Singapore Banks - UOB Kay Hian 2020-03-17: Extreme Circumstances Call For Extreme Measures

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)

Singapore Banks - Extreme Circumstances Call For Extreme Measures

  • The Fed cut the Fed funds rate by an unprecedented 100bp and re-introduced QE during its second unscheduled FOMC meeting last Sunday, an aggressive pre-emptive strike to avert a credit crunch. The worst-case scenario for interest rates has already materialised. Maintain OVERWEIGHT.
  • Our top pick is OCBC (SGX:O39) as its 2020F P/B of 0.80x is below the trough P/Bs in five out of the previous six crises.
  • BUY DBS (SGX:D05) for 2020 dividend yield of 7.1%, which is 2SD above its long-term mean.



WHAT’S NEW


Back to square one of zero interest rate.

  • The Fed has cut the Fed funds rate by an unprecedented 100bp to 0.00-0.25% last Sunday in its second unscheduled FOMC meeting this month. The COVID-19 outbreak has affected global financial conditions. It will weigh on economic activities and pose risks to the economic outlook. The Fed also cited stress in the “energy” sector.
  • Interest rates will be maintained at current levels until the Fed is confident that the economy has weathered recent events.

Maximising usage of its full range of tools.

  • The Fed has announced the purchase of at least US$500b of treasury securities and US$200b of agency mortgage-backed securities over the coming months. If fully implemented, this quantitative easing (QE) programme would increase the size of the Fed’s balance sheet by 17%. It will roll over at auction all principal payments from its holdings of treasury securities and reinvest all principal payments from its holdings of agency mortgage-backed securities. It has also lowered the interest rate charged to banks for emergency short-term loans at its discount window from 1.50% to 0.25%.
  • The Fed also established swap programmes with five foreign central banks, including ECB, BOJ and BOE, to make US dollars readily available in overseas markets.

Averting a potential credit crunch.

  • The bond market grew increasingly dysfunctional last week. The market for mortgage-backed securities seized up and mortgage rates spiked. By last Friday, there were strains on markets for commercial papers, municipal credits and even treasury bonds. In particular, it is unusual that prices of treasury bonds dropped despite the collapse in the stock market. Economic activities are increasingly being funded by the bond market.
  • The Fed responded aggressively as disruption to the normal functioning of the bond market is a threat to financial stability.

Drop in SIBOR cushioned by strength of US$.

  • In the US, the 10-year government bond yield increased 20bp to 0.96% last week. Post-Fed’s intervention, yield has receded 24bp to 0.72% yesterday. In Singapore, the 10-year government bond yield rose 26bp to 1.48% last week. Yield has receded 12bp to 1.36% yesterday. The 3-month SIBOR dropped 10bp to 1.22% on Monday following the Fed’s latest rate cut.
  • Conversely, the 3-month SOR has risen 12bp to 0.58% (previously depressed by weakness of the US$), propelled by strength of the US$ against the S$.

Fed traditionally opposes negative interest rates.

  • It is unclear if US banks could charge negative interest rates under existing legislation. A law passed in 2006 says depositors should receive earnings (did not mention imposition of fees). Any change of the law would require approval from Congress. The structure of the US financial system is different with sizeable money market funds of about US$4t.
  • Public opinion is against negative interest rates. During the global financial crisis, there was much public outcry when some money market funds “broke the buck”. Also, there is no conclusive evidence that the benefits outweigh the costs of negative interest rates.


ACTION


OCBC and UOB more defensive.

  • The average P/B in the month that P/B troughed during that P/B troughed during the past six crises is tabulated below. OCBC (SGX:O39) and UOB (SGX:U11) are currently trading below trough P/Bs in five out of the six crises, the exception being the AFC. DBS (SGX:D05) is trading below trough P/Bs in two out of the six crises.

OCBC and UOB trading below BVPS.

  • We estimate end-20 BVPS at S$19.98 for DBS and S$10.82 for OCBC.
  • DBS is trading at 2020F P/B of only 0.93x, while OCBC is trading below BVPS at 0.80x (1SD below long-term mean).

Dividend yield at 2xSD above long-term mean.

  • Over the past 30 years, DBS and OCBC have hit above dividend yield of 6% once (GFC) while UOB was twice (AFC and GFC). Steep correction that causes dividend yield to overshoot to 6% tends to be followed by a sharp rebound. DBS and OCBC currently trades at attractive 2020F dividend yields of 7.1% and 6.4% respectively.
  • We expect dividend payouts for Singapore banks to be sustainable due to their strong CET-1 CAR, which are above 14%. The banks also have the option to turn on their scrip dividend schemes should regional economies slip into a recession.

Maintain OVERWEIGHT.

  • Banks are yield plays. DBS and OCBC provide attractive dividend yields of 7.1% and 6.4% respectively, which differentiate them from regional peers. Our top pick is OCBC.


SECTOR CATALYSTS

  • Banks evolving into yield plays.


ASSUMPTION CHANGES


DBS (SGX:D05).



OCBC (SGX:O39).



RISKS

  • Outbreak of COVID-19 affecting growth and credit costs in 2020; economic slowdown in China.





Jonathan KOH CFA UOB Kay Hian Research | https://research.uobkayhian.com/ 2020-03-16
SGX Stock Analyst Report BUY MAINTAIN BUY 25.15 DOWN 26.200
BUY MAINTAIN BUY 11.98 DOWN 12.250
NOT RATED MAINTAIN NOT RATED 99998.000 SAME 99998.000



Advertisement



MOST TALKED ABOUT STOCKS / REITS OF THE WEEK



loading.......



ANALYSTS SAY


loading.......