Singapore Banks - CGS-CIMB Research 2021-06-23: As The Rate Cycle Turns

DBS GROUP HOLDINGS LTD (SGX:D05) OVERSEA-CHINESE BANKING CORP (SGX:O39) UNITED OVERSEAS BANK LTD (SGX:U11)

Singapore Banks - As The Rate Cycle Turns

We now see scope for NIM upside as early as FY23F, as Fed Pres. Bullard sees rate hikes in 2022F — earlier than the Fed’s end-2023 timeline.
Our study of rate hike cycles in FY04 and FY15 suggests that Singapore banks re-rate ~4-5 quarters ahead of the first Fed rate hike of the cycle.
This implies a possible re-rating cycle as early as 2Q-3Q21F, in case hikes start in 2022F. Reiterate banks Overweight as share price momentum sets in.

In step with the Fed rate cuts in 2019, short-end interest rates have similarly retraced with 3MLIBOR/3MSIBOR/3MSOR trending to 0.13%/0.43%/0.24% in 2Q21-to date, from a peak of 2.8%/1.9%/1.9% in 4Q18. Unsurprisingly, NIMs across Singapore banks have tumbled, creating a semi-permanent revenue gap until the rate cycle returns.
While we expect NIMs to recover as higher Fed rates eventually transmit into interest rates, we found that the sector tends to re-rate ~4-5 quarters prior to the actual Fed rate hike. Below, we articulate our findings from the rate hike cycles beginning FY04 and FY15.

There have been two rate hike cycles over the course of the past two decades. The first began in Jun 04, where the Fed rates were raised from 1%, peaking at 5.25% in Jun 06. During this cycle, we observed that the pick-up in NIMs across Singapore banks only kicked in ~3-4 quarters after the initial Fed rate hike in Jun 04, with DBS (SGX:D05) leading the pack given its higher ~50% proportion of CASA funding compared to peers’ ~30-35%.
A similar pattern ensued as Fed rates were cut from Sep 07 onwards, with DBS’s NIMs peaking comparatively earlier than peers’.
Meanwhile, share prices visibly re-rated from 2Q03 — ~4 quarters prior to the first Fed rate hike in Jun 04. Over 2Q-3Q04, the sector’s share price performance was mixed, with DBS outperforming the STI by 12%, UOB being market-neutral, and OCBC underperforming by 9%. See charts in report attached below.

The next rate hike cycle began in Dec 15, raising Fed rates from 0.25% to peak at 2.5% in Dec 18. In a similar fashion to the previous hike, NIMs started to really pick up ~5-6 quarters post the first Fed rate hike in Dec 15, with DBS leading the pack once again given its funding profile.
In terms of share price performance, the banks had started to re-rate as early as 3Q14 — ~5 quarters earlier than the first hike in Dec 15. However, the re-rating was short-lived as asset quality concerns surrounding the oil price crash in FY15 started to emerge. At the same time, the next Fed hike came one year later. Thereafter, share prices only re-rated in step with Fed rate hikes, as investors needed to be convinced of consequent hikes to come (and in quick succession), we believe. In 2H14, the financial sector outperformed the STI by ~7-19% before de-rating.

With banks signalling some stabilisation in asset quality amid the tapering off of government-led moratorium schemes, investors have correspondingly tuned down their expectations for hefty credit costs weighing on earnings this year.
As weaker NII was offset by the strength in treasury income and wealth management segments, the re-rating of the financial sector in early-2021 was compounded by investors piling into the reflation trade as 10-year US treasury bond yields rose (implicitly pressuring for higher short-end rates), and increasing COVID-19 vaccination rates across the region pointed to possible economic re-openings in the near term. As a result, the financial sector has outperformed the STI by ~4-8% year-to-date.
Notwithstanding a portion of the rate hike optimism being priced in, we think that a further re-rating is in order as price momentum gains on Fed hike newsflow.

We reiterate our Overweight stance on the sector – staying invested to reap the economic rebound ahead as social distancing measures are eased across the region while share price momentum from rate hike expectations sets in.
Trading at ~1x FY22F P/BV (1 standard deviation below 10-year mean), UOB (SGX:U11) remains our top pick of the sector as a key beneficiary of ASEAN economic re-openings, which we expect should close its valuation gap with peers given investors’ concerns on asset quality.
The MAS is due to announce its decision on whether or not to lift its dividend cap on banks pre-2Q21F earnings. We think that current conditions are ripe enough (sturdy CET1 ratios of ~14-15%, staggered government aid – job support scheme, financing line for SMEs – still in place, stabilising asset quality with portfolio of moratorium loans under control) to expect the cap to be lifted, but caution for some profit-taking as this news plays out.
A key downside risk is asset quality deterioration as a result of prolonged economic closures.
See

Andrea CHOONG CGS-CIMB Research | LIM Siew Khee CGS-CIMB Research | https://www.cgs-cimb.com 2021-06-23

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