DBS Group Holdings hit a new all-time high of $35.42 on Jan 11. Year to date, the local banking behemoth is up 8%. Oversea-Chinese Banking Corp (OCBC) has rallied 6.2% since the start of the year but at $12.11, it is not at an all-time high. Back in 2018, OCBC had traded above $13.73. United Overseas Bank (UOB) is up 8.9% since the start of the year. UOB has been ahead on various digital aspects such as launching its digital bank UOB TMRW across Asean. It has also not written back any of its expected credit loss (ECL) 1 and 2 provisions, leaving multiple avenues to boost earnings.

Three key trends are likely to affect the way banks perform. In a note at the end of 2021, RHB Research summed them up as cyclical recovery, rising interest rates and fee income growth. If the pandemic transitions to an endemic phase, we should expect a cyclical recovery, RHB argues.

The banks themselves are positive about the opening of borders and business momentum picking up. All three banks communicated that loan growth is likely to moderate from the high single-digit loan growth experienced last year.

“Loan growth is expected to be moderately higher than the pre-pandemic average of 5%. This would underpin our projection of a healthy 6% y-o-y recovery in net interest income after two years of decline,” RHB says. In addition, RHB expects limited impact from property cooling measures.

In a Jan 5 update, Macquarie Research says recent property cooling measures could temper retail loan growth assumptions which would translate into 4% to 4.5% growth compared to a previous forecast of 5% growth for 2022.

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Rising interest rates, tighter money

There are two aspects to tighter money — the quantitative easing (QE) taper and rising interest rates. As communicated in the Federal Open Market Committee (FOMC) meeting on Dec 14–15, 2021, the US Federal Reserve has reduced the pace of bond purchases. The accelerated pace of unwinding indicates that the QE taper is likely to be completed by March this year. The flow-through from the end of QE is likely to be felt through higher yields on government bonds, which, in turn, impact yardsticks such as risk-free rates, with indirect effects on discount rates used to value company valuations.

On the interest rate front, so far, the Fed has communicated the likelihood of three rate hikes this year to curb inflationary pressures. Yet, Goldman Sachs is suggesting that the Fed could effect four rate hikes this year. All three banks are likely to be beneficiaries.

Based on banks’ guidance, the interest income enhancement from a 100bps increase for a 12-month period is estimated at $2 billion for DBS, $800 million for OCBC and $500 million to $660 million or a 12bps–16bps net interest margin expansion for UOB, according to RHB’s report.

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In a research note published on Jan 5, Macquarie gave a summary of their views on how Singapore banks will perform as the rate cycle plays out. Macquarie is expecting US rate hikes to start from 2Q2022. Some US economists are expecting a first rate hike in March.

As a result of the increasingly hawkish outlook, Macquarie has upgraded Singapore banks’ earnings estimates by 0.4% to 4.7% for FY2022 and FY2023. Its top pick is UOB followed by DBS which is most sensitive to rate hikes. The Singapore banks are likely to have an average 6bps positive impact on NIM over a 12 month period, in response to each 25bps US rate hike, Macquarie estimates.

“Analysing tightening cycles over the past 20 years, on average, around 40% of the share-price performance was delivered as the yield curve steepened (ahead of the Fed), 40% during the period the Fed is hiking rates and 20% during the period when the banks report higher NIMs,” Macquarie says. The key variables to watch this time are the CPI normalising into 4Q2022 and China’s growth which needs to be above 5% as it is of importance for the region, Macquarie adds.

Raising earnings forecasts

Citi is raising its earnings forecast for DBS by 12% on higher NIMs since DBS has guided that 100bps in US interest rate hikes could add $2 billion to net interest income. ”The bulk of the NIM sensitivity is in SGD as DBS enjoyed a sector-leading SGD CASA (current account savings account) ratio of 94%, with healthy CASA ratios in HKD (77%) and USD (65%),” Citi says in its update.

