SINGAPORE (Aug 12): Slowing global growth and uncertainties over the escalating trade war, tech supply chain, China and Hong Kong have all taken their toll on the share prices of the three local banks — DBS Group Holdings, Oversea-Chinese Banking Corp and United Overseas Bank. Interestingly, both DBS and UOB are still ahead (see Table 1) in terms of price gains, and OCBC is unchanged since the start of the year. Of course, at one point, the banks had double-digit share-price gains, with DBS up 20% since Jan 2.

In 2QFY2019 and 1HFY2019, all three banks reported net profit levels that were above expectations. DBS’s net profit for 1HFY2019 rose 12% y-o-y to $3.25 billion; OCBC’s increased 6% y-o-y to $2.45 billion and UOB’s gained 8% y-o-y to $2.22 billion. Return on equity (ROE) for DBS, OCBC and UOB stood at 13.7%, 11.7% and 12% respectively.

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OCBC and UOB raised their dividends while keeping their dividend payout ratios within their targeted 40%-to-50% range. OCBC’s payout ratio rose to 43% from 40.56% in FY2018, with IHFY2019 dividend per share increasing by five cents, or 25%, to 25 cents. Last year, OCBC raised its 2HFY2018 DPS to 23 cents for a full-year dividend of 43 cents.

UOB’s payout ratio fell to 42.1% from 51% in FY2018, but dividends rose five cents to 55 cents in the first half. In addition to its core dividend, UOB also paid out a special dividend last year. DBS’s payout ratio also fell as net profit rose in 1HFY2019, and dividends stayed flat at 30 cents a quarter, or $1.20 for the year.

As was the case last year, OCBC is also offering a very generous scrip dividend in lieu of a cash payout in 1HFY2019, which will be set at a 10% discount to the average of the daily volume-weighted average prices during the price determination period on Aug 15 and 16.

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OCBC can afford to be generous with dividends this year because its common equity tier 1 (CET1) ratio in 2QFY2019 is now the highest among the three banks, at 14.4% compared with 13.2% a year ago, and 14.2% in 1QFY2019 (see Table 2). OCBC has been accumulating capital through the scrip dividend programme.

During a results briefing on Aug 2, OCBC chief financial officer (CFO) Darren Tan indicated that the accumulation of capital was the result of higher retained earnings, boosted by the scrip dividend, which offset high risk-weighted assets.

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Among the banks, OCBC accumulated the most capital; its CET1 grew 3.97% q-o-q and more than 13% y-o-y, an indication that it has the potential to continue raising dividends. But will it? The answer is probably not as much as investors had hoped.

In the immediate future, OCBC is unlikely to accumulate as much capital as it did in 2QFY2019. “Any increase in capital now will be incremental; I do not see  capital increasing beyond our requirement,” says Samuel Tsien, CEO of OCBC. “In the event that we do not see active deployment of capital, we will find ways to return it to shareholders. In the event that we find market opportunities, we will take them. It depends on the magnitude of the market opportunities.”

With OCBC’s current CET1, it could make an acquisition of around $2 billion, according to a recent UBS report. “The potential M&A is likely to bring down CET1 to an optimum level (we believe 13.5%), which implies a $2 billion acquisition, a little less than half the size of the Wing Hang acquisition,” UBS says in the report.

“In choosing market opportunities, we have to make sure the culture of the target fits [into that of] OCBC. Secondly, the profile of its concentration (such as its businesses and geographies) fits into the profile of OCBC. If we find an opportunity, we would like to look for scale and scope,” Tsien says.

In terms of geography, China is very important to OCBC because it generates so much economic activity, Tsien says. He adds that more will be revealed on OCBC’s Greater China strategy during a trip to Macau with analysts and members of the media on Aug 13 and 14.

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Singapore’s hub economy shields banks’ earnings

All three banks showed net profit growth that was much in excess of Singapore’s GDP growth in 2QCY2019, which was up 0.1% y-o-y and down 3.54% q-o-q. “Singapore has a lot of activities that do not belong to the city state, and that Singapore banks are handling, such as wealth management. Singapore’s is a hub economy and most of the activities that the banks do are not directly related to Singapore but are related to the hub [status], and that allows banks to deliver higher growth than that in the domestic market,” Tsien says. “Our investments in overseas markets have also helped to shield us from the slowdown.”

On the organic front, Tsien is guiding for mid-single-digit loan growth for this year compared with last year and net interest margin to be one basis point (bp) higher in 3QFY2019 versus 2QFY2019’s 1.79%, and 4QFY2019 to be flat. That points to a higher NIM in 2019 than in 2018. What happens next year depends on cues from the US Federal Reserve, which is on an easing path.

While the banks themselves and analysts are expecting lower levels for the Singapore interbank offered rate and the swap offer rate, there are times when a weaker Singapore dollar can keep these rates elevated.

At UOB, CEO Wee Ee Cheong has guided for high single-digit loan growth. Maybank-Kim Eng is now forecasting an 8.8% y-o-y growth in loans in FY2019. Most of this growth is likely to be from UOB’s regional footprint, which it has studiously built up. The bank has just opened a second branch in Hanoi, after it was awarded a foreign-owned subsidiary bank licence. It is also planning to launch its digital bank TMRW in Vietnam, most likely after the launch in Indonesia.

“We are focusing on better-quality loans in Southeast Asia, as the market is still uncertain. These would be consumer and housing loans in Thailand, and Indonesia, where [system loan] growth is still in the double digits,” Wee says.

UOB’s NIM is likely to be 1.8% for the year, Wee says. CFO Lee Wai Fai says the bank has brought its funding costs lower by running off some expensive deposits. Allowances fell 15% y-o-y and credit costs on impaired loans were low at 12bps. Lee says: “We think credit costs will go up slightly in the next two quarters, [but] we can well manage this in our models.”

DBS is guiding for mid-single-digit top-line growth in total income. However, it has the highest NIM among the local banks and its cost-to-income ratio is the lowest. Costs such as further tech investment can be contained, for instance. In addition, during a results briefing on July 29, DBS CEO Piyush Gupta indicated that there is an opportunity for some write-backs from its non-performing loans in the offshore and marine segment, and this could boost DBS’s bottom line.

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Dividends can be sustained

In a nutshell, despite the trade war and market volatility, the higher dividends that the banks are paying their shareholders can be sustained. Already, dividend payout ratios are lower, as dividends are either stable or increasing but net profits are rising at a faster rate.

The three banks have carved out different regional and business strategies that are best suited to their capital structures to deliver double-digit ROE and higher earnings.

In the meantime, with the current market volatility, some of the banks’ price-to-book valuations look attractive (see Charts 1 to 3). While it is difficult to gauge when market volatility will end, investors have to judge for themselves when to invest (or sell), based on their risk profiles and the attractive yields the banks are trading at.

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