Earnings released for the 3QFY2022 ended September by United Overseas Bank (UOB) on Oct 28 and DBS Group Holdings on Nov 3 reflected the positive impact of the US Federal Reserve’s interest rate hikes, which started in earnest in June. Since the start of the year, the US Fed has hiked rates by 50 basis points (bps) in March, and 75 bps each in June, July, September and October. Hence the real acceleration in earnings took place in the local banks’ third quarter.
UOB’s 3QFY2022 net profit of $1.4 billion, up 34% y-o-y and 26% q-o-q, was a record, underpinned by a $1.86 billion net interest income (NII), up 39% y-o-y and 20% q-o-q. Net profit for the nine months to Sept 30 of $3.46 billion was up 12% y-o-y.
DBS also reported a sterling set of results, with net interest income and net profit buoyed by higher net interest margins — much of it thanks to the Fed. Its 3QFY2022 net profit rose 32% y-o-y and 23% q-o-q to $2.236 billion. Net interest income surged 44% y-o-y and 23% q-o-q to $3.02 billion. This seemed to be in line with the guidance given by DBS that its NII would rise by some $2 billion in a 12-month period should the interest rate rise by 100 bps. Interest rates have actually risen faster and further than projections made in 2021 and DBS was always going to be the main beneficiary.
DBS’s other ratios such as net interest margins (NIM) rose to 1.9%, up 32 bps q-o-q and 47 bps y-o-y. Return on equity (ROE) reached a new high of 16.3%. For the nine months to Sept 30, net profit rose 8% to $5.852 billion.
Citi’s costs to impact soon
Before getting too excited about UOB, investors should be aware that the bank has completed the acquisition of Citi’s retail business in Malaysia and Thailand, which officially starts on Nov 1. When the acquisition was first announced, UOB had stated that a $200 million charge for stamp duty to the Malaysian regulators have to be paid likely in 4QFY2022.
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In FY2021, UOB reported a net profit of $4.075 billion and its net profit for FY2022 should likely beat that even with the Citi charge it has to record as expenses. UOB had announced that there would be a $700 million to $800 million one-time charge, including the Malaysian stamp duty to be recognised over two years, along with a 70 bps impact on CET1.
Other than the upcoming charge for the Citi acquisition, UOB’s management sounded cautiously optimistic. “We have guided that a 100 bps rise in interest rates will add $800 million to NII which is $100 million to $150 million per quarter. Our in-house expectation is the Fed will raise in 1QFY2023 and 2QFY2023 before [rates] can come down,” explains Lee Wai Fai, group CFO of UOB.
“This will translate into higher margins but margin growth won’t be as strong as this [3QFY2022] quarter. NIM will still be above 2% but if [interest rates] reach 4%, NIM will be higher by 5 bps to 10 bps,” Lee adds.
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On the credit cost front, group CEO Wee Ee Cheong indicated that total credit costs this year are likely to be around 20 bps. This could be a little heightened next year, with 20 bps to 25 bps of credit costs. The extra 5bps is probably from the Citi acquisition although Citi is forecast to be earnings accretive immediately.
Meanwhile, DBS says the acquisition of Citi’s Taiwan retail business will be completed in August 2023.
‘No line of sight’
In DBS’s 3QFY2022 results briefing, group CEO Piyush Gupta said: “You asked about credit costs but the reality is we have no real line of sight to cost of credit for next year because this year has been fantastic.”
He was referring to 3QFY2022 specific provisions of just 2 bps and the ability for DBS to write back general provisions in its ECL 1 and 2 (expected credit loss) in the first half of this year.
“Rates are going up to 4.75%–5% and we haven’t seen that kind of interest rate environment for a long time. Logic tells you that we should start expecting to see a higher cost of credit,” he continues.
“In our planning assumptions, we’re assuming that we go back to a normalised cost of credit of around 20 bps,” he concludes. While Gupta says DBS has a good pipeline of loans and equity and debt market deals potentially, a US recession would lead to a sharp slowdown in Southeast Asia.
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“Our guidance has been predicated on that there is a lot of uncertainty with these high interest rates, and China’s [recovery] is uncertain,” says Gupta, who is guiding single-digit loan growth for 2023 and NIMs at around 2.25%.
“Several of our Chinese clients are switching over from international to local markets and obviously, we are not that competitive in the local market so you might see a softening or a moderation of [our] momentum in China,” Gupta explains.
