While investors and analysts are likely to pour over the local banks’ granular metrics such as their ECLs (expected credit losses), NPLs (non-performing loans), net interest income (NII), non-interest income, cost-to-income ratio, CET1 (common equity tier 1) ratio, NIMs (net interest margins) and Pillar 3 reports, the first glance is often on the net profit figure.
Based on analysts’ earnings estimates compiled by Bloomberg, DBS Group Holdings is forecast to announce a net profit of $2.41 billion in 3QFY2023 ended September versus $2.69 billion in 2QFY2023 and $2.236 billion in 3QFY2022.
Oversea-Chinese Banking Corp has the most upbeat forecast of $1.84 billion for 3QFY2023 ended September compared to $1.71 billion in 2QFY2023 and $1.60 billion in 3QFY2022. It is the only bank likely to show q-o-q and y-o-y growth.
United Overseas Bank is expected to report a net profit of $1.483 billion in 3QFY2023 ended September compared to a reported net profit of $1.5 billion in 2QFY2022 and $1.4 billion in 3QFY2022.
NIMs under pressure, analysts say
In its outlook for 2HFY2023, JP Morgan errs on the side of caution over NIMs. In a recent report, the US bank points out that mortgage competition is prevalent while loan demand is weak. DBS Group Research concurs. It believes that NIMs could be under pressure because of loan yields due to “intensifying competition amidst weak loan demand amongst local and foreign banks”.
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In addition, fixed mortgage rates have continued to decline into October, in part due to ample liquidity in the system. “We believe that competition could continue to intensify going forward as incremental loans disbursed at tighter margins are still earnings accretive for the banks,” DBS says.
According to JP Morgan, some mortgages cost less than the yield on three-month US T-bills. “Hence, we believe NIM should peak soon, even in the absence of SGD deposit competition,” the US bank says.
In a curtain raiser report on 3QFY2023 earnings, CLSA is less negative and says NIMs may well hold up longer than initially expected. In their 2QFY2023 briefings, CLSA notes that “DBS suggested a possible upward bias in NIMs while OCBC and UOB guided that NIMs would generally hold at current levels. We are of the view that NIMs will peak in 4QFY2023/ 1QFY2024 and the recent Fed moves with another 25 bps hike in 3QFY2023 and potentially another 25/50bps should be supportive.”
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On the other hand, deposit costs could ease if the banks believe there is no advantage in chasing deposits given weak loan growth and benign loan-deposit ratios (LDR), analysts indicate.
DBS Group Research says that competition is likely to erode loan yields despite the US Federal Reserve Board raising the Federal Funds Rate by 25 bps in May and July this year because of increasing competition for mortgages and high-quality corporate loans amid weak loan demand.
“Notably, fixed mortgage rates continued to decline from a peak of 4.25%–4.50% (two- to three-year fixed) in 4QFY2022 to near 3% in recent weeks as local and foreign peers continued to lower their interest rate offerings. These are now significantly lower than the three-month Sora compounded rate of 3.7%, which is commonly used as a benchmark rate for mortgage loans, thus reflecting the competition dynamics as liquidity remains flushed in the system,” DBS elaborates.
Loans fell 1% y-o-y in 2QFY2023, notes Maybank Research. “Weak demand for trade-related debt was a key driver. Continued weakness in China plus the accessibility of cheaper domestic funding could drive contraction in loan volumes, Maybank says. For instance, three-month and six-month Sora of 3.7% and 3.71% respectively are higher than both China’s LPR (loan prime rate) of 3.45% and its MLF (medium-term lending facility) of 2.5%.
For example, CapitaLand China Trust AU8U can access renminbi debt. It raised RMB600 million ($113.3 million) this month in FTZ (free trade zone) offshore bonds maturing in 2026 at 3.8%. This compares to its weighted average cost of debt for onshore and offshore loans on June 30 of 4.25% and 3.43% respectively.
Wealth management shaken by AML
Wealth management, which is a substantial business for DBS and OCBC but increasingly also UOB, could well be impacted by Singapore’s largest money laundering case.
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“The recent unearthing of AML/KYC ( anti-money laundering/know your customer) violations in Singapore could lead to even tighter supervision of flows within and across the country,” JP Morgan says. Bloomberg reported that banks based in Singapore both local and foreign were involved albeit unwittingly in the reported $2.8 billion of money laundering in Singapore.
Meanwhile, any recovery or rebound in wealth management fees may have to wait till next year. Wealth management fees, which have been weak year to date, may only start to recover in 2HFY2024, CLSA suggests. This is mainly because high interest rates raise the cost of capital and dissuade investors from investing in equities and bonds.
