CGS-CIMB Research analysts Andrea Choong and Lim Siew Khee have kept an “overweight” rating on the banking sector, with DBS Group Holdings (DBS) as their most preferred pick, followed by United Overseas Bank (UOB) and Oversea-Chinese Banking Corporation (OCBC).
Earlier in September, the Fed raised interest rates by 75 basis points (bps) to 3.25% in a bid to reel in persistent levels of inflation. This comes after elevated core inflation readings, sparking global fears of stagflation setting in.
In total, the Fed has raised its benchmark lending rate five times this year, with three of these being 75 bps hikes. Another rate hike is expected in November.
In Singapore, investors have also been holding their breath on a recession in the US spilling over into Asian economies, which has led to an overhang on banks’ valuations.
“Although this translates to global economic growth further slowing amid higher unemployment rates, we think that Singapore banks will nonetheless remain beneficiaries from the pass-through of these higher rates into net interest margins (NIMs),” write Lim and Choong.
With the Fed’s notably firmer stance of committing to rate hikes until inflation moderates, the Fed fund futures now imply an approximate 4.3% rate by end-2022, as compared to an approximate 3.7% at end-August, before rising to approximately 4.6% by mid-2023.
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These rates are noticeably higher than the approximate 3.6% peak rate the analysts assumed as inputs into their NIM estimates for the sector.
“Realistically, although higher benchmark rates bode well for banks’ margins, we are cognisant that the region’s economic growth will likely slow as customers hold back on investments and purchases, thereby dragging down loan growth to below the approximate 5% to 7% we factored in for FY2023 ending December 2023,” say Lim and Choong.
To this end, Choong and Lim raise Singapore banks’ earnings per share (EPS) by around 1% to 4% in FY2022 to FY2024, factoring in forward Fed rate expectations and weaker growth of approximately 4% to 5% in FY2023.
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They add that the banks’ sequential NIM expansion will peak around 4QFY2022.
Some risks to the analysts’ estimated earnings upside include a sharper-than-anticipated rise in funding costs from attrition from current account savings account (CASA) into fixed deposits, which have witnessed the highest rates in Singapore in 24 years or due to deposit-gathering efforts by banks, as well as possibly heftier credit costs to come as higher interest rates pressure borrower repayment capacities.
“While we understand that property developer exposures in China remain contained below 1% of gross loans, we think that small-medium enterprises (SMEs) comprising approximately 6% to 13% of gross loans could be a segment at risk if trade sentiment weakens,” write Choong and Lim.
Choong and Lim also note that their stress test of household balances in Singapore has also found that all households servicing a mortgage for public housing, except those at the bottom 10% income levels, will remain below the 55% total debt servicing ratio threshold, even at a 4.5% per annum (p.a.) rates.
The analysts have kept “add” ratings on DBS, OCBC and UOB, with target prices of $40.20, $15.20 and $35.60 respectively.
Lim and Choong observe that DBS had an estimated $1.5 billion in management overlays as at 2QFY2022. “Monetisation of digital assets is a potential re-rating catalyst, although scaling-up and price discovery may take time,” they add.
OCBC’s robust common equity tier one ratio (CET-1) of approximately 15% remains a key tool, the analysts add, whether for mergers and acquisitions (M&As) or to cushion against asset quality deterioration.
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Finally, the analysts observe that the credit quality of UOB’s moratorium portfolio remains healthy, where its key risk of asset quality concerns from its SME and Asean portfolio appear to have been well contained.
Overall, Lim and Choong think that the positive Fed rate hike momentum and stronger NIM expansion ahead will continue to support a sector rerating.
As at 12.08pm, shares in DBS, OCBC and UOB are trading at $33.01, $11.72 and $26.10 respectively.
