Banking – Singapore - UOB Kay Hian 2019-01-18: Relief Rally Explained

Banking – Singapore - UOB Kay Hian Research | SGinvestors.io DBS GROUP HOLDINGS LTD (SGX:D05) OVERSEA-CHINESE BANKING CORP (SGX:O39) UNITED OVERSEAS BANK LTD (SGX:U11)

Banking – Singapore - Relief Rally Explained

  • Financial markets have wrongly interpreted that the Fed was insensitive to the risk of slowdown in growth. The Fed’s reassurance on its dovish disposition has generated a relief rally.
  • The US government shutdown has also postponed future rate hikes. However, banks have transformed into yield plays. Their attractive dividend yields limit potential downside.
  • We maintain BUY for both DBS and OCBC, although we prefer OCBC. Maintain OVERWEIGHT.



WHAT’S NEW


Fed’s dovish twist occurred in mid-Nov 18.

  • 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.
    3. Lagged effect from the nine previous 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 would have to rethink how much further interest rates should be raised and the pace of raising interest rates.

Why did financial markets freak out in December?

  • We believe financial markets had wrongly interpreted that the Fed remains hawkish and was insensitive to the risk of slowdown in growth. There was a massive risk-off flight to safety in government bonds across all maturities in 4Q18, when yields for 2-year to 10-year government bonds compressed by 33-44bp, possibly triggered by concerns over escalation in trade conflict.
  • Investors were further spooked after the Fed raised Fed funds rate by another 25bp after the FOMC meeting in December.

The short-end of the US yield curve became inverted.

  • Yield spread between 2-year and 1-year government bonds has turned negative. This spread bottomed at -13bp on the first trading day of the year (2 Jan 19) but has receded to -3bp.

The Fed continues to reassure markets on its dovish disposition.

  • Nerves have calmed as the Fed has repeatedly pressed home its dovish message:
    1. During the press conference in December, Chairman Powell mentioned that the Fed could afford to be patient on rate hikes if PCE inflation stays below 2%.
    2. The US economy has registered strong expansion in non-farm payroll of 312,000 for the month of December. Chairman Powell re-iterated that the Fed could be patient as it monitors how the economy evolves on 4 Jan 19.
    3. Fed minutes released on 9 Jan 19 indicate that some FOMC members favour keeping Fed funds rate unchanged during the December meeting. Some FOMC members also advocated a slower pace of rate hikes in 2019 due to risks to global growth.
    4. Other FOMC members, such as St Louis Fed President James Bullard and Dallas Fed President Robert Kaplan, have also stepped forward to put forth their dovish case.

Government shutdown further postpones future rate hikes.

  • Today is the 28th day of the US government shutdown. Financial markets are confronted with the prospects of a protracted shutdown due to animosity between President Trump and Democrats-controlled House of Representatives. Both sides have staunchly defended their positions and look unlikely to reconcile.
  • The shutdown affects 800,000 federal workers and thousands of government contractors. A lengthy shutdown could damage consumer sentiment and retail sales, moderating growth in the real economy. The White House’s Council of Economic Advisors estimated that the shutdown reduces quarterly GDP growth by 0.13ppt for every week that it lasts.
  • Some economists expect the US economy to contract in 1Q19 if the shutdown continues till end-March. Thus, the Fed could be reluctant to hike interest rates as long as the shutdown persists.


ACTION


Anticipate headwinds.

  • The stock market could resume its choppy flight path after the relief rally. A successful trade deal between the US and China (outcome should be known by end-February) could extend the relief rally. However, geopolitical headwinds could return thereafter.

Singapore banks have evolved into yield plays.

  • The finalisation of Basel III reforms in Dec 17 has paved the way for banks to hike their dividend payout ratios. DBS and UOB have done so in 2018. We foresee OCBC catching up to hike dividend payout to 45% in 2019 (2017: 37.7%) as its CET-1 CAR has risen to 13.7%.
  • We expect DBS, OCBC and UOB to provide attractive 2019 dividend yields of 4.8%, 4.1% and 4.8% respectively.

Attractive dividend yields provide valuation support.

  • We highlight that the downside for share price is limited at 15% should dividend yield rise from 5% to 6%.

Maintain OVERWEIGHT.

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


DBS (BUY/Target: 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$-CASA ratio of 90.2% (savings accounts: 74.5%, current accounts: 15.7%). It has strengthened deposit franchise in Hong Kong with HK$-CASA ratio improving 20ppt to 56% over the past five years.
  • DBS provides attractive dividend yield of 4.8% based on DPS of S$1.20 for 2019F.


OCBC (BUY/Target: 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 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 4.1%.


SECTOR CATALYSTS

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


ASSUMPTION CHANGES

  • We kept our earnings forecast unchanged.


RISKS

  • Breakdown in trade negotiations between the US and China.





Jonathan Koh CFA UOB Kay Hian Research | https://research.uobkayhian.com/ 2019-01-18
SGX Stock Analyst Report BUY MAINTAIN BUY 28.500 SAME 28.500
BUY MAINTAIN BUY 13.820 SAME 13.820
NOT RATED MAINTAIN NOT RATED 99998.000 SAME 99998.000



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