DBS GROUP HOLDINGS LTD (SGX:D05)
OVERSEA-CHINESE BANKING CORP (SGX:O39)
UNITED OVERSEAS BANK LTD (SGX:U11)
Banks - FD Wars Not Over Yet
- Clear trends of benign asset quality (with higher credit costs), slower regional growth and strong capitalisation are expected to persist into FY19F.
- Sustained NIM uplift will depend on each bank ’s ability to push up asset yields in view of an inevitable rise in funding costs, particularly from FDs.
- Maintain OVERWEIGHT on the sector, with OCBC as our top pick. Sector valuations are attractive at 1.13x FY19F P/BV (ROE: 12%).
Inevitable rise in funding costs ahead
Fundamental trends seen in FY18 to endure into FY19F
- We expect fundamental trends seen in 2018 to endure well into 2019F – continued NIM expansion, credit quality remaining benign albeit with higher impairment charges, a more moderate pace of loan growth as US-China trade talks continue, expense growth from staff remuneration/overhead costs and regional expansion to be largely offset by digitalisation cost savings, and fee income growth to be sustained by stronger wealth management flows.
- On balance, the US Federal funds rate has been raised nine times (+200bp) since December 2015 and is poised to rise further up to an estimated neutral rate, which in a healthy economy neither boosts nor restrains investment and spending. As the Monetary Authority of Singapore (MAS) uses exchange rates as its main monetary policy tool, interest rates in the city state are largely guided by those of the US and expectations of future movements of the Singapore dollar. The Fed’s dovish outlook on interest rate policy forms the base of our house view of three hikes in 2019F and, consequently, a 6-9bp NIM increase in 2019F.
Singapore banks’ NIMs yet to capture full benefits of rising rates
- While it seems intuitive to expect Singapore banks’ NIMs to broaden in step with the Fed funds rate, margin expansion has been capped by
- a lagged pass-through from 3M US$ LIBOR to 3M SIBOR and consequently the time taken to re-price loan books,
- the proportion of each bank’s loan book of fixed vs. floating rates and varying degrees of transmission of the US policy rate into regional interest rates, and
- the bank’s ability to contain funding costs.
- The increase in NIM among the three local banks has so far been relatively muted as compared to the rise in 3M SIBOR – expanding only 2-12bp since December 2015 as compared to the latter, which rose 58bp in the same period. In our view, margin expansion in the coming quarters will depend on banks’ ability to reprice assets above the impending rise in deposit costs.
- All three local banks have similar characteristics in terms of their funding composition, with customer deposits comprising the lion’s share (about 86-88%) of interest-bearing liabilities, thus allowing for a natural funding cost shield of sorts as these deposits are by far cheaper than wholesale funding. In contrast, customer deposits made up just over 60% of foreign banks’ total funding in Singapore, although we note that this smaller proportion is complemented by intragroup funding from their overseas head offices.
- We view customer deposits as a more stable form of funding (compared to intragroup and wholesale market funding) as cross-border liquidity support is dependent on the ability and willingness of a foreign bank’s head office to provide it to their branches in Singapore and may be subject to regulatory approval in certain circumstances. In this respect, we think that there is merit in foreign banks organically building up their share of customer deposits in the domestic market – that is, by way of offering attractive fixed deposit rates - as they lack the branch network required to garner meaningful CASA deposits. We highlight that not all CASA deposits are low-cost as some banks in Singapore offer higher rates for savings accounts in their bid for cheaper funding.
- The impending escalation of interbank borrowing costs, in this case being 3M SIBOR, which rose to an average of 1.75% in November 2018 (average in December 2017: 1.24%), is an additional factor in spurring FD rate competition. Despite local banks’ significantly larger branch and CASA networks than foreign banks, we understand that the former have had to offer more attractive rates to defend market share. Customer deposits cost Singapore banks an average of 0.86-1.4% in 9M18 whereas other funding sources (borrowings and debt issuances) were significantly more expensive at 1.82-2.47%.
