Singapore Banks - UOB Kay Hian 2022-06-28: Upside From Higher Interest Rates Vs Perceived Threat From Looming Recession

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Singapore Banks - Upside From Higher Interest Rates Vs Perceived Threat From Looming Recession

• The Fed accelerated the tempo of rate hikes to quell inflationary pressure. We expect another 75bp hike on 27 July but the intensity of hikes could ease after the FOMC meeting on 21 Sep 22. The resilient labour market and strong households’ and companies’ balance sheets in the US ensure that potential economic downturn, if it materialises, would be mild.
• BUY DBS (SGX:D05) (Target price: S$38.78) and OCBC (SGX:O39) (Target price: S$14.95) for their 2022 dividend yields of 4.8% and 4.9% respectively.
• Maintain OVERWEIGHT.

Fed’s renewed fervour to clamp down on inflation.

• The Fed has accelerated the tempo of interest rate hikes to quell inflationary pressures. It hiked the Fed Funds Rate by a massive 75bp to 1.50% after the Federal Open Market Committee (FOMC) meeting on 15 Jun 22. Based on the Fed’s dot plot, the median projected path for Fed Funds Rate would hit 3.4% by end-22 and 3.8% by end-23.
• The forecast translates to four hikes totalling 200bp in 2H22, and we expect another 75bp hike on 27 July. The rate hikes are front-loaded in 2022 and the intensity of rate hikes could ease after the FOMC meeting on 21 Sep 22.

Interest rates in Singapore have moved up in tandem.

• Higher inflation and the Fed’s intervention have caused short-term interest rates to surge. The US yield curve has flattened, indicating a slowdown in economic growth. Fortunately, the 10-year – 2-year term spread has stayed marginally positive at 0.1%. The current short-end of the yield curve implies forward short-term interest rates at 2.7% for 1-year, 3.4% for 2-year and 3.4% for 3-year.
• 3-month SIBOR (Singapore Interbank Offered Rate) and 3-month Compounded SORA (Singapore Overnight Rate Average) have risen 112bp and 53bp respectively to 1.56% and 0.72% in 1H22.
• UOB Global Economics & Markets Research forecasts 3-month SIBOR and 3-month Compounded SORA to reach 2.75% (+2.31ppt y-o-y) and 2.29% (+2.10ppt y-o-y) respectively by end-22.

Core PCE inflation is receding but at an anaemic pace.

• US core PCE (Personal Consumption Expenditures) inflation peaked at 5.3% in Feb 22, the fastest pace in 30 years, overshooting the Fed’s target of 2.0%. Since then, core PCE inflation eased 0.3ppt m-o-m to 4.9% in Apr 22. The easing of inflationary pressure coincided with the pick-up in economic activities after daily new cases of the Omicron variant subsided. Implied inflation based on 5-year Treasury Inflation-Protected Securities (TIPS) moderated from a peak of 3.6% in mid-April to the current 2.8%.
• Chairman Jerome Powell said that the Fed needs to see compelling evidence with inflation consistently abating over a couple of months before it pulls back from aggressive rate hikes. The Fed needs to prevent expectations of higher inflation becoming unmoored. President of Cleveland Fed Loretta Mester cautioned that it will take a few years to bring inflation back to 2%.

US economy slipping into recession is not a certainty.

• The US economy is resilient with a strong labour market and unemployment rate near a 50-year low of 3.6% in May 22. Companies added 390,000 jobs while average hourly earnings grew 5.2% y-o-y in May 22. There are 2.1 job openings for every unemployed worker. The resilient labour market supports continued growth in domestic consumption to weather the series of interest rate hikes.
• Households’ and companies’ balance sheets are strong, ensuring that the potential economic downturn, if it materialises, would be mild. The probability of a US recession in 2023 is only 4.1% based on an indicator developed by the New York Fed.

Quantitative tightening (QT) has already begun.

