SINGAPORE (Sept 2): Looking beyond current global economic uncertainties, the fact remains that the stock market usually rises in the very long term. The local banks are a good example. Once proxies to GDP growth in Singapore and Malaysia, they now reflect growth in Asia as they gradually regionalise. Economies usually grow over the long term. The 30-year price charts (see Charts 1 to 3) of the three local banks show that their prices have risen over a 30-year period, despite the two occasions on which there were serious declines — during the Asian and global financial crises.
Despite the trade war and its uncertainties, the local banks have carved out different growth strategies.
On Aug 22, United Overseas Bank opened its first branch in Hanoi. A year ago, UOB incorporated UOB Vietnam as a foreign-owned subsidiary bank. In March this year, UOB launched its mobile-only digital bank TMRW in Thailand. A second location, believed to be Indonesia, will be added by year-end, followed by Malaysia and Vietnam. UOB’s strategy is for Asean — where the bank has a growing presence — to be one homogenous market with Singapore as the hub.
In a briefing on Aug 13 and 14, Oversea-Chinese Banking Corp detailed its Greater Bay Area (GBA) and Greater China strategies. CEO Samuel Tsien sees OCBC as an enabler of the flow business and is looking to continue to capture trade, capital and investment flows between GBA and Southeast Asia.
In addition, Bloomberg has said OCBC is looking to acquire Bank Permata in Indonesia. UBS Research estimates that OCBC has room to spend as much as $3 billion to acquire it at a price of 1.5 times Permata’s book value, while maintaining a common equity tier 1 (CET1) ratio of more than 13%.
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On July 31, DBS Group Holdings announced that it was named Singapore’s Most Valuable Brand for the seventh year in a row, with its brand value rising 39% to US$9.03 billion ($12.55 billion) based on Brand Finance’s 2019 “Top 100 Singapore Brands” report. Also in July, DBS was named “World’s Best Bank” by Euromoney and Asia’s best digital bank. This year, DBS was ranked Asean’s most valuable brand for the seventh consecutive year.
All three banks guided for loan growth this year and net interest margins to either match or be slightly higher than FY2018. DBS and OCBC guided for mid-single-digit loan growth, and UOB guided for high-single-digit loan growth. All three posted record net profits, stable asset quality and strong capital ratios for 1HFY2019.
Analysts remain positive about prospects. For OCBC, UOB Kay Hian forecasts net profit of $4.8 billion for FY2019 and $4.96 billion for FY2020, representing y-o-y growth of 6.9% and 3.3% respectively. UOB Kay Hian forecasts a net profit of $6.25 billion in FY2019 for DBS, repre-senting a 13.1% y-o-y growth, and $6.32 billion in FY2020, up 1.1% y-o-y.
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JP Morgan Chase expects UOB’s net profit to grow 2.8% y-o-y to $4.12 billion this year, and a further 10% y-o-y to $4.26 biillion in FY2020.
Despite the awards, sound strategies and record net profits, earnings growth for the next two years and, in the case of UOB and OCBC, higher absolute dividends per share, prices fell sharply in August. However strong the fundamentals, market sentiment has taken a turn for the worse. Short-term investors and traders are now hostage to Trump’s mood swings, which are translating into market volatility.
Trade war’s impact
At a results briefing on Aug 2, OCBC’s Tsien was asked to comment on the impact of the trade war on the supply chain. He says companies with an established presence in Southeast Asia have increased capacity and banking services have grown. “The whole supply chain needs to move, not just the anchor company, and that action is being mobilised now. The migration will not be as significant as people believe because you need software skills and adaptability of labour. China is very good at changing models.”
Singapore’s trade-dependent economy is being affected to a greater extent than other Asian countries. Growth has slowed to a crawl, with 2Q2019 GDP growth of 0.1% y-o-y, and official full-year growth cut to between 0% and 1% from earlier forecasts of 1.5% to 2.5%.
Trade wars have very few winners. In a research note on Aug 26, Nomura Research observed that MNCs with operations in China were more likely to relocate in other low-cost production centres instead of the US, if the current US administration invokes the International Emergency Economic Powers Act of 1977 to implement its order for US companies to leave China.
