Singapore Banks - DBS Research 2020-07-21: Sharp Decline In NIMs In 2Q20


Singapore Banks - Sharp Decline In NIMs In 2Q20

  • Record quarterly decline in net interest margins (NIMs) likely a negative surprise, as repricing on sharply lower benchmark interest rates takes place.
  • Dividends cuts may happen as early as 2Q20 as MAS reviews banks’ capital plans, including dividend payouts; scrip dividend is another possibility.
  • Weaker fee income and provisions to continue to weigh on earnings on top of decline in net interest income, offset by likely strong trading gains.
  • Maintain HOLD on OCBC (SGX:O39) and UOB (SGX:U11), revised Target Price of $9.30 and $20.90, representing ~0.8x FY21F; we remain neutral on Singapore Banks due to limited catalysts ahead of expected weak 2Q20 earnings.

Record quarterly decline in net interest margins (NIMs).

  • We expect Singapore banks to register a record quarterly decline in NIMs in 2Q20, following March’s two Fed rate cuts in response to the spread of COVID-19 in the US, which resulted in the repricing of loans on lower benchmark rates through most of 2Q20. During the quarter, average 3MSIBOR and average 3MLIBOR declined 83 and 93bps, respectively, a multi-fold increase from the previous quarter.
  • We are pencilling in a 16 to 22bps decline q-o-q in NIM during 2Q20 (1Q20 NIM saw a q-o-q change of 0 to -5bps). Across the banks, quarterly NIMs are expected to be near their all-time post-global financial crisis (GFC) low. While 2Q20 should see the bulk of the repricing effect, there could be a spillover effect into 3Q20. Every 10-bps decline in NIM has a 6-8% impact on net profit.
  • Singapore banks actively lowering interest rates on its flagship savings account to partially mitigate effect of lower loan yields. DBS (SGX:D05) and UOB have moved twice, effective in February and August, as well as May and August, respectively, in lowering the maximum interest payable deposit amount and/or interest rates on their flagship accounts. Similarly, OCBC has made changes to its flagship account’s interest rates, effective July 2020.
  • Assuming one maxes out the respective account balances and fulfils non-investment related transactions, interest rates have been reduced by 70 to 124bps across the board. We believe the interest rates reduction on deposits will have more impact on lowering cost of deposits in 3Q20.

Loan growth continues to be varied across banks; net interest income to decline q-o-q.

  • Year-to-date, industry loan growth was 2.3% as outstanding loans continued to decline in April and May m-o-m. We expect OCBC and UOB’s loan growth q-o-q to be marginal for the quarter, with OCBC previously guiding for muted loan growth for the year and UOB guiding for mid-single-digit loan growth, On the other hand, DBS’ loan pipeline as of 1Q20 was healthy with expected further drawdown of non-trade corporate loans in 2Q20. Alongside declining NIMs, we expect net interest income to decline q-o-q.
  • Fee income to bear full brunt of circuit breaker measures. As 2Q20 coincided with the period of circuit breaker in Singapore, from 7 April to 1 June 2020, we believe that impact will be seen in the banks’ fee income where the decline in card fees, wealth management fees, investment banking fees is likely to be offset by loan-related fees in relation to loan activity during the quarter.
  • In 1Q20, DBS registered an 8% y-o-y decline in card fees and we expect a sharper magnitude of decline in 2Q20. While we expect Singapore banks to see higher assets under management (AUM) for its wealth management business due to recovery in underlying market values through 2Q20 as well as net new money increase, we expect an overall weak showing for wealth management fees as the closure of bank branches and circuit breaker measures would have impacted the sale of wealth products and bancassurance among others.

Other non-interest income to see gains.

  • DBS saw strong gains in non-fee non-interest income during 1Q20 largely attributed to gains in investment securities. Accordingly, DBS has been building duration and yield into its investment portfolio which is sitting on unrealised gains over S$1bn after amounts realised in 1Q20, as of 1Q20 earnings call.
  • While OCBC saw +126% y-o-y gains in net investments driven by the sale of debt securities as well as the increase in treasury-related customer flow – this was more than offset by unrealised mark-to-market losses in Great Eastern’s (GEH) investment portfolio with GEH’s insurance income also declining 43% y-o-y to S$157m during 1Q20 due to investment performance. Given the broader market recovery in 2Q20, we expect other non-interest income to see a q-o-q improvement largely across the board on strong trading gains, mark-to-market improvements, especially for GEH’s investment portfolio.

Controlled operating expenses; wage subsidies should support cost-to-income ratios.

  • Continuing from 1Q20’s trend of lower operating expenses (DBS/OCBC/UOB: +4%/+5%/+1% y-o-y and -3%/-12%/-3% q-o-q), due to lower general expenses (in line with lower operating income), we expect wage subsidies for Singaporean workers to also support cost-to-income ratios during the quarter. As such, we expect cost-to-income ratios for 2Q20 to be similar to 1Q20’s.

