Banks - CGS-CIMB Research 2019-03-08: Leaning On Stronger Capital

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

Banks - Leaning On Stronger Capital

• We think the implications of a pause in US rate hikes have been priced into bank valuations. Absence of asset quality pressure should prevent de-rating.
• 2019F could see weaker loan growth momentum in ASEAN markets due to slowing China growth. Resolution of US-China trade conflict is a key catalyst.
• DBS GROUP HOLDINGS LTD (SGX:D05) is our preferred pick for the sector due to its demonstrated execution in raising asset yields, strong CASA funding base, and visibility on dividends.
• Maintain Overweight. The sector trades below mean at 1.2x CY19F P/BV. Stronger CET-1 of c.14% underlines sustained dividend yields in 2019F.

Easing into 2019 - A patient pause, then a Fed rate cut?

• We believe the capital markets have priced in some degree of “patience” into their expectations of further Fed rate hikes in 2019. Poised to be more data-driven, the Fed is waiting on US unemployment and inflation figures to signal the need for further monetary tightening or otherwise. Disappointing US retail sales and industrial production data support the views of several Fed policymakers for one rate hike in 2019, or none at all. We stretch these indicators to consider the effects of a Fed rate cut on the margins of Singapore banks, although this could play out over a longer term horizon.
• In so far as the 9 Fed rate hikes (+225bp) over the past 3 years, Singapore banks' NIMs have risen only 3-8bp. Taking a closer look, most of the rate hike impact took place in 2018 as the time-lag effect of US$ rates on S$ rates passed through while banks managed a gradual repricing of their fixed rate loan portfolios to maintain market share. In part, the funding structure of domestic banks, having a sizeable current account, savings account (CASA) funding base (averaging 44-62% of total customer deposits across the banks), helped in the margin expansion.
• Compared to previous steep cuts in the Fed funds rate of 400bp over a 12-month period during the GFC, we opine that a rate cut may not translate into immediate margin compression as the banks ride on longer-dated loans while reining in funding costs, which typically react more quickly to a change in interbank rates. Instead of margins, negative sentiments from the rate cut could instead weigh more heavily on valuations.

Read-through from 2018 trends

Lower 2019 loan growth guidance

• Growth in regional markets slowed in 2H18 following a resilient 1H18. All three banks guided for more moderate expansion in 2019, with DBS GROUP HOLDINGS LTD (SGX:D05) and UNITED OVERSEAS BANK LTD (UOB, SGX:U11) setting mid single-digit loan growth expectations and OVERSEA-CHINESE BANKING CORP (OCBC, SGX:O39) guiding for a more conservative low-to-mid single-digit growth.
• The environment of rising interest rates, slowing growth in China, and US-China trade tensions have had a part to play in the general outflow of capital from emerging economies and the weaker macroeconomic outlook – the effects of which could be seen in weaker corporate investment demand from 2H18. Accordingly, we have toned down our loan growth assumptions to a more conservative 4-5% across the banks in 2019F, from the 7-11% seen in 2018.
• In 2018, loans extended to Greater China had weakened significantly in 2H18. We understand that banks’ appetite for trade loans in 2H18 was likely curbed by unattractive pricing. Better rates at the end of 4Q18 could see growth from this segment reflected in 1Q19F figures. Dampened mortgage demand is likely to be a recurring feature in 2019F’s playbook. DBS ended 2018 with less than S$2bn of net new mortgages – the bank had forecasted S$4bn at the start of the year, before the property cooling measures were introduced in Jul 2018. While we expect drawdowns from prior bookings will support housing loan growth in 1H19F, expansion from this segment in the later part of the year could be challenged by the reduced pipeline from a 30-40% reduction in bookings.