“Exports [in the latest three months] are booming in Vietnam, growing in the Philippines and China, and only slightly negative in India. In China, the front-loading of shipments ahead of higher tariffs is supporting exports. Elsewhere, however, there will be some relative winners that benefit from trade diversion, and this looks set to intensify,” Nomura says, adding that exports picked up strongly in Taiwan (owing to reshoring of electronics) and the Philippines, followed by Malaysia, Japan, India and Singapore. “By contrast, exports to the US are weak in Korea, Indonesia and Hong Kong,” it adds.
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Tsien also points out that Singapore is seen as a safe haven for trade, wealth management, insurance and reinsurance, legal and arbitration. “Singapore is a hub economy, and most of the activities that banks do may not be directly related to Singapore, but are related to its hub status and allow banks to deliver results that are higher than the domestic Singapore economy,” he says.
Currency concerns
A currency war could turn out to be the collateral damage arising from the trade war. The renminbi is at 7.11 to the US dollar and other Asian currencies are weakening in tandem. “Overall, the weakening of the RMB against the USD should not be viewed as an outlier, as other major global and regional currencies have also recently weakened against the greenback, owing to dovish central bank policies and rising geopolitical risks,” says Manulife Asset Management. “Historically, the central bank has supported the RMB, fixing the currency at a stronger level after acute market selloffs.” China had also spent about US$1 trillion of foreign exchange reserves over the past five years to do this.
“After the RMB’s recent dip, we do not expect further aggressive currency depreciation for two reasons: (1) expectations of a more acute decline could spark capital outflow worries; and (2) the RMB/USD interest-rate gap is now widening, as the [US Federal Reserve] is expected to cut rates further while the [People’s Bank of China] remains neutral,” Manulife says.
Local economists are expecting the Monetary Authority of Singapore to ease policy, which entails the movement of the Singapore dollar to the mid- or lower range of the SGD Nominal Effective Exchange Rate policy band. This implies a weaker Singapore dollar. The RMB, currently at 5.15 to the SGD versus 5.09 at the start of the year, has weakened by 1%. In contrast, the SGD has weakened by 2.08% against the US dollar since the start of the year.
While companies with substantial non-RMB debt exposure and currency mismatches between the RMB and US dollar may be the most vulnerable, Fitch Ratings says the Singapore banks should be well insulated. Like most banks in other jurisdictions, much of the Singapore banks’ exposure to China takes the form of lending to top-tier corporations, short-term trade loans or liquidity placements with major Chinese banks, which is typically lower risk, Fitch Ratings says.
Of course, other risks lurk. Moody’s Investor Service says it will be difficult for the banks to further improve profitability in 2HFY2019 because net income margins will either stagnate or decline as central banks globally cut rates, while credit costs will increase as asset quality weakens.
“Credit costs will increase in the coming quarters in line with increasing asset risks. Digitalisation will improve productivity, but the banks will not benefit from it in the short term because they need to constantly reinvest cost savings to develop digital infrastructure and capabilities. Given that revenue growth will weaken, the three banks’ cost-income ratios will be stable or rise modestly from 42% to 44% in the first half,” Moody’s says.
Dividends maintained
Funding costs are likely to fall. The banks’ low-cost current account savings accounts (CASAs) make up the largest share of their funding mixes. “Funding costs will moderate as market interest rates decline, and thanks to large pools of CASA deposits, the three banks will be able to shed costlier fixed deposits much faster than foreign banks,” Moody’s says.
In the meantime, CET1 remains strong. The three banks’ CET1 ratios remained at 13.6% to 14.4% as at June 30. Among the three banks, OCBC recorded the largest increase in CET1 ratio in 1HFY2019 because of retained earnings supported by its scrip dividend scheme.
“The ratios will remain above 13% in 2019 — within the banks’ target ranges of 13% to 13.5% — even as retained earnings growth weakens. CET1 ratios at that level would be sufficient for the banks to maintain steady dividend payouts,” Moody’s says. The banks’ internal capital generation will continue to outpace capital consumption as loan growth slows, it adds.
With dividends supporting share prices (see table) and growth likely to continue over the medium to long term, albeit at a modest clip, the best way forward for investors is to look past the short-term volatility to a time when the impending recession has passed and the global economy is on a more stable footing. Of note are the banks’ valuations. OCBC and UOB are trading near their lower-bound range, and DBS is no longer overvalued.
