OVERSEA-CHINESE BANKING CORP (SGX:O39)
UNITED OVERSEAS BANK LTD (SGX:U11)
DBS GROUP HOLDINGS LTD (SGX:D05)
Singapore Banks - Uncertainty Looms Over Asset Quality
- 1Q20 earnings likely to be buffered by non-interest income; expect lower net interest income and higher provisions.
- Higher provisions expected through FY20F on weaker macroeconomic outlook arising from COVID-19 pandemic, lower oil price environment, deepening recession outlook in Singapore.
- Likelihood of dividend cuts across the sector on earnings decline.
- Maintain HOLD for OCBC (SGX:O39) and UOB (SGX:U11) with reduced target prices of $7.90 and $17.50 (pegged at c.0.7x FY21F BV) respectively as we revise our earnings by -6 to - 9% through FY21F on higher credit costs; there may be further downside risks arising from higher-than-expected credit costs.
NIM to decline further in 1Q20.
- In 1Q20, the average 3MSIBOR declined c.25bps q-o-q (4Q19: c.12bps decline) and 3MLIBOR fell by 41bps q-o-q (4Q19: 25bps decline), as March saw two Fed rate cuts following the spread of COVID-19 to the United States. We expect 1Q20 NIM to drop by a greater magnitude than 4Q19 primarily due to loans being repriced at lower average rates.
- Recall that NIM softened by 0 to 4bps in 4Q19 across Singapore banks following the 12/25bps decline in 3MSIBOR and 3MLIBOR respectively. We believe upcoming quarters will see sharper declines due to lag effect in repricing of loans.
Cost of funds to come off, albeit slower than loan yields, which will buffer NIM decline further in 2Q20.
- Compared to 4Q19, SGD fixed deposit rates have come off by c.30bps while Singapore banks started to reprice their flagship salary CASA accounts from February 2020 onwards. We believe the lower cost of funds may help to buffer some of the declines in loan yields from 2Q20 onwards but we expect NIM to continue to weaken.
- MAS has also stepped in to directly lend SGD at 0.1% p.a. to banks, to enable banks to price loans off near-zero funding cost to SMEs under the Enhanced Enterprise Financing Scheme by Enterprise Singapore, in a bid to make loans more affordable amid COVID-19 disruptions.
NIM sensitivity: every 10bps decline in NIM has 6-8% impact on net profit.
- Our sensitivity analysis indicates that every 25-bp decline in interest rates that reprices the S$, HK$ and US$ books collectively would lead to NIM declines of c.1-3bps with a corresponding 1.0-2.5% drop in net profit across the Singapore banks. Every 10-bp decline in NIM has a 6-8% impact on net profit. OCBC and UOB are less sensitive to NIM declines due to their funding structure.
Loan growth to hold up for now.
- While OCBC and UOB have guided for low-single digit loan growth in FY20F, we believe loan growth in 1Q20 is likely to hold up due to the slew of refinancing and new liquidity lines drawn during the quarter. Industry loan growth (based on Monetary Authority of Singapore stats) since end Dec-19 till Feb-20 was +3.5% year-to-date.
- We believe ongoing restructuring and refinancing activities should help to cushion loan books in the meantime, especially as banks are encouraged by MAS to utilise their capital buffers as appropriate to support their lending activities.
Impact on fee incomes to be less pronounced in 1Q20.
- We believe 1Q20’s wealth management income and trading income would hold up due to the buoyant markets in January and February 2020, as well as robust market activities during March due to heightened market volatility. However, the AUMs of respective banks may be affected by lower investment valuations.
- In the case of Great Eastern, the ongoing social distancing measures and lower mark-to-market values may have an impact on total weighted new sales.
- For UOB, bancassurance fees of ~$77m per annum starting FY20F for 15 years should help to support fee income growth. Accordingly, credit card activities are likely to be lower in 1Q and 2Q20 as aggregate spending declines (spending mix likely to shift towards consumer staples, supermarket spending).
Expect some cost savings.
- While we expect banks to rein in costs amid revenue headwinds given the current pandemic situation, we also expect some savings in discretionary expenses including travel budgets (~10% of total expenses).
Relief programmes due to COVID-19.
- Since the outbreak of COVID-19, the Singapore government has announced several relief programmes, including but not limited to home loan payment relief, credit cards and unsecured loans relief for individuals; secured term loan relief, Enhanced Enterprise Financing Scheme (SME working capital loans, temporary bridging loans) for SMEs.
- According to The Business Times, > 17,000 consumers have applied to defer mortgage repayments as of 20 April 2020, while > 3,000 consumers have applied to convert outstanding balances in personal unsecured credit into term loans at reduced interest rates; the former is estimated to be < 2% of total industry mortgage loanbook and is likely to result in accrual of interest income for banks in the meantime while the latter represents reduced lifetime values of revenue for such personal unsecured credits.
Increase credit costs assumptions through FY20F on Covid-19, lower oil prices, deepening recession outlook in Singapore.