Lagged repricing effects to flow through into 2019F NIMs

• DBS’s 10bp y-o-y NIM increase in 2018 was underpinned by its robust funding base, 59% of which comprised low-cost CASA. NIM expansion at OCBC and UOB was smaller at 5bp y-o-y. In tandem with the rise of interbank rates (in step with the multiple Fed rate hikes), the banks' funding costs increased in steadfast fashion, thereby keeping a lid on margin expansion. Fixed deposit rates have increased to c.2% in Feb 2019, from c.1.5% a year ago.
• For 2019, banks have generally guided for a continued uptrend, albeit at a slower pace compared to yesteryears. The continued expansion is likely to come from the sustained rise of 3M SIBOR and the ongoing repricing of mortgage board rates towards those of SIBOR-pegged loans. Average 3M SIBOR rose to 1.9% in 2M19 from 1.73% in 4Q18.
• The contributions of regional operations towards bottomline NIM expansion have been a mixed bag in 2018. DBS and OCBC – the two banks with more significant HK operations – benefitted from the steep rise in HIBOR over the year, although the recent downtrend raises some questions over continued margin upside. Margin performance at UOB’s regional operations have not been stellar, with the bank leveraging on higher loan-to-deposit ratios (LDRs) to support NIM growth.

Asset quality to remain stable, albeit with rising credit costs

• It will come as no surprise if credit costs rise across Singapore banks in 2019 as the banks cruised on muted provisions over the past year following the adoption of IFRS9/SFRS109 in Jan 2018. Credit costs in 2018 came up to 12-21bp vs. the 29-60bp recorded in 2017. The banks have guided for normalising provisions towards their respective run rates of 20-25bp for DBS and UOB, and 12-15bp for OCBC.
• Asset quality is still deemed stable, although we observe rising NPL accretion over consequent quarters in 2018 for both OCBC and UOB. Recall that this comes on the back of a portfolio review and accelerated recognition of vulnerable oil and gas (O&G) exposures. New NPLs recorded have so far been attributed to idiosyncratic corporate exposures, mainly in the banks’ regional books, and some flow-through (and reversals) from mortgages.
• In Jan 2019, the liquidation of Coastal Oil Singapore, a Hong Kong-based company all three banks have exposure to, gave rise to questions of a second round of O&G-related deterioration. We understand that there could have been fraud involved in the presentation of Coastal Oil’s cashflows to the banks, resulting in the liquidation being unforeseen by the latter. Full credit costs on the exposure (net of collateral) have been provided for in 4Q18 – the impact of which was heaviest on OCBC. OCBC’s exposure to the Coastal Oil was the largest among peers at US$123m, followed by DBS (US$30m) and UOB (US$20m). Further concerns on the sector have not been highlighted; the banks continue to keep a watch on the asset quality of SMEs.
• See attached PDF report Figure4 for forecasts of Singapore banks' key metrics summary.

Details from 4Q18 performance

DBS GROUP HOLDINGS LTD (SGX:D05)  DBS (SGX:D05) Share Price  DBS (SGX:D05) Target Price  DBS (SGX:D05) Analyst Reports  DBS (SGX:D05) Corporate Actions  DBS (SGX:D05) Announcements  DBS (SGX:D05) Latest News  DBS (SGX:D05) Blog Articles

• DBS was the largest beneficiary of the Fed rate hikes in 2018, with a 10bp y-o-y NIM expansion. The bank’s robust CASA funding base (59% of deposit base) and demonstrated ability to reprice assets underlined its 1bp q-o-q margin expansion in 4Q18. The NIM of DBS’s HK operations increased a strong 27bp y-o-y, although NIMs stagnated in 4Q18 due to the dip of 1M HIBOR to c.1% and ample liquidity conditions.
• DBS’s expectations of a 4-5bp NIM increase in 2019 (without rate hikes) incorporate the stabilisation of HK rates. Management remains positive on a catch-up in fixed mortgage rates towards SIBOR-pegged loans in 2019.
• Weak market-related income was the key drag on its earnings in 4Q18 – treasury customer income dipped to S$257m, the lowest in two years. While the macroeconomic landscape remain challenging, mitigating factors to this include the fact that the shift of corporates out of China due to its trade tensions with the US have not materialised – a positive development to DBS given its larger Greater China exposure. DBS does not have exposure to the many Chinese bond defaults. Corporate loan pipeline is likely to be slower in 2019F, but government-led stimulus could support economic growth (e.g. Changi Terminal 5).
• DBS’s vigorous digitalisation strategy encompasses cost reduction as one of its main goals – from the current 44% cost-to-income (CTI) ratio to 40%. That said, we think that costs are likely to be maintained at current levels in FY19F as the bank expands its footprint in India.

