Financial Sector Outlook - Maybank Kim Eng 2019-04-17: Structural Changes Paying

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

Financial Sector Outlook - Structural Changes Paying

Following not so successful attempts to transform into universal banks pre-GFC, the sector has returned to basics with a renewed focus on commercial banking. Interest income now generates two-thirds of total income and volatile trading has been replaced by more sustainable sources of non-interest income, such as wealth management. These structural changes have improved the quality and visibility of earnings for the sector, in our view.

Additionally, the sector is fully compliant with the BASEL III regulatory standards – the only banks in SE Asia so far – and has some of the strongest capital (13.9% CET1) and provisioning coverages (94%) in the region.

Despite slower economic growth in Singapore, we estimate the sector will see 6% y-o-y loan growth in 2019E. This should be driven by their exposure to higher growth overseas markets in SE Asia and Greater China. 30-50% of sector earnings are generated overseas.
Concurrently, we expect NIMs to increase 5-6bps y-o-y even without any further interest rate hikes, as existing loan yields catch up to past hikes. These drivers should help earnings momentum remain positive going forward and also provide better dividend visibility for the sector.
Separately, the sector has been investing heavily in technology to streamline banking processes, better integrate overseas businesses and generate timely, responsive customer insights. We believe these investments should provide opportunities for new revenue streams and better opex management in the medium term.

The known unknown is the impact of IFRS9, as this accounting standard requires pro-cyclical provisioning. As a result, any major sectoral asset quality distress may result in upside risks to credit charges. Given weakening economic growth - particularly in Singapore - this needs to be closely watched.

The sector PB is 8% below its historical mean. This is a steep discount given ROEs are set to expand 71bps to 11.9% by 2021E; the highest level since the GFC.
Additionally, the sector is likely to provide a highly defensible 4.5% dividend yield in 2019E – amongst the highest in the SE Asian region.

DBS GROUP HOLDINGS LTD (SGX:D05) and UNITED OVERSEAS BANK LTD (SGX:U11) are our top picks. We believe both banks are the best geared towards continued margin expansion given their large CASA funding bases and mortgage portfolios – which are currently being re-priced higher. Their regional operations are also well integrated, providing growth support to counter a slower home market.
Additionally, their strong balance sheets and capital ratios should provide cover during times of uncertainty as investors look to shift towards quality.