Singapore Banks - DBS Research 2018-12-04: At The Crossroads


Singapore Banks - At The Crossroads

  • Three trends to watch in 2019:
    1. NIM expansion as key earnings driver;
    2. credit costs normalising;
    3. loan growth moderating from high base.
  • Higher dividend payout ratio and dividend yield to support share prices.
  • Singapore banks trading near 1S.D. below 10-year average P/BV multiple.
  • BUY ratings for both UOB and OCBC; prefer UOB.

Trends to watch in 2019

Singapore banks’ share prices have corrected > 20% from the peak, now trading near 1S.D. below 10-year average P/BV multiple.

  • Singapore banks’ share prices rallied earlier in the year on the back of NIM expansion expectations, strong loan growth, and benign credit environment. Since then, share prices have corrected > 20% from their peak in May 2018 on US-China trade war concerns, fears of China slowdown, and to a lesser extent, Singapore property cooling measures.

Will 2019 be a better year?

  • We believe the sustainability of
    1. NIM expansion and
    2. asset quality
    hold the key to Singapore banks’ valuations.
  • Singapore banks are now trading near 1S.D. below their 10-year average P/BV multiple. We believe sustained NIM expansion and continuing benign credit environment should drive Singapore banks’ valuations towards 10-year average P/BV multiples, on the back of expectations of above historical average earnings growth in FY19-20F.
  • Attractive dividend yields should also lend support to share prices, with UOB offering close to 5% and OCBC with c.4%.

Continues to deliver resilient earnings.

  • We believe that Singapore banks will continue to deliver resilient earnings, having come from a high base as FY2018F is a record year with c.27% y-o-y earnings growth expected (excluding exceptional items in FY2017). We expect Singapore banks to deliver earnings growth of c. 8% in FY2019.
  • While growth in non-interest income may moderate as a result of weaker market-related income, stronger net interest income and low credit costs should continue to support earnings.

Prefer UOB for its strong dividend yield.

  • Although we have BUY ratings on both UOB and OCBC, we prefer UOB for the following reasons:
    1. higher dividend yield versus OCBC,
    2. strong capital position; building up its liquidity buffers as it continues to grow loan book and NIM,
    3. defensive pick as it has a smaller exposure to China among the local banks and a more defensive wealth management franchise.
  • Our BUY rating on OCBC is premised on
    1. ongoing NIM expansion on full impact of loan repricing,
    2. stronger capital position post scrip dividend issue (now in line with peers),
    3. higher dividends could be a share price catalyst.

(1) SIBOR rally continues, NIM expansion story should remain intact

Higher pass-through seen in 2018; more room for SIBOR/SOR to head higher.

  • We finally saw the impact of higher Fed Fund rates in 2018 translating to higher LIBOR and SIBOR/SOR with a stronger pass-through as USD continues to strengthen against SGD. As 3MLIBOR rises to factor in a December rate hike (and to a lesser extent, tighter funding conditions towards the end of the year), some pass-through can be seen in SGD rates.
  • We continue to see 3MSIBOR/SOR having .....

Effect of ongoing loans repricing to be seen in following quarters…

  • Meanwhile, we believe that ongoing loans repricing should continue to support increases in loan yields as floating rate loans are repriced on a higher benchmark rate, while fixed rate loans that reach maturity are also repriced based on higher benchmark rates.
  • Recall that it takes up to 90 days for a full re-pricing to take place, hence we expect the effect of ongoing repricing to be seen in the next few quarters as benchmark rates continue to tick up.

… and increase in loan yields should outpace the rise in cost of funds, translating to higher NIM.

  • We believe that the NIM expansion story is still intact, even though in 2018, NIM quarterly trends across the banks have diverged from quarter to quarter (recall that OCBC’s NIM was flat for three quarters since 4Q17 before spiking in 3Q18 as OCBC repriced its mortgage loans later than the other banks, also in part due to excess USD liquidity); UOB on the other hand saw steady NIM expansion through 2017 and 1Q18, and slight decline in NIM in the last two quarters as it built up liquidity buffers in anticipation of increased competition in the deposits space towards year-end, and loan pipeline.
  • While SGD fixed deposit (which contributes meaningfully to OCBC and UOB’s funding strategy) rates have also been on the rise since the start of the year, we believe that putting aside quarter-on-quarter movements, directionally, the increase in loan yields should outpace the rise in cost of funds.
  • We believe that NIM is on an uptrend in 2019 and expect c.6-7bps improvement y-o-y in 2019 at the minimum (2018F: c.8bps improvement y-o-y). Our sensitivity analysis indicates that every 25-bp rise in interest rates that reprices the S$, HK$ and US$ books collectively would lift average NIM by 3bps with a corresponding 2% increase in sector earnings.

(2) Credit cost remains low amid benign credit environment

New NPL formation largely stable, credit environment remains benign.

