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Banks’ earnings rising on loan growth, fees and write-backs

Goola Warden
Goola Warden11/11/2021 02:24 PM GMT+08  • 7 min read
Banks’ earnings rising on loan growth, fees and write-backs
Banks earnings should continue to rise in 2022 on loan growth, fees, and write-backs
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Since the local banks announced their 3QFY2021 ended September results, the stock prices of DBS Group Holdings, Oversea-Chinese Banking Corp (OCBC) and United Overseas Bank (UOB) have gone up by less than 1%, 1% and 3% respectively as at Nov 8.

The price movement is a reflection of how investors perceive the banks’ third-quarter results. Hence, if Covid-19 vaccination rates continue on their trajectory and regional economies recover, banks are the best proxy for a recovery.

Operationally, UOB recorded the most gains in net interest income. This is reflected in its loan growth which is 9% higher y-o-y and 3% higher q-o-q. However, loan growth uses up capital. Hence, UOB’s risk-weighted assets (RWA) rose 5% q-o-q compared to DBS’s RWA which was 2.3% higher q-o-q and OCBC’s RWA which was 2.8% higher q-o-q. As a consequence, in 3QFY2021, UOB’s common equity tier 1 (CET1) ratio fell to 13.5% from 14.2% a quarter ago while OCBC’s CET1 ratio also declined to 15.5% from 16.1% a quarter ago.

Both OCBC and UOB pay dividends twice a year — in the second and third quarters. Hence, this affects CET1 as dividends are paid from retained earnings. DBS pays its dividends quarterly and its CET1 is affected in the second quarter because it pays the 1Q and 4Q dividends in the second quarter.

Is UOB’s lower CET1 a concern to investors? Lee Wai Fai, group CFO of UOB, says he expects the banking group’s CET1 ratio to remain stable at 13.5%. “We can plan and sustain our organic growth strategy keeping CET1 ratio at this level and improve our return on RWA (RoRWA) by driving [up] fee income. We’ve also locked-in capital in our [regional] subsidiaries that have not been utilised,” Lee explains.

“We want to grow quality loans. Our retail and wholesale [banking] strategy is not just about loan growth but getting fees to come in to grow RoRWA,” he continues. UOB has plans to double its fee-based income by 2026, which will provide sustainability of returns to generate capital, which in turn can be used to grow loans. “Loans growth will be 5%–6% from internally generated capital,” Lee adds.

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According to Lee, the impact of Basel IV is likely to be manageable for UOB. Lower risk weights are likely to be associated with mortgages and some corporate loans. Most probably, risk weights of credit conversion factors for cancellable commitments rise to 10% from 0%, and the much talked about fundamental review of the trading book is likely to attract higher risk weights.

OCBC sees growth in green loans

Helen Wong, group CEO, OCBC, says, “we expected momentum to grow in the latter part of the year. We see our 3QFY2021 loan growth, to be 6% y-o-y, to pick up. We’ve seen our pipeline pick up in Singapore, Greater China and across the region.”

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Wong is particularly positive about green financing loans. A third of OCBC’s loan growth of $16 billion this year is from green loans. Already, OCBC has $30 billion of committed sustainability loans and is likely to achieve its target of $25 billion of sustainability loans by 2025 to be attained well ahead of the timeline when these loans are drawn down.

On the flip side, OCBC’s net interest margins (NIM) fell by 6 basis points (bps) q-o-q to 1.52% in 3QFY2021. This was due to three reasons, according to Darren Tan, OCBC’s group CFO. The bank recorded a one-off decline because of interest reversal from the downgrade of a few Malaysian and Indonesian loans to non-performing. Secondly, yields on good quality corporate loans were low, because of excess liquidity, and third, lower gapping income.

Wong indicates that NIM is likely to remain stable at the current level, and the banking group is looking to wealth management income from its Greater China initiatives to boost total income, and for loan growth.

