SINGAPORE (Jan 3): Singapore banks are expected to benefit from the increase in interest rates along with the Fed’s rate hike in December.

But there is a flip side to higher interest rates for local lenders, says RHB’s analyst Leng Seng Choon.

Leng points out that non-performing loans (NPLs) rose to 12% in 1998 while the country experienced higher interest rates and weaker currencies regionally.

On the other hand, NPLs only increased to 2.4% in 2008, as central banks kept interest rates low.

Still, Leng believes the higher interest rates expected this year would not impact NPL ratios “significantly”.

However, credit costs would continue to increase as the value of collaterals placed by oil and gas companies are expected to be eroded during the year.

Looking ahead, Leng anticipates NPLs to continue rising despite the improvement in the oil and gas outlook.

That’s because the brokerage had noted signs of a slowdown in payments from the small and medium sized enterprises as early as 3QFY16.

“[It] makes us believe that there is an increased likelihood of increase in SME segment NPLs during 2017,” said Leng, adding that the increase NPLs would results in higher provisions for all the banks.

To that end, Leng recommends DBS Group with a buy rating and a target price of $18.38, “for being the most sensitive to a rise in interest rates”. By RHB’s estimates, DBS’s earnings could increase by 1.7% for every 0.1 percentage point increase in the Singapore Interbank Offer Rate, arising from the higher interest rates announced by the Fed. For OCBC and UOB, earnings would only increase by 0.8% and 1.2% respectively.

On top of that, RHB recommends Singapore Exchange for its growing derivatives business that would likely lift the average daily value of securities listed on the exchange, and improve the bourse’s earnings growth.

Shares in DBS, OCBC, UOB and SGX are trading at $17.17, $8.87, $20.05 and $7.10 respectively.