SINGAPORE (June 29): The three Singapore banks reported double-digit y-o-y earnings growth for the first quarter. Harsh Modi, an analyst at JPMorgan who covers the banking sector for South Asia and Asean, expects the momentum to continue for the rest of the year.
For 1QFY2018, DBS Group Holdings reported a net profit of $1.52 billion, up 26% y-o-y and 25% q-o-q; Oversea-Chinese Banking Corp (OCBC) reported a net profit of $1.11 billion, up 29% y-o-y and 8% q-o-q; and United Overseas Bank announced a net profit of $978 million, up 21% y-o-y and 14% q-o-q.
In its results review and outlook, JPMorgan says it expects DBS to announce a net profit of $6.14 billion for FY2018, up 40% y-o-y. OCBC’s forecast earnings is likely to be $5.33 billion, up 30% y-o-y. UOB is expected to report $4.01 billion, up 21.8% y-o-y. JPMorgan’s estimates for DBS and OCBC are higher than Bloomberg’s consensus estimates by 4% and 12.9% respectively.
For FY2017, DBS reported a 4% rise in net profit to $4.37 billion; OCBC’s net profit for the same year rose 19% to $4.15 billion and UOB’s was 9% higher y-o-y to $3.39 billion.
As Modi tells it, once the banks got past the oil and gas non-performing loan (NPL) cycle in 2017, their share prices started to rally. The second part of the rally took place when their income and earnings started to show a rebound in growth. Over the past year, better net interest margins, steady loan growth and wealth management income spurred this growth.
All that is priced in, Modi reckons, which is why Singapore banks’ share prices have not pushed much higher in the second quarter. “In the last few months, Singapore banks have been range-bound after hitting a high in April. As expectations started playing out and got matched, investors started booking profits,” he says.
Rising local interest rates
The long-expected “pass through” from the tightening by the US Federal Reserve is finally materialising. The three-month Singapore Interbank Offered Rate and three-month Swap Offer Rate by which local banks price their loans, have risen about 40bps and 50bps respectively since January. The higher local Sibor and SOR rates are also partly due to tightening liquidity. The reason for lower US dollar liquidity is simply the end of quantitative easing and fewer US dollars sloshing around. Whenever dollar liquidity falls, the Singapore dollar weakens and Sibor and SOR rise.
Some economists expect the Singapore dollar to continue to weaken because of a host of negatives such as trade protectionism, financial market volatility, higher oil prices and emerging-market stress. The lower Singapore dollar nominal effective exchange rate (NEER) is likely to place upward pressure on SOR, they say.
Modi thinks rising interest rates are good for banks and he believes interest rates are set to move to even higher levels. “Sibor is moving up. Three-month Libor (London interbank offered rate) is 82bps above Sibor. That gives legroom for domestic Singapore dollar rates to go up,” he says.
The local banks’ loan growth is likely to hold up. DBS’s focus is expected to be on mortgages, and corporate loans that are likely to be booked out of Singapore. OCBC and UOB have a more regional footprint. For instance, OCBC is looking to the Greater Bay Area for growth. Its CEO Samuel Tsien said at a media briefing in June that he was expecting to double annual profit before tax from the GBA from $500 million to $1 billion by 2023. This increased earnings base will be supported by an annual 15% rise in loans in the GBA, from $35 billion currently to $80 billion by 2023.
OCBC’s 1QFY2018 loan growth is up 10% y-o-y and 4% q-o-q, ahead of the high single digit figure Tsien had guided earlier this year. “In the event of a global trade war, I think our high single digit loan growth expectation will still be achievable,” he had said during the bank’s 1Q results briefing.
Piyush Gupta, CEO of DBS, was similarly conservative. “We grew 2% [q-o-q] in the [first] quarter on loan growth and we’ll probably do roughly the same rate every quarter for the rest of the year, which would give 8% loan growth. I think, also, in a rising interest rate environment, it’s not clear to me whether loan demand slows down in the later part of the year or not. So, I think 8% guidance is probably fairly accurate at this point.” (Rising interest rates, although good for loan yields, could stress some smaller companies and raise their credit costs.)
The local banks’ wealth management businesses continued to perform well in 1Q. Despite volatile markets given higher yields (on fixed income and risk-free rates) and the developing trade war, the Asian wealth management business’ strong showing is expected to continue. “Our JP Morgan Global Banks equity team did an in-depth study on wealth management and their conclusion was the high-net-worth wealth management business, especially in Asia, is one of the most attractive segments to be in, and this is where the Singaporean banks have built up a formidable lead and they are competing with the best. In fact, in some cases, they are the best,” Modi observes.
DBS, which is ranked among the top 10 private banks by assets under management in Asia, reported a 28% rise in wealth management income to $663 million for 1Q. Total AUM, including in the mass affluent sector, rose 22% to $208 billion.
OCBC reported a 22% rise in wealth management income to $727 million. Bank of Singapore, OCBC’s private banking unit, saw AUM rise 19% y-o-y to US$102 billion ($139 billion). This is not comparable to DBS’s AUM as it reflects very-high-net-worth private banking customers only.
Lower provisions, high capital ratios
DBS has guided on credit costs normalising to the 25bps-to-27bps range. Gupta is reluctant to guide that there could be write-backs, though. “I’m still not entirely sure what the interest rate impact might be on some of the portfolios and that’s why we are holding the guidance. If the interest rate impact on the unsecured consumer and SME (portfolio) is really benign, then we could do much better than 20bps. But we are holding the guidance with the expectation that there will be a pickup in cost of credit on account of the interest rate increases; it’s just very hard to fathom how much that might be,” he said during the 1Q results briefing.