Benign credit costs

DBS was able to write back $138 million of general provisions, which are now termed expected credit loss or ECL 1 and 2, compared to $22 million for OCBC and none for UOB. This brings DBS’s recoveries for nine months to $413 million. DBS’s major geographies are Singapore and Hong Kong which are developed markets. Developed markets have controlled the pandemic to a much greater degree than emerging markets because of better access to vaccines, Covid-busting drugs, and better healthcare management all around. As a result, DBS’s macroeconomic variable (MEV) model is likely to be differentiated from UOB’s and OCBC’s MEV models. OCBC and UOB have to impute a slower recovery in Asean this year.

Even with the $413 million write-back, DBS’s general allowance overlays built up in prior periods were maintained. General allowance reserves stood at $3.92 billion compared to $4.3 billion as at Dec 31, 2020. The general allowance reserves were $600 million above the MAS requirement and $1.1 billion above Tier-2 eligibility. Total allowance coverage was 107%.

OCBC had a $22 million write-back in 3QFY2021. This arose because of the transfer of some loans downgraded to ECL3, taking ECL 3 to $185 million, $54 million higher q-o-q. Total cumulative non-performing assets (NPA) were lower at $4.13 billion, and as a result, the NPA coverage ratio was lower at 97% compared to 104% in 2Q2021.

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According to Lee, UOB had robust loan growth. Hence, its general provisions amounted to 1% of its gross loans. Since UOB did not add to its ECL 1 and 2 in 3QFY2021 despite the loan growth, Lee considers this as a form of write-back.

UOB explains conservative stance

Lee cites three scenarios when UOB would do a write-back. “Based on our bottom-up analysis of our portfolio, we earlier stated that $2 billion of loans were vulnerable but that it has reduced based on our latest review. If any of this manifests itself, I will reverse GP,” he says referring to the vulnerable loans turning non-performing.

“The second scenario is when the general economic outlook is better and macro factors are less stressful. That might be true for Singapore currently but not so for the region. The third is to look at total GP/performing loans ratio. For UOB, it used to be 70 bps. Now we’re at 1%,” Lee elaborates. He indicates that this ratio is unlikely to revert to 70bps, but could settle somewhere between 70bps and 1%.

Interestingly, DBS’s GP/performing loans is at 0.88 bps which appears to be a stable ratio. That could be because both Singapore and Hong Kong have recovered from the worst ravages of Covid-19.

All three banks are guiding for stable NIM, with DBS expecting interest rates to firm as early as next year. Lee of UOB expects its NIMs to firm towards the end of 2022 as it expects that central banks in Asean are likely to adopt accommodative monetary stances to facilitate and accelerate recovery in 2022. OCBC is looking at being an intermediating between trade and investment flows in the Greater China-Asean corridor and green financing for loan growth.

“Singapore’s three largest banks by assets — DBS, OCBC and UOB — reported strong and stable profitability for 3QFY2021 as declines in credit costs made up for mild contraction of NIMs. Overall asset quality was stable despite some weaknesses in some overseas loans in the case of OCBC. Capital ratios remain high, although they declined mildly at OCBC and UOB. We expect that the three banks will maintain strong profitability and assets quality in 2022 as economic conditions recover,” says Moody’s Investors Service in an update.

According to Bloomberg’s poll, analysts are most bullish on DBS, expecting its net profit this year to surpass FY2019’s $6.39 billion and to surge past FY2020’s $4.72 billion to $6.72 billion. In FY2022, analysts are expecting a 4.6% growth to $7.02 billion.

OCBC is expected to notch up a 40% growth in FY2021 to record a net profit of $4.98 billion, with a further 7.6% growth in FY2022 to $5.36 billion. In FY2021, UOB’s net profit is expected to recover by 36% to $3.976 billion, but would only match the $4.34 billion net profit recorded in FY2019 in FY2022.

Interestingly, UOB’s net profit for the first nine months is $3.06 billion, up 36% y-o-y, OCBC’s nine-month net profit is $3.88 billion, up 58% y-o-y and DBS’s net profit in the same period is $5.41 billion (including $413 million of write-backs), up 46% y-o-y. It appears possible for all three banks to beat their forecasts.

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