The net interest income (NII) of the three local banks has benefitted from the four hikes in the Federal Funds Rate (FFR) by the US Federal Reserve to the extent that the higher NII was able to offset lower non-interest income and result in net profit growth.
In March, the US Fed raised the FFR by 50 bps, and by 75bps in June and July. In total, the Fed has raised rates by 200 bps this year. Undoubtedly, this has had a positive impact on the NII of banks, which rose by double digits y-o-y for all three of them (see table 1).
Since the Fed could continue to raise rates in 2H2022, albeit at a gentler pace, local banks should continue to report earnings growth. This should be a positive for their dividends, thus keeping shareholders content. Even if the US economy slows further and the Fed pauses, the current levels of interest rates will continue to boost banks’ 2HFY2022 earnings compared with levels a year ago.
In the 2QFY2022 ended June 30, DBS Group Holdings’ NII rose by 17% y-o-y, Oversea-Chinese Banking Corp’s (OCBC) NII was up 16% and United Overseas Bank’s (UOB) NII surged 18%. These double-digit gains in NII were able to offset lower non-interest income. Mainly, wealth management income generally fell. OCBC’s 88%-owned Great Eastern Holdings, contributed 16% to its net profit in 2QFY2022.
Was it because of Sora?
Net interest margins (NIM) rose for all three banks (see table 2). The most spectacular move q-o-q was that of OCBC. Its NIM in 1QFY2022 averaged 1.55%. In 2QFY2022, NIM surged to 1.71%. The reason? OCBC appears to have benefitted from a move to Sora (Singapore overnight rate average) where the “transmission” of higher rates on its loan portfolio is faster than Sibor and SOR (the old interest rates references).
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OCBC group CFO Darren Tan attributes the gain in NIM and NII mainly to the rise of more than 100 bps in local interest rates in 2QFY2022. For example, Sora rose from 0.55% or thereabouts in early June to more than 1.8% in July before retreating.
“We see an upward revision in terms of interest rates on our asset side. We’ve been building up Casa (current account savings account). Our Casa ratio remains relatively high at around 62% of deposits,” Tan notes. As such, the “asset side” (loans) repriced faster than deposits. Usually, the Casa of banks is often the customer’s transaction account, which remains low cost.
However, Tan acknowledges that the tussle for consumer deposits is beginning. “There’s already a movement to fixed deposit and competition in terms of higher fixed deposit rates offered by competitors. We do have to also match with some of this competition, which means that there will be some follow-through in terms of rises on deposits.” In other words, the cost of funding is likely to rise when some Casa migrates to fixed deposits.
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“We do think that there could be some [further] upside for our NIM for the rest of the year, but the magnitude may not be the same amount that we saw this quarter,” Tan says.
According to Tan, 15% of OCBC’s loan book is now priced off Sora (Singapore overnight rate average). “[The sharp rise in NIMs] is also partly because of the movement into Sora. We’re looking at maybe 15% of our loan book that is Sora repriced. Sora is an overnight rate and the response time [for repricing] is even faster compared to the SOR and Sibor which is why we were pleasantly surprised by this upswing in terms of interest rates,” Tan explains.
“OCBC’s investor relations has issued a clarification on its 2QFY2022 exit NIM. It should be 1.81%. Earlier OCBC’s management had mentioned the exit NIM was 1.71%. Hence, we presume the full-year and 4QFY2022 exit NIM guidance mentioned earlier is voided,” notes DBS Group Research in an update to clients.
OCBC’s NIM of 1.71% for 2QFY2022 was the highest among the local banks (see table 2) and showed the most uplift compared to its 1QFY2022’s NIM of 1.55%. On Aug 3, during a results briefing, OCBC’s top management had guided that NIMs for the year are likely to be higher than 1.7%.
According to Piyush Gupta, group CEO of DBS, Sora is the slowest in terms of impact on DBS’s NIMs and NII because it is backwards-looking. “In some cases, in the mortgage book, for example, all of the mortgage loans are calculated on a backwards-looking three-month Sora. We take the three-month average of Sora and then we price the volume mortgages for the next month based on the three-month average,” he explains. For Sora, the NIM on the fixed rate loans will not go up till all the fixed rate loans have been repriced. Hence, the NIM on the Sora-based loans will go up more slowly. However, if rates start dropping, the reverse happens, Gupta says.
At any rate, although DBS’s NIMs averaged 1.58% in 2QFY2022, group CFO Chng Sok Hui is guiding for NIMs to average around 2% in 2HFY2022. This is because the “exit NIM” in 2QFY2022 was 1.63% and NIM averaged 1.8% in July. Gupta says around 35% of its Singapore portfolio of $165 billion is on Sora, translating into around 13% of the overall book. DBS’s loan portfolio is the largest among the local banks at $430.7 billion.
In the case of UOB, only around 10% of its portfolio has been moved to Sora. “Sora is computed based on the volume-weighted average rate of actual borrowing transactions in the unsecured overnight interbank SGD cash market. With the rising rate environment, Sora has correspondingly been on an increasing trend, which is generally positive for the bank’s NIM,” a UOB spokeswoman says.
