Analysts from UOB Kay Hian and PhillipCapital have kept their “overweight” calls on the Singapore banking sector as all three local banks recorded net interest margin (NIM) improvements across the board, which contributed to the higher net interest income (NII) during the 2QFY2022 ended June.
For the 2QFY2022, DBS Group Holdings (DBS) reported a net profit of $1.82 billion, up 7% y-o-y, while Oversea-Chinese Banking Corporation (OCBC) saw earnings increase by 28% y-o-y to $1.16 billion. Meanwhile, United Overseas Bank (UOB)’s net profit increased by 11% y-o-y to $1.11 billion for the period.
“The accelerated pace of NIM expansion and increased sensitivity to higher interest rate are a pleasant surprise,” says UOB Kay Hian analyst Jonathan Koh.
The NIM expansions were supported by the strong pass-through from hikes in the US Fed Funds Rate to higher domestic interest rates.
The Singapore Overnight Rate Average (SORA) and the three-month Singapore Interbank Offered Rates (SIBOR) increased by 105 basis points (bps) and 112 bps respectively to 1.66% and 1.91% during the 2QFY2022.
To Koh, DBS and OCBC’s results surpassed expectations, while UOB’s results stood in line.
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At their current levels, both DBS and OCBC provide attractive dividend yields of 5.2% and 5.1% respectively for the FY2023, according to the analyst’s estimates.
As such, he expects DBS and OCBC to increase their distributions per share by 17% and 7% respectively to $1.68 and 60 cents in the FY2023.
“OCBC is most resilient with the highest common equity tier 1 capital adequacy ratio (CET-1 CAR) of 14.9%, followed by 14.2% for DBS,” says Koh.
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To this end, the analyst sees banks gaining bargaining power as liquidity is tightened due to higher interest rates and quantitative tightening.
“They benefit from NIM expansion with DBS being the most sensitive to higher interest rates. The Russia-Ukraine war causes inflation to be elevated, which could keep bond yields higher for longer,” he says.
Furthermore, OCBC and UOB will stand to benefit from the reorientation of supply chains towards Asean countries.
“Asean countries benefit from easing of safe distancing measures and resumption of air travel. In particular, Malaysia and Indonesia gain from recovery in domestic consumption and higher energy and commodity prices. Asean countries benefit from the ongoing disruption to the global supply chain. Many multinational companies have adopted the China + 1 strategy and have plans to set up alternative production facilities within the Asean region,” he writes.
In his report, the analyst notes the Fed’s renewed fervour to clamp down on inflation; the Fed has accelerated the tempo of interest rate hikes to quell inflationary pressures.
“[The Fed] hiked the Fed Funds Rate by a massive 75bp to 1.50% after the Federal Open Market Committee (FOMC) meeting on June 15. Based on the Fed’s dot plot, the median projected path for Fed Funds Rate would hit 3.4% by end-22 and 3.8% by end-2023,” says Koh. “The forecast translates to four hikes totalling 200 bps in 2HFY2022. The Fed hiked the Fed Funds Rate by another 75 bps on July 27. The intensity of rate hikes could ease after the FOMC meeting on Sept 21.”
In addition, the analyst notes that all three banks’ exposure to the real estate sector in mainland China is limited.
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DBS has 0.5% of its total loans, or $2 billion, exposed to half a dozen companies that are mainly state-owned enterprises (SOEs) and network customers in the country.
“DBS also have exposure to Singapore REITs (S-REITs) investing in China. Its exposure to privately owned enterprises (POEs) is considered small,” says Koh.
OCBC has 0.8% of its total loans, or $2.3 billion, exposed to mainland China’s real estate sector. The loans comprise primarily network customers from Singapore and Hong Kong who expanded into China.
“[OCBC] has small exposure to residential mortgages for completed projects in Shanghai and the Pearl River Delta region,” says the analyst.
UOB has 0.9% of its total loans, or $3 billion exposed. These include state-owned enterprises and privately owned enterprises each account for 50% of the exposure. “Management is comfortable with loan-to-value ratio for these real estate developers and they are not in danger of turning into non-performing loans (NPLs).”
Koh has kept “buy” on DBS and OCBC with target prices of $43.60 and $16.18 respectively.
To him, sector catalysts include NIM expansion in FY2022 and FY2023 driven by the upcycle in interest rates, the recovery of the economy from the easing of Covid-19 restrictions, and more dividends paid out by the banks on the back of receding Covid-19 risks.
In addition to his “overweight” call on the Singapore banking sector, PhillipCapital’s Glenn Thum has kept his “buy” calls on DBS, OCBC and UOB with unchanged target prices of $41.60, $14.22 and $35.70 respectively.
The banks’ earnings for the 2QFY2022 all stood within the analyst’s expectations as their NIIs and NIMs rose across the board.
“We remain positive on banks. Bank dividend yields are attractive at 5% with upside surprises due to excess capital ratios. Stable economic conditions and rising interest rates remain tailwinds for the banking sector. Singapore Exchange (SGX) is another beneficiary of higher interest rates,” says Thum.
“Pressure points for the banks will be higher staff costs and a nudge in general provisioning due to weaker economic assumptions,” he adds.
Shares in DBS, OCBC and UOB closed at $32.80, $12.20 and $27.20 respectively on Aug 15.
