The main focus this year is for the local banks to navigate between tailwinds from higher interest rates, headwinds on wealth management income due to market volatility and the impact of inflation on their customers. Rising interest rates are net positive for banks.
For all three, this trend will have a positive impact on net interest income. The key is that the positive impact needs to more than offset the headwinds created on the wealth management front and the impact of inflation and rising rates on customers.
Rising rates boost net interest income
Based on the banks’ own models, which include some movement from cheap CASA to higher cost fixed deposits, the impact remains positive. For DBS Group Holdings, group CEO Piyush Gupta has articulated that a 1 basis point (bp) rise in interest rates adds $18 million to $20 million to net interest income. Hence, a 100bps rise in interest rates, which is likely over the course of a 12-month period, would add some $1.8 billion to $2 billion to DBS’s net interest income.
In 1QFY2022 ended March, DBS’s CASA ratio (CASA to total deposits) was 75%. DBS also reported net interest income of $2.19 billion in the same period, up 4% y-o-y and 2% q-o-q. All three banks have a December year-end.
Helen Wong, group CEO of Oversea-Chinese Banking Corp (OCBC), reiterates that the guidance she gave in February still stands. This entails an increase of 1% in interest rates, that leads to an 18bps increase in net interest margins and a $700 million increase in net interest income on an annualised basis. As at end March, OCBC’s CASA ratio stood at 62.7%, down marginally q-o-q but up y-o-y.
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Lee Wai Fai, group CFO of United Overseas Bank (UOB), points out that every 25bps rise in interest rates is likely to lead to a rise in net interest income of $150 million, translating into a $600 million rise based on 100bps hike on an annualised basis. As at end March, UOB’s CASA ratio was 55.9%, down a tad q-o-q but up significantly y-o-y.
In 1QFY2022, DBS reported a 4% y-o-y rise and a 2% q-o-q rise in net interest income to $2.19 billion, OCBC recorded a 4% y-o-y rise and 1% q-o-q rise in net interest income to $1.5 billion and UOB reported a 10% y-o-y rise and 1% q-o-q rise in net interest income to $1.7 billion.
So far this year, the US Federal Reserve has announced a 75bps hike in the US Federal Funds Rate. The pass-through depends on US dollar liquidity in Singapore. So far, there is some pass-through but it is unlikely to be 100%. Since the start of the year, Sora has risen from 0.1949% to 0.3227%.
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At any rate, net interest margins for the banks appear to have bottomed and have started firming. In 1QFY2022, DBS’s NIM was up 3bps q-o-q but down 3bps y-o-y to 1.46%. OCBC’s NIM fell 1bp y-o-y but rose 3bps q-o-q to 1.55%; UOB’s NIM rose 1bp y-o-y and 2bps q-o-q to 1.58%.
Headwinds from interest rates, inflation
Rising interest rates are negative for bond and securities portfolios. This was obvious in OCBC’s 88%-owned Great Eastern Holdings which experienced a 50% drop in net profit during the first quarter because of mark-to-market losses for its bond portfolios.
Similarly, all three banks are likely to have had mark-to-market losses for their high-quality liquid assets (HQLA) portfolio that is required by regulators and is an important part of the banks’ liquidity coverage ratio (LCR). HQLA is the numerator in the LCR with net cash outflow as the denominator.
LCR of all three banks are comfortably above 100%. In 1QFY2022, DBS reported an LCR of 138%, while the LCR of OCBC and UOB were 151% and 129% respectively. Any movement in HQLA does not impact the P&L but there is an impact on banks shareholders funds and hence their net asset values per share.
As an observation, both OCBC and UOB experienced NAV increases y-o-y and q-o-q, while DBS saw a marginal dip in NAV per share q-o-q.
Interest rates are rising because of inflation. This may be good for banks but rising rates are not great for companies. In fact, rising rates and inflationary pressures are raising operating expenditures for companies. For instance, REIT managers have articulated that higher utility costs are causing property expenses to rise. For some REITs, utility costs are likely to rise by 2x to 3x.
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For the banks, inflation is a second-order impact. “We will continue to be somewhat cautious about releasing general provisions,” Gupta says. In 1QFY2022, DBS wrote back some $112 million after releasing $447 million in general provisions in FY2021 ended December, 2021.