  • New NPL formation as well as NPL ratio among the banks were largely stable throughout 2018 as the credit environment remains benign. The banks have performed various stress tests using trade war scenarios, as well as their Greater China exposure and are keeping their eyes on the potentially vulnerable names.

Keep watch on SME loan book.

  • In 3Q18, OCBC highlighted that while NPLs on new non-mortgages are largely scattered and not concentrated in any particular industry, and attributable to a few small manufacturing companies and a palm oil-related company, going forward, there may be concerns of a general slowdown in the economy depending on developments in the US-China trade tensions.
  • UOB is also closely monitoring accounts that show some vulnerability, and assessing the need to make provisions for some of these accounts. We continue to keep a watch on SME loan books. However, we note that SME loans are generally well secured and expect any NPLs to be contained.

Credit costs likely to trend towards more normalised levels.

  • Credit costs were at a record low in 2018 with the implementation of IFRS9/SFRS109 alongside stable NPL formation. We continue to see a largely benign credit environment in 2019, though we believe that credit costs should still inch higher y-o-y towards more normalised levels in the coming year.
  • UOB and OCBC are guiding for credit costs of 20-25bps and 12-15bps for FY2019F (3Q18 - UOB: 18bps; OCBC: 8bps) respectively, still below historical through-the-cycle levels of c.32bps and c.18bps. We forecast credit costs to come in at the lower end of the guidance range at 12bps and 20bps respectively for OCBC and UOB in FY2019F.

NPL coverage ratio remains healthy, though below historical levels.

  • With the implementation of IFRS9/SFRS109, NPL coverage ratio of Singapore banks is now at c.80-90%. In our view, though the NPL coverage ratio is below historical levels of typically ≥100%, it remains healthy compared to regional peers.

3) Loan growth to moderate from high base

Singapore banks benefitted from broad-based loan growth.

  • Both UOB and OCBC saw YTD loan growth of c.8% in 3Q18 (c.10% annualised), supported by both domestic and ex-Singapore loans. Loan growth was broad-based, including building and construction loans, loans to financial institutions, investment and holding companies amongst others.
  • UOB benefitted from strong growth in loans to manufacturing, while OCBC saw strong growth in general commerce, transportation, storage and communications loans.

Growth to moderate in 2019.

  • We believe that loan growth will continue to be supported by drawdowns from property development projects and regional corporate loans, but moderating to c.6-7% for the Singapore banks in 2019 for the following reasons:
    1. decline in new home sales post implementation of property cooling measures, and
    2. potential impact on business sentiment arising from US-China trade war.
  • In the longer term, we continue to see Singapore banks as potential beneficiaries from trade diversion into the Southeast Asian region. Sensitivity of loan growth to earnings is marginal (every 1-ppt increase in loan growth leads to only less than 1% impact on earnings).

4) Market conditions may affect some portion of non-interest income; overall growth trend for non-interest income intact.

Softer wealth management income, trading income.

  • We are starting to see how market condition has affected parts of non-interest income across the banks, such as mark-to-market losses in UOB due to accounting asymmetry in its hedges.
  • Generally, wealth-related income momentum was also softer. However, the overall growth trend is intact for non-interest income, especially for wealth management which remains a growth area for the Singapore banks. (See section on Growing wealth management income below).

5) Capital and dividends.

Strong capital position.

  • In 3Q18, all Singapore banks recorded CET1 ratios of above 13.0%, with UOB having the highest ratio at 14.1%, which is above its comfortable range of 12.5% to 13.5%.
  • While OCBC’s CET1 ratio has been lower than its peers, since OCBC commenced scrip dividends in 2Q18, its CET1 ratio improved to 13.6% in 3Q18, above management’s comfortable range, which is similar to UOB’s.

Upside to dividends.

  • During FY2018, UOB committed to a new dividend payout ratio of c.50% (of net profit), subject to minimum CET1 ratio of 13.5% and sustainable business performance. UOB would be paying more dividends in 2H18 than 1H18 where it paid < 50% of net profit. For OCBC, its dividend payout ratio has been c. 37% and with management reaffirming their commitment to a steady, predictable quantum of 40-50% dividend payout ratio, we believe that there may be potential for higher dividends now that OCBC has shored up its capital. At 40% dividend payout ratio, this translates to c.44 Scts (FY2017: 37 Scts). We believe Singapore banks’ strong dividend yield of c.4-5% provides strong support to their share prices.

Growing wealth management income

Wealth management continues to be a growth driver.

  • In the last eight years, wealth management has grown from a small fraction to nearly one-third of total fee and commission income for both DBS and OCBC. The banks’ existing consumer customer franchise network, relationships with SME business owners, growth of wealth in the region continue to drive organic growth in wealth management income, post the wave of acquisitions by DBS and OCBC.