The local banks are among the highest capitalised and highest rated banks globally. No surprise then that Modi does not consider capital ratios an issue. “There is clarity from Basel and that gives comfort to all the banks so that they don’t have to worry too much about capital beyond where they are.”
Based on the ratio of risk-weighted assets (RWA) to total assets, all three banks have ratios of around 60%, which is relatively high, Modi says. In addition, all three local banks have elevated common equity tier-1 (CET1) ratios of at least 13%, which is twice the minimum regulatory requirement.
In its 1Q results briefing, DBS CFO Chng Sok Hui indicated that the bank’s CET1 ratio will be 13% after the payment of its final and special dividend, which together amount to a payout of $2.81 billion. However, if earnings growth remains strong, capital will continue to build up from the accretion of retained earnings. Based on JPMorgan’s forecast earnings of $6.14 billion, DBS could easily pay out more than 50% of its net profit and still have significant retained earnings.
OCBC’s CET1 is likely to build up from retained earnings, eventual optimisation of OCBC Wing Hang’s RWA, and accretion from the sale of a 33.33% stake in Hong Kong Life Insurance by OCBC Wing Hang to First Origin International for HK$2.37 billion ($411.1 million) in cash.
What could go wrong?
Cost of funds is a concern for Modi. For Singapore banks, cost of funds such as deposits has moved up 12bps in the last six months. Higher deposit costs may lower the benefits that banks get from charging more for their loans. “If cost of funds keeps on increasing, we may get a negative surprise. As of now, the deposit franchise of Singapore banks gives me comfort,” he says.
It is the banks’ overseas operations that could cause their overall cost of funds to rise. For instance, DBS attributed the 10bps rise in its cost of funds to its Hong Kong unit. “In Hong Kong, for example, we still have a fair amount of fixed deposits. So when Libor or [the Hong Kong Interbank Offered Rate] go up, our funding costs in deposits go up as well,” Gupta says. The important thing is for loan yields to be higher than the cost of fixed deposits, he adds.
In the property sector, the Monetary Authority of Singapore and the government have put in place several property cooling measures since 2011. These include loan-to-value ratios, duration of loans and total debt servicing ratios. There are also anti-speculative measures such as additional buyers stamp duty and sellers stamp duty for individuals, and additional conveyancing stamp duty for property holding entities. MAS has stipulated that banks must apply a specified medium-term interest rate of 3.5% for housing loans for new borrowers. This is above the actual cost of home loans, currently a tad below 2%. Hence, Modi argues that an asset-quality problem is unlikely for Singapore banks on the property front.
On the other hand, during DBS’s results briefing, Gupta sounded a cautious note given the developing trade war. “I guess the trade war is on everybody’s mind. Our own sense is that the broader trade issues, tariff barriers on steel, aluminium, cars and so on, will have some impact. But unless there’s a big crisis of confidence, we don’t see them as having a real material impact on the overall business climate,” he says. “I think the impact on the technology sector needs to be watched. Because actions in the US on the back of intellectual property concerns about Chinese companies could have [broader] ramifications. That could even get into the supply chain of the tech sector. It’s hard to [ascertain] what the impact of that might be, but my own sense is that you will see some more noise in the technology sector, although, overall, I don’t expect the trade wars to materially derail the economy.”
Since early May, banks’ share prices have experienced volatility as both the US and China have ramped up trade war rhetoric. DBS and OCBC have larger footprints in Greater China, owing to their respective acquisitions of Dao Heng Bank in 2002 and Wing Hang Bank in 2014.
Greater China accounted for 33% of DBS’s profit before tax, and 25.5% of total assets. Greater China (including OCBC Wing Hang) contributed 21% to OCBC’s profit before tax. “DBS and OCBC benefit more from growth within Greater China. However, they will be affected more if trade conflicts escalate, resulting in a broader slowdown at China’s coastal provinces,” says UOB Kay Hian in a recent note to its clients.
The esoteric and ephemeral positions taken by the current US administration continue to reverberate across global markets. On June 25, US media reported that the US intends to impose investment restrictions on countries that try to steal its technology. US Treasury Secretary Steven Mnuchin said in a tweet that a forthcoming statement on investment restrictions is “not specific to China, but to all countries that are trying to steal our technology”.
Some economists and strategists are beginning to draw similarities between the current economic climate and the Asian financial crisis, where emerging-market currencies weakened significantly against the US dollar. This, in turn, created a crisis for corporates and banks with US dollar debt.
Modi rubbishes this view. “Our base case is not even close to 2013, and 1997 is far away. The regulators have taken so many measures in terms of strengthening reserves and monetary policy tools, regulations, banking measures and macro prudential measures, that we are comfortable,” he says. Of course, whenever there is a dollar shortage there is always volatility, he continues. “Our base case is [the banks should be able to] navigate [the volatility], and their underlying strength and resilience are intact.”
In a report dated May 7, JPMorgan has DBS as one of its highes t-conviction picks across Asia banks. “The stock offers a combination of tech savvy, revenue beta, cost discipline, high yield and relatively undemanding valuations, which sets it up for continued outperformance over the next 12 to 18 months,” the report says. “Our December 2018 price target of $34 is based on our dividend discount model, assuming a fair price-to-book value multiple of 1.65 times, with a normalised ROE [return on equity] of 13.6%, a risk-free rate of 3.50%, cost of capital of 9.50%, and a growth rate of 3.25%.”
DBS last traded at a price-to-book ratio of 1.45 times based on a book value of $18.29 as at March 31.