Gupta raises concerns about the “second and third level impact” of the Russian-Ukraine war, such as rising commodity prices and inflation. What happens if prices go up and volumes come down, and what is the impact on margins he wonders. Some industries where margins cannot go up on the back of inflation could start creating their own little headwinds, Gupta says. He expects credit costs of about 20bps this year, pointing out that in 1QFY2022, DBS had specific provisions of 15bps. “Fortunately for us, our own portfolio continues to remain resilient. We have spent the time doing a lot of stress tests on commodities, food, agri-mining and all the usual industries,” including the impact on fast moving consumer goods, and the property sector in the context of China, Gupta indicates.
“We see headwinds and we want to be prudent to manage our portfolio, but we are quite resilient, although there is uncertainty in the outlook,” Wong says.
Although the IMF has moderated global growth forecasts and some economists have raised the dreaded S (stagflation) and R (recession) words, regional economies focused on commodities could weather these trends.
“As a Southeast Asia bank focusing on intra regional flows, we are less directly impacted by the Russia Ukraine conflict. Economies in our part of the world are recovering, Consumption is picking up and business activities resuming,” says Lee reading out a statement on April 29 on behalf of UOB group CEO Wee Ee Cheong, who was recovering from Covid.
While the lockdowns in China are negatively impacting supply chains, Wee’s statement sees a positive turn to supply chain challenges. “The trade and investment corridor between Asean and China takes us in a unique position to serve the needs of customers. The current disruptions to the global supply chain will show the importance of the role of our region,” Lee says.
Rising commodity prices could have a modest positive impact on UOB and OCBC given their Southeast Asian presence. Both Malaysia and Indonesia are likely to benefit from higher oil and palm oil prices. Elsewhere in Southeast Asia, Thailand and Vietnam are seen as beneficiaries of changing global supply chains.
“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 also 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,” notes UOB Kay Hian in an update on the banks.
On the whole, the banks are maintaining their credit cost guidance given at the start of the year. Wong of OCBC expects credit costs to stay at 22bps to 25 bps of loans while Lee of UOB says he expects credit costs to land at around 20bps to 25bps for the full year.
All three banks have maintained their management overlays and general provision reserves. DBS’s general provisions reserves topped $3.75 billion, UOB’s topped $2.98 billion while OCBC’s was $1.93 billion.
Which bank is cheapest?
DBS’s 1QFY2022 net profit of $1.8 billion, up 30% q-o-q but down 10% y-o-y, was just a tad outside the consensus forecast of $1.88 billion on Bloomberg. OCBC’s net profit of $1.36 billion was up 39% q-o-q but down 10% y-o-y but was comfortably above the $1.2 billion consensus forecast on Bloomberg. UOB underperformed expectations. Its net profit of $906 million, down 11% q-o-q and 10% y-o-y, was notably below a consensus forecast of $1.02 billion.
UOB’s miss was because of a one-time cost from hedging as interest rates climbed. Its trading and investment income reported a 70% y-o-y decrease following a $117 million loss under “others”.
Lee explains: “The sharp drop was mainly from the accounting asymmetry on hedges for our perpetual capital securities. These hedges were done earlier when rates were lower. They were meant to match our funding profile to the asset book repricing. However, from the accounting perspective, there is a mismatch between the mark-to-market line on the hedges.”
The $117 million impact is a onetime cost and unlikely to recur. On the other hand, the pass-through from rising interest rates is likely to be felt. Lee indicates that some 80% of its loan portfolio could get repriced on the back of these rising rates, leading to a net positive impact on UOB’s net interest income and bottomline.
Amanda Choong, banking analyst at CGS-CIMB, says she is keeping “add” ratings on all three banks. She has raised her target prices for DBS and UOB by 30 cents to $40.20 and 20 cents to $35.60 respectively because of the Fed hikes but is moderating income from treasury and wealth.
“OCBC’s $14.20 target price is unchanged as the earnings rise from stronger NIMs and treasury income is offset by softer wealth,” Choong says.
The banks are well-positioned to sustain their dividend policies in FY2022, the CGS-CIMB report says. Choong is anticipating dividends of $1.44 from DBS, $1.20 from UOB and 60 cents from OCBC. In 2HFY2021 ended June, OCBC announced a dividend of 28 cents per share, compared with 60 cents by UOB, and a final quarterly dividend of 36 cents by DBS. In 1QFY2022, DBS has maintained its 36 cents dividend.
“OCBC remains our top pick for the sector given its more attractive risk-reward profile,” Choong says. To be sure, in 4QFY2021, OCBC appears to have “kitchen-sinked” its bad loans. In terms of price to book, OCBC is the cheapest among the three banks. OCBC also trades at the lowest multiple and the highest dividend yield (see table 2).