FD rate competition to continue as interbank borrowing costs rise
- While unresolved trade tensions and spillover uncertainties have set the tone for slower regional growth in 2019F, banks have nonetheless started shoring up their liquidity buffers in view of escalating funding costs. MAS data showed that industry DBU (mainly S$) FDs had in fact returned to a growth pace after contracting for over a year; in August 2018, FD growth came in at 4.4% y-o-y while that of CASA deposits slowed to 0.9% y-o-y.
- The spike in industry FD growth came hand in hand with very attractive promotional rates across the board, with the exception of DBS GROUP HOLDINGS LTD (SGX:D05). Among the domestic systemically important banks (DSIBs), promotional rates for a minimum placement of S$20,000 for a 12-month tenure reached as high as 1.88% p.a. – this comes against the average board rate of 0.1-0.95% p.a. Although only offering standard board rates, DBS also increased its rates for longer-tenure FDs in December 2018 by 5-18bp p.a. in a bid to secure its stronghold of customer deposits. While most of these campaigns are slated to expire by end-January, we expect the stiff deposit-taking competition to persist with refreshed campaigns or a broad-based increase in board rates as interbank lending rates continue to rise.
- Notably, the spread between customer loan yields and deposit costs has not widened significantly even as 3M SIBOR and SOR flourished. DBS has been the only local bank to deliver consistent improvement in customer loan spreads over the past year while those of OVERSEA-CHINESE BANKING CORP (SGX:O39) and UNITED OVERSEAS BANK LTD (SGX:U11) faltered. We believe NIMs have yet to capture the full benefits of higher interest rates as funding costs have risen about 48-53bp, which is about as much as asset yields have increased (46-50bp) since December 2015, as banks focused on maintaining healthy buffers in preparation for tighter liquidity conditions ahead.
- Apart from nimbly repricing its assets, DBS’s funding costs were well-contained by virtue of its significant pool of CASA deposits. OCBC’s timing in shoring up liquidity ahead of its peers (since 2H17) resulted in higher deposit costs and stagnant NIMs over the past year. That said, the release of excess (and expensive) funding relieved OCBC of some deposit cost pressures, contributing to its NIM uplift in 3Q18. In contrast, UOB’s margins have dipped q-o-q since 1Q18 despite recording stronger loan yields earlier in the year; the bank’s 43% CASA ratio is the lowest among the three local banks.
- Separately, the MAS’s requirement for banks to maintain minimum net stable funding ratios (NSFRs) may also spur a rise in funding costs, although this remains a secondary concern at present. Locally-headquartered DSIBs, such as DBS, OCBC and UOB, are required to maintain 100% ratios while others, such as HSBC, Standard Chartered Bank, Citibank and Maybank, are imposed 50% requirements. Broadly, banks may increase their NSFRs using longer-tenured funding instruments, such as medium-term notes and fixed deposits.
- While all DSIBs have met the MAS’s NSFR regulation, those of the local banks are noticeably lower than the average 122% across DSIBs (excluding Maybank Singapore) and are just above their required 100%. In our view, the spillover effects of losing market share of customer deposits, albeit marginally, due to aggressive FD competition from foreign banks and the need to maintain a buffer above the 100% NSFR requirement are likely to result in higher funding costs for DBS, OCBC and UOB, especially in a normalising interest rate environment.
Valuation & Recommendation
Maintain Overweight with OCBC as our top pick
- With macroeconomic growth potentially slanting towards a positive bias given the Fed’s recently tempered view on further rate hikes, we maintain our Overweight stance on Singapore banks. With the sector trading below its long-term mean of 1.2x P/BV with a forward ROE close to its 15-year peak of 12%, we think that its valuation is attractive. Our top picks for the sector are OCBC, UOB and DBS, in that order.
- OCBC is our preferred pick in the banking sector; we have an ADD call on the stock. As it has the second-largest proportion of CASA deposits among the local banks, we think that OCBC is also well-positioned to record good NIM expansion as most of its repricing efforts have only started coming into effect in the past quarter. Our target price of S$14.00 is based on GGM valuation (LTG: 3%, ROE 11.8%). At 1.1x FY19F P/BV, below its 10-year historical average of 1.4x, its valuation appears undemanding, in our view.
Andrea CHOONG
CGS-CIMB Research
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LIM Siew Khee
CGS-CIMB Research
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https://research.itradecimb.com/
2019-01-02
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