“We took a blended sensitivity to the US dollar rate, with some modelling assumptions around how other interest rates are correlated and how much CASA could convert to fixed deposits. In the past, we guided to $14 million per basis point, with the impact spread over a few years. But with the profile we have today, we find that the bulk of the $18 million–$20 million crystallises within the first year. So, if we see a 100 basis point US dollar rate hike, we are talking about a $2 billion increase in net interest income, the bulk of which will be in the first year,” Citi explains, referring to its DBS forecast.

DBS is most levered of the three large Singapore banks to rising rates, due to its large low-cost deposit base and sizeable presence in Hong Kong, says Bloomberg Intelligence. “The pre-tax profit of DBS could get a 7%–8% boost in the year following each 25 bps rise in US benchmark interest rates, more than the 4%–5% for OCBC and UOB, based on our sensitivity analysis, assuming DBS sustains double-digit loan growth and some negative migration to time deposits,” Bloomberg says.

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Citi has raised UOB’s earnings forecasts 6%-11% on higher NIMs. UOB has guided that 25bps move in short-term rates may change NIMs by 3bps–4bps. “UOB’s NIMs are sensitive to rising rates with around 65% of group loans denominated in SGD/ USD. The bulk of the NIM sensitivity is in SGD where UOB has less than 60% SGD CASA ratio, with a group CASA ratio of around 56%. UOB previously guided NIM sensitivity on a blended basis, whereby a 25bp movement in short-term rates could move NIM by 3-4bps. By currencies, SGD is likely to contribute around half, the rest from the non-USD book. For USD, the combination of modest CASA mix and shorter-duration assets means a proportionately lower contribution in a rising interest rate backdrop,” Citi elaborates.

Earnings at OCBC could be as much as 12% higher than Citi’s original forecast on higher NIMs, the US bank says. OCBC has previously guided that a 100bps change in interest rates could imply an impact of some $800 million on net interest income. “OCBC’s NIMs are sensitive to rising rates with 72% of group loans denominated in SGD/ USD/HKD. The bulk of the NIM sensitivity is in SGD where OCBC has a 78% SGD CASA ratio, with a group CASA ratio of 63%,” Citi says.

Inflation and credit costs

These higher earnings forecasts for the banks are based on inflationary pressures but with inflation remaining benign. “A little inflation is helpful; too much can harm,” Macquarie says.

One common concern among investors is if rising inflation will erode purchasing power and negate the improving asset quality trend. A study by ratings agency Fitch on US banks’ performance over 37 years concluded a CPI between 1%–3% was optimal for loan losses and banking return on assets (ROA), with a CPI of more than 4% lifting loan losses, Macquarie points out.

For now, asset quality and credit costs are manageable. In fact, both DBS and OCBC have had recoveries from previous provisions which have been written back.

Bloomberg says its model, based on consensus forecasts, estimates credit costs of 12–23 bps in 2022 and 2023 for the banks. “To offset the full-year revenue benefit from a 100-basis-point increase in interest rates, the credit cost of DBS, OCBC and UOB would have to increase to about 55-63 bps, much higher than the long-term average of 30-39bps over the past 20 years,” Bloomberg says.

“DBS, whose net interest income benefits more from Fed Fund rate hikes than local peers, has a strong earnings buffer to defend against asset quality risk. Singapore banks may also have the benefit of a considerable time lag of at least three quarters before asset quality starts to deteriorate on higher borrowing costs,” Bloomberg adds.

Wealth management could continue to drive fee income, RHB says. Rising affluence, strong household balance sheets and WealthTech could underpin fees. “Fee income growth would also be supported by a recovery in cross-border activities, while the introduction of digital solutions for wholesale customers should further spur growth in fees from transaction services. We believe low double-digit growth in net fee income remains achievable in FY2022,” RHB says.

RHB’s top pick is UOB. “Its 9M2021 results underscores its growing fee income base (wealth management and loan-related), healthy asset quality with robust general provision buffers (with loan loss coverage of 106%) and the resumption of a 50% dividend payout,” RHB says.

It has a target of $33.50. DBS of course benefits most from the interest rate cycle, and RHB has a target of $40.40 for Southeast Asia’s largest bank.

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Results wrap: Banks navigate interest rates, inflation, growing headwinds