- We believe the relief programmes will go a long way in helping individuals and corporates cope with tight liquidity in the meantime. We understand that in the meantime, loans under moratoriums will not be classified as NPLs and hence do not expect specific provisions to increase materially in 1Q20 for the time being.
- We expect 1Q20 to record higher general provisions due to changes in macroeconomic variables. Currently we assume ~48bps (previous: ~33bps) credit cost in FY20F, to reflect expectations of higher credit costs from Covid-impacted sectors, generic sectors due to recession scenario in Singapore, lower oil price environment, with downside risks.
More special provisions expected through the year.
- Some weaker credits may eventually turn to NPLs due to inability to repay interest and/or principal in the longer term, though loans through Enhanced Enterprise Financing Scheme will see 90% of the risk embedded shared by the government.
- In general, we expect higher credit costs given the weaker macroeconomic outlook, where in Singapore, extension of circuit breaker will drag the imminent recovery of business activities and services in Singapore, potentially deepening recession outlook. This compares with previous asset quality cycles, e.g. peak of 2016 oil and gas crisis saw > 40bps total credit costs and peak of Great Financial Crisis saw > 100bps total credit costs.
- According to our sensitivity analysis, every 10bps uptick in credit costs may impact sector earnings by c.5-6%. Our base case excludes mortgage NPLs, which may creep up if massive unemployment hits.
Details on oil and gas-related exposure.
- Lower oil prices have also led to concerns over commodity-related exposures, such as in Hin Leong, where Singapore banks reportedly have c. US$680m of exposure (according to Bloomberg). According to UOB, oil and gas book is estimated to be c.2.5% of loans (from c.4.5% in 4Q17), of which ~70-80% have been provisioned for.
- According to OCBC, oil and gas exposure accounts for c.5% of total loans, which includes oil majors, trading companies and offshore support vessel sector, with NPL ratio at 0.8% as of Dec 2019. As of 4Q19, OCBC has written down values of vessels to scrap value (3% of refreshed valuation) through FY 19 for vessels with less than one year of charter. (See loan exposure by sector in Appendix of attached PDF report)
Keeping watch on credit weakness
- The COVID19 pandemic has led to both demand and supply shock, impacting tourism, hospitality, retail, airlines directly, while impacting supply chains globally. We continue to SMEs, which may have less liquidity to tide themselves through, compared to larger corporates which may have access to more liquidity.
- We are also watchful on regional credits as merging markets are likely to have more risks from higher informal labour unemployment, supply chain distribution impact (SMEs get hit the most) e.g. Malaysia, Indonesia and India.
Valuation & Recommendation
Asset quality the wild card; maintain HOLD on OCBC and UOB.
- Singapore banks are now trading at c.0.8-0.9x FY21F BV. We lowered our TPs and retain our HOLD calls on OCBC (Target Price: S$7.90) and UOB (Target Price:S$17.50), as we cut earnings by another 5-9% through FY21F on higher credit costs and slower growth in non-interest income, as we believe there are limited catalysts at this juncture, as asset quality remains the wild card to valuations.
- Our TPs are pegged to c.0.7x FY21F BV, which is the trough valuation levels during GFC.
- See
Likelihood of dividend cuts.
- We believe dividend cuts are imminent across the sector on earnings decline; for OCBC, we believe OCBC might adopt scrip dividend with a discount (historical discount level is 10%) while we see S$1.10 DPS as a key support level for UOB’s dividend (FY19: S$1.10 DPS + S$0.20 special DPS) as UOB is committed to a dividend payout ratio of 50% subject to CET1 CAR of 13.5% and sustainable financial performance .
- See
Key Risks
Worsened asset quality trend.
- A larger-than-expected NPL arising from generic sectors and/or commodities-related exposure, as well as a worse-than-expected COVID-19 pandemic situation globally which will affect tourism and retail businesses could unwind expectations of credit cost and NPL declines, thus posing risks to earnings. Further, unemployment arising from recession could pose risks to mortgages and unsecured consumer lending among others. Based on our sensitivity analysis, every 10-bp uptick in credit costs may impact sector earnings by c.5-6%.
Recession risks.
- A deeper-than-expected recession in Singapore, a worse-than-expected COVID-19 outbreak in Singapore and regionally and a less firm macroeconomic outlook going forward could temper our fee income and loan growth expectations. Although loan growth is less sensitive to earnings, any deceleration as a result of weaker sentiment would dent top-line prospects.
NIM pressures.
- According to our sensitivity analysis, every 25-bp cut in interest rates may have an impact of 1-3bps on NIM for FY20F, while every 10-bp change in NIM has a 6-8% earnings impact on banks’ FY20F bottom line. More rate cuts than expected (market is currently pricing in no further Fed cuts in FY20F) would add further pressure on NIM and adversely affect earnings.
See also SGX Market Update: Oil Price Gyration – What does this mean for Singapore Banks?
Rui Wen LIM
DBS Group Research
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https://www.dbsvickers.com/
2020-04-22
SGX Stock
Analyst Report
7.90
DOWN
8.600
17.50
DOWN
19.000
99998.000
SAME
99998.000
