SINGAPORE (Dec 20): In the past 10 years, the local banks have given investors decent returns. DBS Group Holdings’ total shareholder returns stand at 157%, or a compound annual growth rate of 9.9%. Oversea-Chinese Banking Corp (OCBC) has returned 84.6% in the past decade, for a CAGR of 6.3%; and United Overseas Bank would have returned 99% in 10 years, or a CAGR of 7%. All three outperformed the Straits Times Index’s CAGR of 4.7% in the same period.

In the short term, banks are likely to remain profitable despite an economic slowdown in Singapore triggered by the US-China trade war, political unrest in Hong Kong and the lowering of interest rates by the US Federal Reserve thrice this year. Slower GDP growth usually results in lower demand for loans. Low interest rates have a negative impact on banks because they pressure their net interest margins. Slow loan growth and slimmer NIMs are negative for banks.

Fee income rises

On the flip side, the local banks have altered the make-up of their non-interest income. All three banks are focusing on fee income and wealth management. In 3QFY2019, Bank of Singapore, the private banking subsidiary of OCBC, grew its assets under management by 5% y-o-y to US$110 billion (as at Sept 30). OCBC’s fee income rose 10% y-o-y and 6% q-o-q to a new high of $550 million.

In 3QFY2019, DBS’s wealth management AUM (as at Sept 30) grew 9% y-o-y to $230 billion (DBS includes its Treasures customers in its AUM. )DBS’s fee income was also at a new quarterly high of $951 million.

According to a recent Maybank-Kim Eng report, 10 years ago, trading and investment securities contributed more than half of non-interest income for Singapore banks. In the nine months to Sept 30 (9M2019), this had shrunk to 44%, with fee income taking its place.

“This post-[global financial crisis] structural change should improve the visibility of non-interest income. Add to this an extra layer of stability, with fee origination being driven largely by wealth management and retail. The sector’s increasing retail focus on both interest and non-interest income should keep credit charges in check better than wholesale-heavy banking systems regionally,” Maybank-Kim Eng says in an update on Dec 16.

Slower earnings growth in 2020

DBS, OCBC and UOB continue to report substantial net profits in 3QFY2019 of $1.629 billion, $1.172 billion and $1.118 billion respectively.

During their third-quarter results briefings, the banks articulated that they were expecting very modest growth in 2020. DBS is guiding for low single-digit loan growth, NIM that is seven basis points lower than the 1.9% achieved this year and credit costs at 21bps. OCBC has guided for low single-digit loan growth in 2020, along with the narrower NIM that OCBC has achieved this year. For the first nine months, NIM averaged 1.77%. UOB expects mid-single-digit loan growth next year, NIM that is five to 10bps lower than the 1.79% achieved so far this year and credit costs in the range of 20 to 25bps.

With continued, albeit slower, earnings growth, the local banks should be able to maintain their dividends, analysts say. Interestingly, OCBC had the highest common equity tier 1 (CET1) ratio at 14.4%. In its 3QFY2019 results briefing, CEO Samuel Tsien declined to comment when asked whether OCBC planned on buying Indonesia’s Bank Permata despite numerous wire service reports. Eventually, Bangkok Bank announced the planned acquisition of Bank Permata.

That leaves OCBC with excess capital. In addition, OCBC Wing Hang is likely to move to an internal ratings-based approach for credit risk. This enables the bank to model its own inputs for calculating risk-weighted assets from credit exposures to retail, corporate, financial institution and sovereign borrowers, subject to supervisory approval. The lower the risk-weighted assets, the higher the capital ratio. OCBC could pay out more in dividends if it so chooses.

UBS had said in November that “if the M&A opportunity [for OCBC] doesn’t materialise, capital might be returned to shareholders and we believe more clarity on this might emerge by year-end results”.

Well prepared for external shocks

Further comfort for the local banks’ performance comes from the Monetary Authority of Singapore’s Financial Stability Review for November 2019 released on Nov 28. MAS announced its industry-wide stress test (IWST) results, which show that banks in Singapore have the capacity to withstand severe shocks.

Under the stress test, domestically systemically important banks (D-SIBs) were required to assume a protracted recession centred on a major slowdown in China and disruptions in global financial markets amid ongoing US-China trade tensions and weak global trade. These external shocks were assumed to impact Singapore via a contraction in economic growth, rising unemployment and substantial declines in property prices.

“The stress test results showed that all banks would remain solvent, with their total capital adequacy ratio remaining above MAS regulatory requirements,” the MAS review says.

With the rise of China, and Asean eventually emerging as a homogenous market through the Asean Economic Community in the next decade, economic growth in the region should continue, with the local banks benefiting.

Maybank-Kim Eng says its top pick is UOB for its conservative balance sheet management. “For a shorter time horizon, we like DBS for potential higher dividends, given CET1 levels in excess of regulatory and management safety requirements.”

As we enter the new decade, OCBC’s price-to-book is near a decade low (see chart), an indication of undervaluation.