Likely to continue seeing elevated general provisions, lower specific provisions during 2Q20.

  • DBS/OCBC/UOB have guided for 80-130bps (S$3- 5bn), 100-130bps, and 100-120bps of credit costs cumulatively over the next two years respectively. We believe the banks are likely to write more provisions in FY20F and expect to continue seeing elevated general provisions during 2Q20 due to the deterioration in the general economic outlook that will lead to further macro-economic variables’ (MEV) downgrade during the quarter. We believe UOB will see higher general provisions compared to its peers that have written more provisions (to P&L) during 1Q20, as UOB took a S$260m RLAR adjustment (~10bps of CET1 ratio) during 1Q20 in addition to its provisioning. Barring any chunky non-performing loans formation during the quarter, we believe specific provisions in 2Q20 may be lower than that in 1Q20, which included provisions for the banks’ exposures to Hin Leong.

Watchful for 2H20 as government support measures taper off.

  • We continue to remain watchful for 2H20 as various government support measures taper off (e.g. rental rebates, wage subsidies, among others), which may lead to ceasing of some businesses should underlying demand of these businesses fail to recover during the Phase 2 period.

Some dividend cuts expected as early as 2Q20; scrip dividend as capital management tool.

  • In July 2020, MAS announced that it is currently reviewing banks’ capital plans, including dividend payouts and that banks’ capital management should be approached “from a position of strength”. According to MAS managing director Ravi Menon, banks “should start early and not wait until the capital position starts looking weaker”.
  • During their 1Q20 earnings calls, the managements of Singapore banks have generally kept their dividend options open. Currently, DBS pays an absolute DPS of 33 Scts per quarter, while UOB has a dividend payout ratio policy of ~50%, subject to a minimum CET1 ratio of 13.5% and sustainable outlook and OCBC’s commits to a sustainable dividend in line with its long-term growth prospects.
  • Should the absolute DPS for DBS and OCBC be maintained in FY20F, their dividend payout ratio would be ~65-70% which we believe is relatively high. We believe that given the steep earnings decline expected across banks in FY20F and economic uncertainty amid a protracted pandemic, banks may likely err on the side of caution and voluntarily cut back on dividends and buffer up capital levels. Banks could also adopt scrip dividend with discount as a capital management tool (e.g. OCBC’s historical scrip dividend offers 10% discount).
  • See DBS Dividend History, OCBC Dividend History, UOB Dividend History.

Valuation and recommendation

Downside risks to earnings and dividends; maintain HOLD on OCBC and UOB.

  • Singapore banks are now trading at c.0.8-1.0x FY21F BV. We have increased our TPs but retain our HOLD calls on OCBC (Target Price: S$9.30) and UOB (Target Price: S$20.90), representing ~0.8x FY21F BV.
  • We believe there are limited catalysts at this juncture ahead of a weak 2Q20 earnings season, as there are downside risks to earnings arising from lower NIM, if Singapore banks’ NIMs break below post- GFC lows. This could lead to lower dividends.
  • Our revised TPs are derived from Gordon Growth Model (8% ROE, 3% growth, 9% cost of equity) as we expect FY21F ROEs to be c.8% levels, weighed down by NIMs, slower loan growth and provisions. Our previous TPs were pegged to GFC trough levels of ~0.7x FY21F BV, at the height of COVID-19 outbreak globally.
  • See

Key risks

NIM pressures.

  • According to our sensitivity analysis, every 25-bps cut in interest rates may have an impact of 1-3bps on NIM for FY20F, while every 10-bps change in NIM has a 6-8% earnings impact on banks’ FY20F bottom-line. As we expect record quarterly decline in NIMs in 2Q20 to reach post-GFC lows, there may be downside risks should NIMs break below the post-GFC levels, though we expect the further effect of rationalisation on deposits cost to come through in 3Q20.

Deteriorating 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 that will affect tourism and retail businesses could unwind expectations of credit cost and NPL declines, thus posing risks to earnings.
  • Further, worse-than-expected unemployment arising from a deep recession could pose risks to mortgages and unsecured consumer lending among others, though this is not our base case. Based on our sensitivity analysis, every 10-bps uptick in credit costs may impact sector earnings by c.7-8%.

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.
  • DBS Group Research currently expects full year GDP growth to decline 5.7% y-o-y, with entire cycle to take about 24 months on average to recover. Sectors that are worst hit by the pandemic, i.e. tourism, aviation and construction could potentially take as long as more than two years to recover back to pre-COVID levels (in terms of real GDP).

See also

Rui Wen LIM DBS Group Research | https://www.dbsvickers.com/ 2020-07-21
SGX Stock Analyst Report NOT RATED MAINTAIN NOT RATED 99998.000 SAME 99998.000