• Quantitative tightening (QT) commenced on 1 Jun 22. Monthly cap for treasury securities was initially set at US$30b and increases to US$60b after three months. Monthly cap for mortgage-backed securities started at US$17.5b and increases to US$35b after three months.
• The pace of QT is much faster compared to the monthly cap of US$50b for the last QT conducted in 2018 and 1H19 when the Fed’s balance sheet contracted 16%.

Manageable impact from QT during 2018 and 1H19.

• We analyse the impact of QT on the share price performance of Singapore banks during 2018 and 1H19, the only historical precedent of QT. We observed that banks’ share prices gained 24.1% and outperformed the STI by 15.9% over three quarters during 2H17 (the 6 months prior to QT) and 1Q18 (commencement of QT).

Maintain OVERWEIGHT on Singapore banks

• Banks gain bargaining power as liquidity is tightened due to higher interest rates and QT. They benefit from NIM expansion with DBS being the most sensitive to higher interest rates. The Russia-Ukraine war exacerbates higher inflation, which could keep bond yields higher for longer.
• OCBC and UOB benefit from reorientation of supply chains towards ASEAN countries.
• BUY DBS (Target price: S$38.78) and OCBC (Target price: S$14.95) for their 2022 dividend yields of 4.8% and 4.9% respectively.

Assumption Changes

• We raised our 2023 earnings forecast for DBS by 7% and OCBC by 3%. Our earnings revisions are tempered by expectations of higher credit costs of 27bp for DBS (previous: 22bp) and OCBC (previous: 24bp) due to slowdown in economic growth in 2023.
• We have factored in US Fed Funds Rate reaching 3.25% by end-22 and stabilising thereafter in 2023.

DBS (SGX:D05)

• We expect DBS (SGX:D05)’s NIM to expand by 9bp to 1.54% in 2022 and 43bp to 1.97% in 2023. We forecast earnings growth of 15.9% in 2023 and 9.7% in 2024.
• We expect dividend of S$1.44 from in 2022 and S$1.48 from DBS in 2023, which represents dividend payout ratios of 56.4% and 50.0% respectively. DBS provides dividend yields of 4.8% for 2022 and 4.9% for 2023.
• Our target price of S$38.78 for DBS is based on 1.69x 2023F P/B, derived from the Gordon Growth model (ROE: 13.3%, COE: 8.5% (previous: 8.25%), growth: 1.5%).
• See
  • DBS's Share Price,
  • DBS's Target Price,
  • DBS's Analyst Reports,
  • DBS's Dividend History,
  • DBS's Announcements,
  • DBS's Latest News.

OCBC (SGX:O39)

• We expect OCBC (SGX:O39)’s NIM to expand by 6bp to 1.61% in 2022 and expand 27bp to 1.88% in 2023. We forecast earnings growth of 11.0% in 2023 and 6.1% in 2024.
• We expect dividend of S$0.56 in 2022 and S$0.60 from OCBC in 2023, which represents dividend payout ratio of 50.2% and 48.4% respectively. OCBC provides dividend yield of 4.9% for 2022 and 5.3% for 2023.
• Our target price of S$14.95 for OCBC is based on 1.20x 2023F P/B, derived from the Gordon Growth model (ROE: 10.1%, COE: 8.5% (previous: 8.25%), growth: 0.5%).
• See
  • OCBC's Share Price,
  • OCBC's Target Price,
  • OCBC's Analyst Reports,
  • OCBC's Dividend History,
  • OCBC's Announcements,
  • OCBC's Latest News.

Sector Catalysts

• NIM expansion in 2022 and 2023, driven by upcycle in interest rates.
• Strengthening of economic growth driven by easing of safe distancing measures and reopening of international borders after Singapore has weathered the Omicron variant.

Sector Risks

• Escalation of the Russia-Ukraine war beyond Ukraine.
• Geopolitical tension and trade conflict between the US, China and Russia.

Jonathan KOH CFA UOB Kay Hian Research | https://research.uobkayhian.com/ 2022-06-28

SGX Stock Analyst Report BUY MAINTAIN BUY 38.78 UP 37.550

BUY MAINTAIN BUY 14.95 DOWN 15.050