OVERSEA-CHINESE BANKING CORP (SGX:O39)  OCBC Bank (SGX:O39) Share Price  OCBC Bank (SGX:O39) Target Price  OCBC Bank (SGX:O39) Analyst Reports  OCBC Bank (SGX:O39) Corporate Actions  OCBC Bank (SGX:O39) Announcements  OCBC Bank (SGX:O39) Latest News  OCBC Bank (SGX:O39) Blog Articles

• Weaker wealth management income and mark-to-market (MTM) losses from Great Eastern resulted in OCBC recording the largest total income contraction in 4Q18 (-8% q-o-q) amongst Singapore banks. Its quarterly wealth management and trading incomes were the lowest in two years. Income from its insurance segment remained volatile, but we think its trading income could rebound for the better in 1Q19F on improved market performance. Loan growth was a tepid 0.5% q-o-q, during which NIM stayed flat at 1.72% in 4Q18. Recall that OCBC had started shoring up on its funding base in 2H17 in anticipation of higher funding costs. Despite releasing some of that liquidity in 3Q18, the build-up of more expensive fixed deposits (FDs) resulted in OCBC experiencing a larger rise in deposit costs (+35bp y-o-y) vs. DBS (+29bp y-o-y) and UOB (+28bp y-o-y).
• Credit costs escalated to 32bp in 4Q18 due to provisions for Coastal Oil Singapore and exposure to the O&G support sector in Malaysia. Additional impairments were taken as the bank revised cashflow expectations on its O&G portfolio. There provisions were attributable to seven accounts (belonging to five groups) where increased charter rates did not materialise; collateral for these exposures have been marked down to 30% of current market values.
• Dividend payout came up to 43% for FY18 – a level lower than the c.50% declared by peers. This comes against its higher CET-1 ratio of 14% in 4Q18 and scrip dividend scheme for 2H18 DPS which allows for a larger payout capacity. While its dividend policy for FY19 remains in the works, the bank has
• guided that it will retain capital for “defensive” and “offensive” purposes – the former so as to maintain a buffer against harsher operating conditions and the latter for opportunistic prospects, although the bank is not looking at any at the moment.

UNITED OVERSEAS BANK LTD (SGX:U11)  UOB (SGX:U11) Share Price  UOB (SGX:U11) Target Price  UOB (SGX:U11) Analyst Reports  UOB (SGX:U11) Corporate Actions  UOB (SGX:U11) Announcements  UOB (SGX:U11) Latest News  UOB (SGX:U11) Blog Articles

• As with peers, UOB was hit by weaker wealth management and trading fees as a result of the volatile capital markets in 4Q18. That said, part of the impact was cushioned by the structure of its wealth management franchise – broadly comprising its high net worth (HNW) SME clients – which generates more stable recurring fees as opposed to income driven by client trading activity, as seen in its peers.
• The 1bp q-o-q NIM contraction in 4Q18 was disappointing given that it delivered the strongest (+2.7% q-o-q) loan growth amongst peers. We think most of these loans were extended to the corporate segment, yielding very thin margins. Notably, the NIM expansion in FY18 have largely been supported by the bank’s Singapore operations, where a further rise in asset yields hinges on continued mortgage repricing in FY19F. UOB’s regional operations in Malaysia, Thailand, Indonesia and Greater China recorded y-o-y NIM compression. Full-year credit costs of 16bp were within expectations. The bank guides for some NPL accretion in FY19; we think the increase should be manageable.
• The renewal of UOB’s bancassurance agreement with Prudential extends their original alliance through to 2034. The renewed agreement will see UOB receiving S$1.15bn in fees (amortised over the 15-year period), providing a boost of S$76.7m per year to its non-II. The agreement also adds Vietnam as a new market for the distribution of Prudential’s products through UOB.
• The bank’s 50% dividend payout ratio came through a final 50Scts and 20Scts special DPS for 2H18. UOB’s strong 13.9% CET-1 capital ratio provides support for FY19F dividends to be maintained at current absolute levels, although the bank guides for excess capital to be retained for regional business expansion, such as in Indonesia and Vietnam.

