The three local banks have a North Asian presence: Both DBS Group Holdings and Oversea-Chinese Banking Corp (OCBC), through their acquisitions of Dao Heng Bank in 2001 and Wing Hang Bank in 2014, respectively, increased their presence in mainland China over the past two decades, while United Overseas Bank U11 (UOB) has a branch in Hong Kong (unlike DBS and OCBC) as well as some 21 branches and offices in mainland China.
However, unlike banks such as HSBC and Standard Chartered, the Singapore banks’ presence in China is meant to serve not only Chinese companies in China, but also Chinese companies in Southeast Asia.
“North Asia and Asean are two different propositions. The reasons you would be in North Asia are different from the reasons you’d be in some of the growth markets in Southeast Asia,” notes Nick Lord, regional banking analyst at Morgan Stanley.
The North Asian presence is to attract companies to expand into growth areas in Southeast Asia. “There are a lot of opportunities out in Asean to take advantage of. At the same time, we’re seeing increased intra-Asian flows. Singapore banks are generally well positioned to take advantage of those flows because they operate in multiple Asean geographies,” Lord continues.
Markets with the biggest structural growth prospects would be those with population growth, relatively lower banking penetration levels, and GDP growth. Asean fits the bill. Moreover, Asean is an attractive destination for friend-shoring as part of the supply chain.
“The local banks are already positioned in some of the most attractive growth markets in the world. You’re already where you want to be. It’s more a case of an acceleration strategy,” Lord says. Which is why he sees them making bolt-on acquisitions. Most recently, OCBC announced on Nov 16 it has agreed to acquire the Indonesian operations of Commonwealth Bank.
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“The acquisition signifies the OCBC Group’s continued commitment to the Indonesian market given its growth potential, which in turn underpins the ratings of OCBC Indonesia. This commitment is also reflected in OCBC Indonesia’s recent brand and logo change to OCBC from OCBC NISP, which follows a similar rebranding exercise in the parent’s other key market in Greater China,” says a Fitch Ratings report.
In 2022, UOB acquired the retail operations of Citigroup in Malaysia, Indonesia, Thailand and Vietnam. Although the cost of Citi was $5.9 billion, on a valuation basis the goodwill was $900 million or a price-to-book of 1.18x. Subsequently, DBS Group Holdings acquired Citi’s retail operations in Taiwan last year.
“The advancement of technology lowers the barriers to customer acquisition. In a way, that makes the hurdles for corporate acquisitions higher because you can achieve so much more organically than you could do previously. That tells you future M&As in the sector will be selective and small-scale,” Lord notes.
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All three local banks can onboard customers digitally, seamlessly, and without physically going into a branch.
Headwinds ahead
During the banks’ 3QFY2023 for the three months to end-September results briefings, it was clear that the local banks faced challenges in growing their net interest income (NII) due to slow or absent loan growth while net interest margins (NIMs) are believed to be peaking.
“We’re working on the assumption that we’re at the peak in terms of interest rates. Expectations are they will come down at some stage next year. There are various views on when. The question is, where do they go down to? Morgan Stanley forecasts a Fed Funds Rate of 2.5% at the end of 2025,” Lord says.
The Federal Reserve raised the Federal Funds Rate (FFR) four times this year. The last rate hike in July took the FFR from 5.25% to 5.5%. Since 2022, the “pass-through’” to Singapore has been almost 100%, with local risk-free rates reflecting the direction of the yield on 10-year US treasuries.
While there is some uncertainty as to where interest rates may end up next year, the local banks’ NIMs are at or near their peaks. During DBS Group Holdings’ results briefing, it was articulated that the bulk of NII improvement from the interest rate cycle is largely behind us.
“I expect full-year NIM this year to probably wind up around 2.16%. For next year, full-year NIM should be at similar levels, maybe slightly off. Net interest income will be flattish or slightly up from loan growth even if NIM is slightly down. Our model shows that a marginal NIM decline will be compensated for by a pick-up in loan growth, counterbalancing the impact on NII. So it is safe to assume that NII will be stable, and rise modestly when Citi Taiwan is included,” says Piyush Gupta, group CEO of DBS, during its results briefing on Nov 6.
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More than that, a mortgage war is brewing. “We have not seen pricing pressure in the large corporate book, which forms the bulk of our lending. Where we have seen some pressure is in trade, and we have let some trade loans run off. Trade is low margin and if it is well priced, you should get 40 to 50 basis points [bps], but when it starts getting to 25 bps, we prefer to let it run off. We are also seeing pressure on the mortgage book in Singapore. Our through-the-door pricing was about 3.3% during the quarter but some competitors are at 3.0%–3.1%,” Gupta concedes.
DBS has around $100 billion of loans which have yet to be repriced, of which $10 billion were repriced in 4Q2023, $40 billion in 2024 and the remaining $50 billion of loans subsequently. The loans getting repriced are projected to give a lift of between 1.8% and 2%.
As evidenced by the local banks’ tepid loan growth, rising interest rates have acted as a double-edged sword. The banks were able to reprice their loan books. On the other hand, as rates rose, banks’ better-heeled customers preferred to repay their loans, a phenomenon reported by both Gupta and Wee Ee Cheong, group CEO at UOB.