Adequate capital ratios
UOB’s CET1 fell by 30 bps q-o-q to 12.8% in 3Q2022. This was caused by the bank’s securities portfolio where there was a mark-to-market impact of around $1.8 billion. All banks have to hold HQLA (high-quality liquid assets) and FVOCI (fair value through other comprehensive income) securities to satisfy regulatory minimum net stable funding ratios and liquidity coverage ratios. The $1.8 billion will be fully recovered as and when the securities mature during the next three years. Both the securities portfolios of local and foreign banks have and are likely to continue to record mark-to-market losses.
DBS’s CET1 fell by 40 bps or 0.4 percentage points (ppt). Out of the 0.4 ppt impact on CET1, 0.3 ppt was from the mark-to-market effect on FVOCI and 0.1 ppt from RWA (risk-weighted asset) growth. At any rate, DBS’s CET1 of 13.8% is above 12.5%–13.5% of the guidance it has given. Its leverage ratio of 6.1% is twice the level of the regulatory floor of 3%. Plenty of cushion
Unlike the other banks, UOB has not written back any of its general provisions. The provisions made for relief loans that were eventually fully repaid, were not written back but moved to the management overlay which is the amount over and above gross provisions that banks hold. UOB’s management overlay is around $1.5 billion.
“The Covid relief portfolio is a lot stronger than we thought and we don’t see further specific provisions, so we have excess provisions, and added them to the management overlay. We have a bigger buffer and that gives us comfort. But we still add 1% to general provisions, so if credit costs go to 25 bps–30 bps, we can take that hit,” Lee elaborates.
DBS announced $153 million of general provisions in 3QFY2022, taking allowance coverage to 120%, and 216% if collaterals were included. DBS also added $350 million general provision overlays despite portfolio improvements and recoveries. All in, DBS has some $3.9 billion in general provisioning reserves as at Sept 30 with plenty of cushion should credit costs rise next year.
Future of finance
Looking ahead, DBS, UOB and OverseaChinese Banking Corp are part of the Monetary Authority of Singapore’s plans in piloting various forms of purpose bound money (PBM). DBS along with JP Morgan and some other partners formed Partior to commercialise cross-border foreign exchange transactions and settlements using distributed ledger technology (DLT).
DBS, again with JP Morgan, is involved in Project Guardian to identify use cases in decentralised finance (DeFi) that could benefit financial institutions in terms of efficiencies from transactions and settlements involving tokenised assets.
More recently, MAS has announced Project Ubin+. The original Project Ubin explored use cases involving cross-border transactions and settlements using digital currencies in real-time.
UOB CEO Wee says “clients are optimistic about Southeast Asia’s potential as an alternative production base”. He cites the nickel industry in Indonesia, where upstream and downstream supply networks are benefitting from the electric vehicle (EV) industry.
“Our extensive regional footprint and deep local and sector expertise give us a competitive edge in banking these trade and investment flows and enable us to facilitate and capture cross-border connectivity,” Wee indicates.
The strategy, according to Wee, will be to focus on connectivity, personalisation and sustainability. Connectivity is UOB’s raison d’être as it links its various markets and partners across Asean for both wholesale and retail banking, he says, while personalisation is a nod to UOB TMRW which continues to gain digital-only customers. Sustainability is part of a global effort and where UOB is working to help customers transition to a greener future, he adds.
In the past two years, DBS has made acquisitions in India and Taiwan. When asked about geopolitical pressure points around Taiwan, Gupta says: “Our overarching view has always been that as an Asia-centric commercial bank, our strategy includes a healthy view on North Asia. You cannot be an Asia-centric bank without a meaningful North Asia presence.”
Gupta sounds a lot more positive about India than about the general world economy. DBS acquired Lakshmi Vilas Bank (LVB) in December 2020. While some market watchers were concerned about the acquisition, LVB is performing above expectations, he says. Moreover, institutional investors are increasingly bullish on India because of its higher growth rates, just as China is easing.
“India continues to be our fastest-growing franchise over the last year or two and the outlook for next year is also very promising. We’re still integrating the business. The underlying portfolio quality has been better than we thought and we actually got recoveries on that as well,” Gupta says.
Earnings estimates from Bloomberg’s post-results poll of analysts have UOB’s net profit in 4QFY2022 at $1.353 billion and FY2022 net profit at $4.655 billion. The average forecast net profit for FY2023 is $5.419 billion.
Although DBS is forecast to record a net profit of $2.182 billion in 4QFY2022, this is likely to be exceeded noticeably at its current “run rate”. Analysts are forecasting a net profit of $9.224 billion in FY2023. If all goes according to plan, DBS should be able to breach the $10 billion mark in net profit as soon as 2024.