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Double-digit y-o-y gains in NII
Previously, DBS had guided that every 1 bp rise in interest rates is likely to cause an $18 million to $20 million rise in net interest income. Hence a 100 bps rise, which has already taken place, would lead to an additional NII of $2 billion. In 2QFY2022, DBS’s NII was $2.45 billion, up 17% y-o-y. In FY2021, NII stood at $8.44 billion. Undoubtedly, DBS is the biggest beneficiary of rising interest rates. As it stands, DBS’s NII is likely to top $10 billion, which in itself is something of a record.
UOB announced the largest rise in NII, up 18% y-o-y to $1.86 billion. In 2QFY2022, UOB’s NII rose by $285 million y-o-y and for 1HFY2022, its NII rose by $440 million. Lee Wai Fai, group CFO at UOB, says: “We are quite confident that the margin expansion will more than offset the slowdown in [non-interest income and wealth management] and that our total income will continue to grow.”
The view of UOB is that there will be an economic slowdown but not a full-blown recession in its core markets of Singapore, Malaysia, Indonesia and Vietnam.
OCBC’s NII rose by $238 million in 2QFY2022 alone, and at a much faster clip than in 1HFY2022 when NII rose by around $300 million. Even if OCBC’s NIM gains abate, group CEO Helen Wong has guided for mid-single-digit loan growth which — on its current NIM level of 1.71% — would still lead to double-digit gains in NII in 2HFY2022.
The 2HFY2022 earnings of banks should show an improvement in their 1HFY2022 earnings. According to Bloomberg’s poll of analysts, DBS’s FY2022 net profit is likely to top $7.43 billion (in 1HFY2022, DBS reported a net profit of $3.61 billion). OCBC’s FY2022 net profit is forecast at $5.56 billion compared to its 1HFY2022 net profit of $2.84 billion. UOB’s FY2022 net profit is estimated to be $4.41 billion compared to its 1HFY2022 earnings of $2.02 billion.
Slowdown, recession, inflation, China
“There is much talk about recession risk amid rising interest rates. This backdrop has two divergent implications for banks. On one hand, increasing rates will boost our NII but higher costs will weigh on our credit costs as revenue slows,” acknowledges Wee Ee Cheong, group CEO of UOB.
“We don’t see a recession, we see a slowdown. We are observing a few things. One is the trend of rising interest rates. I think it is manageable. The second is strong employment. That is important. Third, if you look at the long-term prospect of Asean, which is recovering from Covid, most of the countries in Southeast Asia are net exporters of commodities,” Wee notes.
Unlike DBS and OCBC, UOB has only a modest onshore presence in China. Instead, its fortunes are tied to Asean where it has a growing physical and digital footprint.
Of the three bank CEOs, Gupta sounded the most cautious. His message on Aug 4 during DBS’s results briefing was a departure from his previously upbeat prognosis of the Asian markets. If inflation does not abate and food shortages continue with Russia’s blockade of Ukraine’s Black Sea ports, social unrest could develop in some emerging markets.
“[If] we have higher inflation, I think the central banks will be willing to push through with more aggressive interest rate hikes. The central banks have made inflation their No 1 priority and so you could see that come through. However, if you do see that, you can start to expect a more significant slowdown. Subsequently, you could have a deeper recession in the West. The impact of that in Asia will also be more material,” Gupta says.
The elephant in the room is probably China. “China’s Covid policies are unclear. Do they really start opening up after October? The issues in the property sector and some of the concerns around possible systemic risk coming from that sector are all relatively unclear. Again, our base case is that the situation continues to be controlled and managed,” Gupta cautions.
On the other hand, DBS is experiencing “good momentum” on its loan book. “Pipelines are good. So, for non-trade loans, we should be able to get another percentage point of growth in each quarter. That should get us to the mid-single-digit loan growth that we have previously given guidance to,” adds Gupta.
Wealth management, which for the past decade was low-hanging fruit for the likes of DBS and OCBC, is likely to be a lot more challenging. The era of cheap money is over and there are concerns over the impact and possible fallout from the Chinese real estate sector.
During 2QFY2022, OCBC has added overlays for its China real estate sector, Wong of OCBC says. DBS still has some $1.8 billion of management overlays and UOB, which usually has a conservative provisioning policy, also has elevated management overlays. UOB has guided for 25 bps of credit costs while OCBC’s guidance implies 30 bps of credit costs.
So far, China’s sabre rattling over Taiwan has not impacted the operations of DBS and OCBC. However, their Hong Kong subsidiaries reported declines in earnings in 1HFY2022. Net profit for DBS Hong Kong declined by 4% y-o-y to $593 million. OCBC Wing Hang’s net profit in 1HFY2022 fell by 24% to HK$871 million ($153 million) while 2QFY2022 earnings fell 39% to HK$337 million.