Wealth management remains a strong growth engine for OCBC in the long run.

  • For OCBC, wealth management remains a strong growth engine in the long run, especially since its acquisition of Barclays’ wealth and investment management arm in Asia. In 3Q18, OCBC’s private banking AUM at US$105m represented an increase of 3% q-o-q and 11% y-o-y as mark-to-market valuations were lower.
  • Bank of Singapore continued to see net new money inflows as it builds up its capabilities.

Great Eastern Holdings a key differentiator for OCBC.

  • In particular, OCBC’s subsidiary, Great Eastern Holdings (SGX:G07), is a key differentiator for OCBC as it has a longstanding track record in offering a complete range of wealth-related and insurance products both in Singapore and Malaysia. OCBC’s increasing stake in Great Eastern Holdings over the years demonstrates the importance of an insurance subsidiary to the group’s wealth business.
  • Previously, Great Eastern Holdings was exploring ways to divest a 30% stake in Great Eastern Malaysia (GELM) in reaction to Bank Negara Malaysia’s (BNM) stricter enforcement of the 70% foreign ownership cap on insurers. With the change of government, we understand that OCBC is still in discussions with the Malaysian authorities that will enable GELM to satisfy foreign ownership requirements of insurance companies in Malaysia, including making a certain contribution to a special insurance development trust fund.
  • In our view, other viable options for these companies to pare down their stakes are:
    1. list (IPO) 30% of their shares to the public;
    2. joint-venture with a local partner; or
    3. divest to local institutional investors.
  • We believe retaining 100% ownership of GELM is beneficial for OCBC in terms of earnings contribution.

Regional agenda remains imperative

Diversifying geographically.

  • Singapore banks have been pursuing their regional agenda in their own ways, especially in the last decade, and will continue to do so as they seek to diversify revenue streams geographically as Singapore’s landscape remains competitive.
  • Both UOB and OCBC’s second largest source of profits are from Malaysia, where both banks have strong and longstanding track records, competing closely with the Malaysian banks.
  • Both UOB and OCBC have also been building up their presence in Indonesia in the last few years. Although still a small contribution, we believe, over time, this will drive ROEs.

UOB continues to step up its ASEAN presence.

  • UOB is the only Singapore bank with a substantial earnings contribution from Thailand, and continues to expand its ASEAN geographical footprint by incorporating a fully-owned subsidiary in Vietnam in Aug 2018. Collectively, Malaysia, Thailand and Indonesia make up c.19% of its profit before tax (in 9M18).
  • In the longer term, we believe UOB is well-positioned to capture flows into Southeast Asia as the bank is able to offer ecosystem support for companies looking to invest in Southeast Asia. There may also be opportunities in North Thailand arising from China’s Belt and Road Initiative.

OCBC targeting Greater Bay Area.

  • OCBC has set its target to expand in the Greater Bay Area (GBA), which comprises Hong Kong, Macau and cities in the Guangdong province. OCBC is currently the fourth largest foreign bank by network size and continues to invest in the GBA franchise, with two-thirds of S$200m to be invested in technology expenditure.
  • OCBC expects to obtain at least S$1bn in pre-tax profit from GBA, doubling the contribution in 2017.

Building presence through digital initiatives.

  • The Singapore banks have been building up their presence in Indonesia, which we believe could drive ROEs over time.
  • OCBC NISP has started cross-referring SME owners to OCBC’s private banking services, while continuing to embark on a mobile-first strategy and various partnerships to grow its market share in Indonesia (For more details, please refer to our previous report: OCBC Bank: Digital quest to grow Indonesia market share).
  • In the meantime, UOB also continues to add talent headcount into Indonesia. We are also expecting UOB to announce the launch of its Digital Bank, starting with one of the ASEAN countries, by early 2019 as it seeks to target potential underserved customers outside of Singapore. More recently, UOB has also entered into a strategic alliance with Grab regionally (For more details, please refer to our previous report: UOB: Grab-bing a regional alliance).

Updates on other overseas investments.

  • OCBC’s sale of its 33.33% stake in Hong Kong Life Insurance was aborted at end-Sep 2018. The original plan was for OCBC WHB to enter into a distribution agreement to distribute Hong Kong Life’s insurance products in Hong Kong. OCBC has re-started discussions on potential options as it remains keen to divest this stake.
  • On the other hand, UOB owns approx. 12% of Evergrowing Bank in China, which is still getting clearance for its financials, and has future IPO plans. UOB had previously mentioned in its 2Q18 results briefing that it does not expect this investment to have a significant impact on its books as it had already taken a significant discount to Evergrowing’s net tangible assets when valuing the investment on its books.

Company Report:

Sue Lin LIM DBS Group Research | https://www.dbsvickers.com/ 2018-12-04
SGX Stock Analyst Report BUY MAINTAIN BUY 13.200 SAME 13.200