DBS OCBC UOB Banks - CGS-CIMB Research 2019-05-21: Trump Card


DBS OCBC UOB Banks - Trump Card

  • Sector valuations have de-rated close to the levels seen after the initial 10% tariffs were introduced in Sep 2018.
  • Continued headwinds may surface as China retaliates with more tariffs. As such, we downgrade the sector to Neutral from Overweight.
  • We revise our loan growth expectations across the sector to account for weaker regional growth as corporates adopt a wait-and-see approach.
  • We downgrade DBS GROUP HOLDINGS LTD (SGX:D05) to HOLD. Valuations are relatively more expensive at 1.3x CY19F P/BV. An attractive point of entry would be at 1.2x P/BV or below.

Tariff hike de-rates sector to levels seen after initial 10% tariff

  • Singapore banks’ share prices have dipped by up to 3% since the US hiked tariffs on Chinese goods to up to 25% on 10 May. See DBS share price, OCBC share price, UOB share price.
  • We think that the prolonged uncertainties could weigh on regional growth, and revise our loan growth across the Singapore banks to below our initial mid-single-digit forecast.
  • Singapore banks’ loans to the Greater China region had decelerated over FY18 as the trade negotiations played out; we think this could happen this time around as well.

NIM performance was mixed in 1Q19; we expect more in 2Q19

  • NIM expansion across the 3 banks was mixed in 1Q19 – DBS GROUP HOLDINGS LTD (SGX:D05) +1bp q-o-q, OVERSEA-CHINESE BANKING CORP (OCBC, SGX:O39) +4bp, and UNITED OVERSEAS BANK LTD (UOB, SGX:U11) -1bp. Most of this was attributable to the mortgage repricing exercise which began in early-2019.
  • We expect NIM expansion from these repricing effects to peak in 2Q19 and hopefully sustain at those levels amid more moderate expectations of regional loan growth. We think UOB could see the largest NIM expansion in 2Q19 if it manages to release its excess liquidity (5% deposit growth in 1Q19) amid slower loan drawdowns.

1Q19 could see the last pinch from O&G NPLs for the time being

  • Credit costs were another mixed bag as write-backs helped lower those for DBS and UOB, while unexpected provisions for OSV NPLs pushed OCBC’s impairments higher than what were seen in FY17 when the banks cleaned up their books for weak O&G exposures.
  • DBS guided for specific provisions (SPs) to be below its cycle average, and UOB errs on the lower end of its 20-25bp guidance.
  • We think OCBC could be clear of impairment surprises for now, and expect quarterly credit costs to normalise downwards.

Trends on the ground

US-China trade war – an eye for an eye makes the whole world blind

  • Looking back to when President Trump implemented the 10% trade tariffs on US$200bn of Chinese goods in Sep 2018, the STI fell 167 points (or 5.2%) over the following 2 months. DBS share price, OCBC share price and UOB share price dipped 11%, 4%, and 11% in the same period respectively. A consequent agreement between the US and China to halt the increase in trade tariffs (to 25%) in Dec 2018 allowed for a momentary breather.
  • Singapore banks’ share prices have retraced by 1-2% since the higher 25% tariff was implemented on US$200bn of Chinese imports into the US on 10 May 2019. In tandem, sector valuations have de-rated to 1.2x P/BV since the tariff hike announcement.
  • Negative spillover sentiments from the trade war have so far materialised in reduced cross-border transactions and weaker regional growth as corporates adopt a wait-and-see approach. Loan growth guidance in FY19 has been moderated to mid-single-digits (from 7-11% in FY18), but we think this may be revised downwards if the tensions heighten further.
  • That said, we believe that the regional connectivity of Singapore banks will serve as a shield of sorts from this potential slowdown, as they aid their clients in shifting supply chains out of Greater China into ASEAN economies. As most of the banks’ exposures in Greater China comprise trade finance facilities or exposures to larger banks and SOEs, asset quality in this region has so far remained contained.

Have the funding pressures peaked?

