Singapore Banks - OCBC Investment 2020-05-12: Navigating Multiple Headwinds

Singapore Banks - OCBC Investment Research | SGinvestors.io DBS GROUP HOLDINGS LTD (SGX:D05) UNITED OVERSEAS BANK LTD (SGX:U11)

Singapore Banks - Navigating Multiple Headwinds

  • Singapore banks are entering the current downturn from a position of balance sheet strength and should benefit from some downside support from the government’s Covid-19 policy measures.
  • However, we see a challenging outlook ahead as the sector navigates multiple headwinds: from net interest margin (NIM) contraction due to a prolonged low interest rate environment, to higher credit risks and earnings pressure amid a global recessionary backdrop and the potential resurgence of US-China trade frictions.

Singapore banks 1Q20 results highlights: NIM pressures ahead, oil & gas disclosures

  • In the recent 1Q results release, the sector reported stable top line growth and non-performing loan (NPL) ratios of 1.5-1.6% but saw double-digit earnings contraction from a year ago due to substantial hikes in provisions (as expected) to strengthen coverage and pre-empt increased credit risks. The average sector net profit declined -30% y-o-y while pre-provision profits grew modestly at +2.2% y-o-y.
  • As of end 1Q20, oil and gas industry exposure as a percentage of total group loans is estimated at a higher ~6% for DBS (SGX:D05) and ~3.6% for UOB (SGX:U11), which is expected to be manageable.
  • Other highlights included reduced guidance as expected for growth prospects over 2020- 2021E, an uptick in non-performing loans and more disclosures provided on loan exposures in the wake of the downturn from Covid-19.

More provisions ahead, heightened credit concerns in 2020E-2021E

  • With the deterioration of the credit cycle, we expect that increased provisions and NIM contraction will continue to feature in the upcoming quarters across the sector as the lagged effect of the Fed’s recent aggressive cuts in interest rates passes through. Key sector trends to monitor ahead will be NIM pressures (which should start more meaningfully from 2Q), asset quality trends, expected credit losses and the extent of provisioning required over the coming quarters.
  • The government support measures and loans moratorium in Singapore should lead to NPLs and provisions spread out over two years. Credit costs should also reverse from the benign below-cycle average levels of the past years (FY19 sector range of 18bps-33bps), with increases over 2020-2021E projected at a cumulative ~100-130bps (i.e. 50-65bps per year, markedly higher compared to the average of 28-31bps for DBS and UOB from the period of 2011-2019, and close to the 110bps-117bps for UOB and DBS respectively in 2009.

Earnings headwinds, some downside risks for dividends if downturn deepens

  • Sector CET1 ratios however are strong at above 14% as of end 1Q20, which could see some softening in the coming quarters but should still remain at decent low-teen levels. Unlike some parts of the world where regulators have restricted dividend payments in order to conserve capital, at this point, we do not expect Singapore banks to see a similar restriction from regulators.
  • In its recent 1Q results update, DBS reiterated its commitment to a quarterly absolute dividend per share (DPS) of SGD0.33/share which suggests ~6.8% forward yield and raised FY20E dividend payout ratio in the high 70s% level. The guidance came understandably with caveats that the dividend policy is subject to management discretion and a base case scenario of lockdowns in major economies easing by middle 2020. On the other hand, in line with their conservative stance, UOB’s management has maintained its guidance for a ~50% payout ratio so long as CET1 ratios remain above 13.5%, citing its focus on ensuring the bank maintains a stable credit rating.
  • Near term, we expect dividends should be a stronger supportive factor for DBS’ share price compared to UOB’s. DBS Share Price should see some support from the upcoming payment of both 4Q19 and 1Q20 quarterly dividends totaling SGD0.66/share, with coinciding ex-dates of 26 May 2020 due to the delay of its prior FY19 AGM from Covid-19 restrictions. The differences in their payout policies - an absolute quarterly dividend payment committed by DBS versus a payout ratio for UOB - implies a lower absolute DPS amount ahead for UOB, in line with the broad earnings contraction expected in the sector.
  • Although bank managements have maintained their dividend policy in the latest 1Q results release, the guidance came understandably with caveats due to the developing and limited visibility brought about by Covid-19. We see downside risks for sector dividends, should the downturn becomes more protracted and deeper than currently expected, particularly in a scenario where a second wave of Covid-19 occurs or a more permanent change in consumer and business behavior takes place (particularly in highly impacted industries such as hospitality, cruise ships, food & beverage, aviation etc) which could result in a longer term negative impact on potential GDP growth.

Long term value is emerging, despite a lackluster outlook in 2020 with credit costs expected to peak in 1H 2021.

  • Our underweight stance in financials is maintained in view of prolonged low interest rates and multiple earnings headwinds ahead. Given the lacklustre growth prospects, we see a subdued outlook for the sector and advise investors to limit their overall exposure to financials within their portfolios.
  • Overall, we expect near term sector performance of Singapore banks to move in line with the broad equity index during this period of softer growth, with a more meaningful rebound likely when the macro growth outlook picks up. We currently have Hold ratings for both UOB and DBS in recognition that valuations for Singapore banks are already trading below book values, pricing in lowered growth expectations and starting to offer value for long term investors who can tolerate potential volatility from weaker results expected in upcoming quarters. Valuations wise, we still see more long term value emerging in UOB over DBS with the former’s price/book multiple is already below its previous GFC trough multiple.
  • With domestic loans making up two thirds of total loans exposure for the sector and a more prolonged Covid-19 management situation domestically, we expect modest loans growth to contribute towards a challenging recovery outlook for the sector this year. As such, near term sector performance should be largely in line with the broad equity market, with a more meaningful rebound likely only when the macro growth outlook picks up.

OCBC Research Team OCBC Investment Research | https://www.iocbc.com/ 2020-05-12
SGX Stock Analyst Report HOLD MAINTAIN HOLD 20.000 SAME 20.000