Valuation and Recommendation

Maintain Overweight on the sector

• We maintain our Overweight call on Singapore banks. We believe the current sector valuations of 1.18x 2019F P/BV (ROE: 11.9%) have priced in expectations of more modest NIM expansion in 2019F as the Fed takes a patient pause on rate hikes. In our view, the still-benign credit environment provides some support for valuations to be sustained above 1.1x P/BV (-1 s.d. from 15-year mean). Historically, valuations had dipped below these levels only during periods of severe asset quality pressures – the GFC and O&G downturn – when credit costs averaged 29-54bp while NPLs stood at 1.4-2.1%. We are cognisant, though, that Fed rate cuts could would be a key de-rating catalyst for the sector.
• The sector also trades below its 15-year historical mean of 1.3x CY19F P/BV. With RWA growth generally tracking that of loan expansion, the advent of slower regional loan growth forms the basis of strong capital buffers in the year ahead (barring acquisitions). Adjusting for final dividends, the 13.5% pro-forma CET-1 ratio of the banks are still deemed strong and provide visibility to sustained dividends in 2019F, in our view.

Our order of preference: DBS, UOB then OCBC

• Our top pick among Singapore banks is DBS (GGM-based Target Price of S$29.00 on 1.5x CY19F P/BV). DBS’s share price has performed well, gaining c.7% since the start of the year – recouping some of the weakness experienced in 4Q18 due to market volatility and risk-off sentiment. DBS would be best-placed to capture further NIM upside given its strong funding base, mainly comprising CASA deposits. Although we think the market has priced in expectations of a delay in Fed rate hikes, there could be a negative reaction if regional loan growth slows more than expected. We believe a resolution of US-China trade tensions beyond the delay in planned tariff implementations would a key catalyst for DBS given its exposure to Greater China. We like that its strong 13.9% CET-1 ratio provides visibility to FY19F dividends. Although trading above 15-year mean of 1.2x P/BV, DBS offers an ROE of c.12%, which is superior to peers’ c.10.5%.
• Our second choice is UOB. We have an ADD rating on the bank with Target Price of S$29.00 (1.1x CY19F P/BV, ROE: 10.7%). Valuations are attractive at -1 s.d. of 15-year mean. We believe UOB could be the most shielded from US-China trade war uncertainties given its smaller exposure to the Greater China region. The bank’s smaller trading book and the more stable characteristic of its wealth management segment (less driven by client trading activities) underline its earnings visibility. NIMs should continue to expand as the bank reprices its loans, although this should be at a smaller quantum compared to DBS.
• Our least preferred is OCBC; we have a HOLD call on the stock with Target Price of S$12.00 (1.1x CY19F P/BV, ROE: c.11%). Despite having a larger CASA base compared to UOB, OCBC’s funding costs have risen the most amongst the three Singapore banks in FY18. While we think that wealth management and trading income could rebound on the back of better capital market performance in 1Q19F, the effects of any capital markets weakness in 2019 could be heftier on OCBC due to compounded effects from Great Eastern Holdings (SGX:G07). We think its weaker loan growth prospects, volatile insurance contributions, and cloudy dividend guidance could cap OCBC share price in the near term.
• See attached PDF report for comparison of South & South East Asia Financial Services stocks. 

Andrea CHOONG CGS-CIMB Research | LIM Siew Khee CGS-CIMB Research | https://research.itradecimb.com/ 2019-03-08

SGX Stock Analyst Report ADD MAINTAIN ADD 29.000 SAME 29.000

HOLD MAINTAIN HOLD 12.000 SAME 12.000

ADD MAINTAIN ADD 29.000 SAME 29.000