Banking – Singapore - UOB Kay Hian 2019-01-08: A Dovish Twist, Limiting Upside For US Interest Rates

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DBS GROUP HOLDINGS LTD (SGX:D05) OVERSEA-CHINESE BANKING CORP (SGX:O39) UNITED OVERSEAS BANK LTD (SGX:U11)

Banking – Singapore - A Dovish Twist, Limiting Upside For US Interest Rates

• NIM expansion should moderate because the pace of rate hikes will be more gradual in 2019. However, banks have transformed into yield plays, which perform better when upward pressures on interest rates have eased.
• Our study on mean reversion indicates that the re-rating for DBS due to its management bench strength and benefits from rising interest rates are in the advanced stages.
• Maintain BUY on DBS and OCBC, but we prefer OCBC. Maintain OVERWEIGHT.

WHAT’S NEW

Jerome Powell: Prepare for headwinds in 2019.

• Chairman Jerome Powell highlighted potential headwinds buffeting the US economy in 2019 during the Q&A session at the Global Perspectives Speaker Series organised by Dallas Fed on 14 Nov 18. These headwinds are:
  1. Slowdown in growth overseas;
  2. Fading impact from fiscal stimulus, such as cuts to corporate income tax rate and increased fiscal spending; and
  3. Lagged effect from previous nine hikes in Fed funds rate since late-15.
• Chairman Powell re-iterated that the Fed’s goal is to extend the economic recovery while keeping unemployment and inflation low. He said that the Fed will have to rethink how much further interest rates should be raised and the pace of raising interest rates.

Our take on FOMC meeting on 19 Dec 18 – Dovish bias.

• Many investors were disappointed when the Fed raised interest rate by another 25bp after the FOMC meeting in December. Nevertheless, we assess the underlying tone remains dovish. Chairman Powell observed that some crosscurrents have emerged since 4Q18. While the domestic economy in the US remains strong, overseas growth is slowing. Fed board members have lowered the median projection for GDP growth in 2019 from 2.5% to 2.3%. They added in their policy statement that the Fed will monitor global economic and financial developments to assess their implications for the US’ economic outlook.
• The median projection for Fed funds rate was revised downwards by 0.2ppt to 2.9%, which implies two rate hikes instead of three for 2019. The Fed can afford to be more patient with rate hikes, ie pace of rate hikes to be more gradual, if Personal Consumption Expenditures (PCE) inflation stays below 2%. We expect the Fed funds rate to be raised by 25bp twice during the FOMC meetings in May and September.

ACTION

Pace of rate hikes to be more gradual.

• Implications of Fed’s dovish disposition:

Ready to act if required.

• Chairman Powell has signalled readiness for accommodation in the event that moderation in US GDP growth is more severe than expected, ie return of “Greenspan put”. The Fed stressed that it will monitor global economic and financial developments to assess their impact on the US’ economic outlook.

Singapore banks evolved into yield plays.

• We expect DBS, OCBC and UOB to provide attractive 2019 dividend yields of 5.1%, 4.2% and 5.1% respectively.

Attractive dividend yields provide valuation support.

• Downside for share price is limited at 15% should dividend yield rise from 5% to 6%.

Mean reversion.

• Going forward, OCBC could benefit from mean reversion in an environment where interest rates rise at a more gradual pace.

Maintain OVERWEIGHT.

• We maintain our BUY recommendations for DBS and OCBC. However, we have switched our preference from DBS to OCBC.

DBS (Rating: BUY / Target Price: S$28.50).

• DBS GROUP HOLDINGS LTD (SGX:D05) is beneficiary of rising interest rates in Singapore and Hong Kong. It has a high S$- CASA ratio of 90.2% (savings accounts: 74.5%, current accounts: 15.7%). It has strengthened its deposit franchise in Hong Kong with HK$-CASA ratio improving 20ppt to 56% over the past five years.
• DBS provides attractive dividend yield of 5.1% based on DPS of S$1.20 for 2019F.

OCBC (Rating: BUY / Target Price: S$13.82).

• OVERSEA-CHINESE BANKING CORP (SGX:O39)’s CET-1 CAR improved 0.4ppt q-o-q to 13.7% in 3Q18, at the higher end of the target range of 12.5-13.5%. It plans to implement an internal ratings-based approach (IRBA) to compute risk-weighted assets for OCBC Wing Hang in 2019/20, which would further improve CET-1 CAR by another 0.6ppt.
• We expect OCBC to increase dividend payout ratio towards mid-40%, bringing 2019F DPS to S$0.48, which provides a dividend yield of 4.2%.

SECTOR CATALYSTS

• Attractive dividend yield. OCBC has more room to raise dividend payout ratio.

ASSUMPTION CHANGES

• We have marginally trimmed earnings forecasts for DBS and OCBC.

RISKS

• Breakdown in trade negotiations between the US and China.

Jonathan Koh CFA UOB Kay Hian Research | https://research.uobkayhian.com/ 2019-01-08

SGX Stock Analyst Report BUY MAINTAIN BUY 28.50 DOWN 29.500

BUY MAINTAIN BUY 13.82 DOWN 14.050

NOT RATED MAINTAIN NOT RATED 99998.000 SAME 99998.000