY 35.500 Same 35.500
BUY Maintain BUY 16.500 Same 16.500
NOT RATED Maintain NOT RATED 99998.000 Same 99998.000



Advertisement



MOST TALKED ABOUT STOCKS / REITS OF THE WEEK



loading.......



ANALYSTS SAY


loading.......