In the interim, banks are likely to be burdened with large wealth management/private banking deposits, keeping LDRs lower than in previous cycles. “Despite reasonable new money inflows in 2QFY2023, wealth management fees showed little signs of recovery given cautious client sentiment and high rates keeping funds locked up in deposits. These trends are likely to persist in 3QFY2023, increasing downside risks to fee income,” the Maybank report dated Oct 12 notes.
Explaining the 40 bps of provisions
Asset quality so far this year appears to be relatively benign, analysts say. To date, the only problem is with US commercial real estate (CRE) loans for S-REITs with US assets. “We continue to look towards a normalisation in overall credit costs in FY2023/2024 in a higher-for-even-longer interest rate environment while expecting 3QFY2023 asset quality to be largely benign. We believe DBS/OCBC/ UOB’s management overlays … continue to provide strong support to the banks’ share prices,” DBS says.
However, JP Morgan has a word of caution and suggests credit costs could end at the high end or even above the high end of guidance. “In an economic downturn, credit costs tend to average 40 bps–60 bps for two years in a row. This empirical history is the key basis for our 40 bps provisions in 2024 and 2025. Among CRE, we worry about the Hong Kong property exposure. The banks appear quite comfortable with the names as they are to large and reputed clients,” JP Morgan says.
However, Hong Kong REITs trade at a 42% discount to RNAV. JP Morgan says this “suggests a degree of disconnect”. Note that US S-REITs are trading at cents to the dollar.
Singapore banks are not the lowest-cost borrowers in foreign currencies which increases the probability of their taking slightly higher-risk borrowers to make spreads, JP Morgan points out.
So far, the banks have said their exposure to US CRE is manageable and these are to network clients. Nonetheless, the high risk-free rates in the US, Europe, the UK and Australia imply that refinancing property-related debt comes with higher risks.
Meanwhile, with SME and non-mortgage consumer loans, the key risk will come from weaker cash flows, JP Morgan says.
Loss given default (LGD) for the three banks per Basel disclosures is about 10%–13%. (LGD is the estimated amount of money the bank loses when a borrower defaults on a loan.) The guidance from banks is for credit costs of about 20 bps based on 1HFY2023 briefings.
“This suggests that banks are implicitly guiding for about 50 bps of NPL formation, assuming LGD remains closer to 40%,” JP Morgan calculates. When rates are moving up dramatically and the economic growth outlook is likely to be below potential in most markets, the probability of default (PD) is likely to rise. “That is effectively what we assume in our forecast of 40 bps provisions for 2024 and 2025,” JP Morgan explains.
Dividend plays
All three local banks have dividend yields of more than 5%–6%. OCBC, which announced a dividend payout ratio of 50% earlier this year, raised its 1HFY2023 dividend by 43% y-o-y to 40 cents. Annualised, this provides a dividend yield of more than 6.1% based on its current price.
UOB’s payout ratio stays at around 50%. Based on a higher net profit, UOB raised its dividend to 85 cents in 1HFY2023, up from 60 cents in 1HFY2022. This gives UOB a yield of 5.9% based on current prices.
DBS pays dividends quarterly. Its quarterly dividend of 48 cents translates into an annualised dividend of $1.92, and a yield of 5.1%. In a recent report, Citi has cautioned that a special dividend from DBS could be affected by its most recent outage. This is because Citi believes that DBS may have additional capital requirements as its operational risk-weighted assets (RWA) may have to rise. On Oct 14, DBS suffered outages for its digital, ATM and payment services. The Monetary Authority (MAS) had imposed additional capital requirements of 1.8x operational RWA (risk-weighted assets) for past incidents in November 2021, and March and May this year. On Sept 29, it appeared that DBS suffered a delay in processing Fast and PayNow transactions. Citi suggests that DBS could face additional responses from MAS for the September and Oct 14 problems. “Assuming MAS imposes 0.3x to 0.6x additional RWA charge, DBS’s excess capital is reduced to [the] $2 billion to $1 billion [range] from $3 billion indicated on DBS Digital Day 2023,” Citi says.
In addition, Citi indicates that DBS may be affected by reputational risk to the bank as it promotes digital transactions. From a dividend perspective, Citi prefers OCBC.
DBS Group Research also likes OCBC: “OCBC and UOB’s share prices continue to be supported by undemanding valuations of and high dividend yields of 6%. While we do not see any immediate catalysts to its share prices as NII nears peak, we prefer OCBC to UOB, as OCBC has more headroom to lift dividends, alongside a higher provision coverage ratio of 131% compared to UOB’s 99%.”