  • We believe that the mounting funding pressures seen over FY18 have cooled off somewhat with the moderation in regional loan growth and the pause in Fed rate hikes. As the Singapore banks are mainly funded by their strong local deposit franchises, most of the higher funding pressures came in the form of higher fixed deposit (FD) rates, from c.1.4% in Jan 2018 to c.1.9% in Dec 2018.
  • Notably, most of the higher FD rates offered in the market came from foreign banks, which had the push of fulfilling required net stable funding ratios. Although our findings (see Figure4 in attached PDF report) do not record the rates offered on some current account deposits which were well above the FD rates offered and required no lock-in period, again, these promotions were largely offered by foreign banks in Singapore, which had much smaller deposit franchises here compared to the listed Singapore banks.
  • Fixed deposit rates have started to ease in Apr 2019, and we think that this will further protract in the coming months. The rise in funding costs among Singapore banks in 1Q19 has also started to taper, paving the way for NIM expansion from their efforts in raising asset yields.

Virtual banks – is Singapore ready?

  • The Monetary Authority of Singapore has been mulling the decision to grant virtual banking licences to digital-only banks operated by financial technology (fintech) firms. This piece of news comes as the Hong Kong Monetary Authority approved 4 additional virtual banking licences in its city state following the 4 granted in Mar and Apr 2019.
  • This begs the question of whether Singapore is ready to embrace an influx of virtual competitors in the banking scene. We believe that the short answer to this is yes, but only if the same regulations imposed onto commercial banks are set upon these virtual banks as well.
  • The introduction of Basel III regulations (and soon a reformed version) put into place guidelines for higher capital buffers and liquidity requirements, among others – in our view, all of which should be maintained as safeguards for an institution holding customer deposits. Having said that, setting these high barriers to entry for a newcomer could be opined to be too punitive, seeing which the regulator could gradually impose these regulations on a phased-in basis.
  • The target segment for virtual banks would most likely be retail and SME customers given their smaller capital bases at start-up. This could pose a threat to the local banks if these virtual banks are able to scale up with speed. Amongst Singapore banks, we estimate UOB to have the largest proportion of SME loans at 21% (or S$56bn) of its loan book in FY18.

Singapore Banks 1Q19 highlights

1Q19 earnings strength underpinned by rebound in markets

  • The 1Q19 earnings beat across all 3 Singapore banks was primarily due to the strong rebound in capital markets from the general risk-off sentiment in 4Q18. Apart from merely regaining momentum to pre-4Q18 levels, the pick-up in investment activity saw net trading income coming in close to, or above the quarterly figure seen in recent years. Notably, MTM gains from Great Eastern had given OCBC a sizeable lift in this respect.
  • The banks’ wealth management (WM) segments generally performed well. WM income for DBS and OCBC rose 15% and 27% y-o-y respectively, although UOB’s WM fees dipped 18% y-o-y. DBS and OCBC also recorded improved AUM balances of S$230n (+11% y-o-y) and S$108bn (+6% y-o-y). UOB’s AUM balances were estimated by the Asian Private Banker to have stood at c.S$34bn as at end-2018.

Asset quality held up with strong capitalisation to boot

  • Asset quality across the banks held up well with 1Q19 net new NPA formation coming in below cycle averages although credit cost performance was mixed. Both DBS and UOB surprised on the upside as the former guided for specific provisions (SP) to trend below its through-cycle average while a write-back on a non-loan contingent exposure helped lower UOB’s overall credit costs. OCBC recorded higher-than-expected credit costs as it wrote down collaterals on OSVs pending employment to 6% of their refreshed valuations (or 3% if logistic costs were taken into account) and took a 45-55% haircut on the refreshed valuation of OSVs under employment (with charter contracts exceeding 1 year or with visibility of upcoming utilisation).
  • While DBS recorded a net write-back in general provisions (GP or stage 1 and 2 expected credit losses(ECL)) due to better portfolio credit quality and improved external credit conditions during the quarter, both OCBC and UOB experienced the opposite, with increased GP in 1Q19. We believe that the higher GP at UOB could be partly due to its strong 3% q-o-q loan growth, but even more so, that OCBC’s explanation of a riskier macroeconomic outlook overlay could apply UOB’s ECL model as well.
  • Strong capitalisation remains a notable feature of Singapore banks, with CET-1 capital ratios hovering at c.14% in 1Q19. As always, high capital levels come as a balancing act against ROEs and dividend payouts.
    • We think that the case for DBS and UOB to increase their dividends beyond an absolute S$1.20/share (c.50% payout) could be dimmer as the need to keep strong absorption buffers escalate amid the trade war uncertainty. See DBS dividend history, UOB dividend history.
    • OCBC has reiterated its stance of maintaining its 40-50% dividend payout guidance in favour of guarding against uncertainty, or more likely, for an offensive acquisition play. See OCBC dividend history
  • All said, we think that asset quality should remain supported by the pause in Fed rate hikes in the near term, although the escalation of defaults amongst Chinese firms and the sustained US-China trade tensions remain a point of concern.