Wee expects UOB’s NIM to remain at its current level. For the nine months to September 30, UOB’s NIM was 2.12%. Helen Wong, group CEO of OCBC is expecting its NIM to hang around 2.25% this year and for 1HFY2024.
During UOB’s 3Q2023 results briefing on Oct 28, group CFO Lee Wai Fai said: “Management is taking a view that Asean continues to grow. With the tech platform, we can capture other businesses because of relationships.”
During the third quarter, UOB increased its provision and lowered its management overlay from around $1.4 billion to more than $1 billion. Lee explains: “We increased provisions. We changed the macroeconomic variable model to look at a more difficult environment so normal general provisions increased. Based on the outlook, we were worried about the valuation of collaterals. We lowered those valuations and this was [classified as] specific provisions which went up, not because of new NPL [non-performing loan] formation but because of the reduction in the valuation of the collateral.”
Asset concerns
In addition, UOB relooked at the credits that are likely to be vulnerable and downgraded them. This caused risk-weighted assets to go up in the absence of loan growth, causing Common Equity Tier-1 to fall by 6 bps q-o-q to 13%. “If we can protect our credit quality and liquidity, and keep credit costs manageable, we are strengthening the balance sheet,” Lee says.
One of the main risks for Singapore banks (especially DBS and OCBC) is Hong Kong property exposure, analysts have indicated. Hong Kong REITs are pricing in a 42% discount to RNAV versus the 10-year average discount to RNAV of around 11%, they say. This suggests an elevated probability of risks to transacted property prices in Hong Kong.
Concerns arose because of HSBC’s 3QFY2023 results where it reported a 17.3% q-o-q rise in credit losses and other credit impairment charges to US$1.07 billion ($1.43 billion). “The charge is mostly towards stage 3 (US$900 million) or NPL exposures with US$500 million for Chinese commercial real estate exposures given that the operating environment for China’s property market has not recovered as expected,” OCBC Credit Research says.
For HSBC, as at Sept 30, US$3.5 billion out of US$13 billion in loans and advances to China commercial real estate is classified as credit impaired.
“Our presence in China is small so we can pick and choose opportunities without getting buffeted by the macro aggregates,” Gupta says. However, when asked what drove DBS’s specific allowances in 3Q2023, Gupta acknowledges it was “a couple of cases from smaller property-related exposures in China, which we topped up allowances for”. He also added DBS does not “have a lot of US-based commercial real estate exposure, which some other banks have”.
The exposure of Singapore banks to China’s commercial real estate is much lower than HSBC’s. “We have $3 billion in loans to Chinese developers. We are quite comfortable. We have looked at the cash flows and the ratings of these companies and they are highly profitable. We keep a very close watch on our Greater China property portfolio,” UOB CFO Lee says. Elsewhere, Lee says UOB has US companies with data centres as customers.
Although Greater China accounts for $73 billion or 24% of OCBC’s total loans, mainland Chinese loans account for $7 billion or 9.6% of the 24%. As at Sept 30, loans to commercial real estate accounted for $13 billion of the total loans of $289 billion, with a loan-to-value of 50% to 60%.
“The main areas of concern have been identified in analyst calls. There are some risks in terms of office and commercial real estate, globally. Analysts have discussed China’s commercial real estate where the Singapore banks don’t seem to have a significant problem. Hong Kong commercial real estate is something analysts are asking questions of, but it doesn’t feel like the banks will be impacted,” Lord observes.
While Morgan Stanley is forecasting higher levels of loan loss charges in 2024 compared to 2023, they are not significantly higher.
“The first half of 2023 was quite low. We were at a higher run rate in 3Q2023. I assume we will be at a higher run rate in 4Q2023 and stay at that run rate into next year which means for the full year [of 2024] to get a higher run rate. But I think this is the end of the higher interest rate cycle. I don’t see any sizeable pockets of stress that would cause loan loss charges to shoot up from here,” Lord reckons.
Increasingly, Singapore banks are being viewed as growth plus dividend plays. At current levels, DBS’s yield is above 6%. The most notable move this year is Wong’s decision to provide OCBC’s shareholders with a 50% payout ratio. For nine months to Sept 30, OCBC’s net profit rose by 32% to $5.4 billion.
Both DBS and UOB reported a 33% y-o-y growth in net profit for the nine months to Sept 30, to $7.8 billion and $4.56 billion respectively. UOB’s dividend payout ratio is 50%. DBS has sometimes paid out more than 50% of its net profits and has committed to a quarterly dividend of 48 cents.
“We currently have relatively slow loan growth. Even in the context of higher loan growth relative to returns, the banks will still be generating a lot of capital. A key part of the investment thesis for the banks is the extent to which they return that capital to shareholders,” Lord says. “All the banks have given you pretty clear guidance as to how they’re going to return capital. All our discussion of margins, returns, fees and different growth areas [is about] capital return.”
As an indication of the banks’ dividend payouts next year, Bloomberg’s estimates for DBS’s net profit in FY2024 is $10.121 billion, OCBC’s is $7.184 billion and UOB’s is $5.982 billion.