Varying NIM performance as repricing effects come through

  • NIM expansion was varied in 1Q19, with DBS +1bp q-o-q to 1.88%, OCBC +4bp to 1.76%, and UOB -1bp to 1.79%. For context, DBS displayed steady NIM performance over the past year, OCBC’s held steady after a +5bp jump in 3Q18, and those of UOB’s have contracted for a fourth consecutive quarter now.
  • All 3 banks have actively been managing their funding bases over FY18 with respect to the projected timing of their loan drawdowns – DBS and OCBC having been more successful at this as compared to UOB. That said, we remain hopeful for a reversal in UOB’s declining NIM trend; the release of its deposit chest amid slower loan growth in the coming quarters should drive this trend.
  • The residual effects of the repricing on Singapore banks’ mortgage books are likely to continue into 2Q19, albeit at a smaller quantum than seen in 1Q19; NIM expansion could peak in 3Q19 as the immediate repricing impact runs off.
  • We expect to FY19 NIM expansion to be in the range of +5bp for DBS, +5bp for OCBC, and flattish for UOB. A Fed rate cut poses as the largest downside risk for Singapore banks, although we think that its downward pressure on NIMs may not be immediate given lagged transmission effects.

Valuation and recommendation

UOB most preferred, followed by OCBC then DBS

  • Our preferred pick is UOB given that its valuations look the most attractive after its share price de-rated recently. Although OCBC appeared to withstand better in terms of share price performance vs. DBS and UOB, we think that UOB is best placed to benefit from a shift in supply chains out of Greater China into ASEAN; UOB has the largest ASEAN exposure (73% of gross loans) amongst the local banks. Dividend payout ratio is likely to be maintained at 50% in FY19. See UOB share price, UOB dividend history.
  • We downgrade DBS to a HOLD on expensive valuations and trade war concerns. See report: DBS Group - Caught In The Crossfire. At the current DBS share price, P/BV valuations are 1 s.d. above its long-term mean. We think that an escalation in trade war retaliations could affect DBS the most given its 30% loan book exposure to Greater China/HK (highest amongst Singapore banks) and that about 18% (trading and wealth management income) of its total income was derived from capital markets in FY18. DBS’s switch to quarterly dividend payouts (vs. semi-annually) may provide some stability to its share price although valuations appear expensive relative to peers. See DBS share price, DBS dividend history.
  • In the same vein, OCBC is also likely to be impacted by swings in investment income (MTM gains/losses) from Great Eastern Holdings (SGX:G07) amid volatile markets. OCBC’s 14.2% CET-1 ratio and the activation of its scrip dividend scheme amid slowing credit growth hint at the capacity for higher dividend payouts, although the bank maintains that the excess capital could be retained for both defensive (uncertain macro volatility) and offensive (M&A) purposes. OCBC trades at 1.1x CY19F P/BV, about -1s.d. below long term mean. See OCBC share price, OCBC dividend history.
  • See attached PDF report for sector comparison of south & southeast asia banks.

Andrea CHOONG CGS-CIMB Research | LIM Siew Khee CGS-CIMB Research | https://research.itradecimb.com/ 2019-05-21
SGX Stock Analyst Report HOLD DOWNGRADE ADD 27.640 DOWN 30.00