Highlighted Companies
DBS Group ADD, TP S$40.20, S$32.93 close
DBS had an estimated S$1.5bn in management overlays as at 2Q22. Monetisation of digital assets is a potential rerating catalyst, although scaling-up and price discovery may take time.
OCBC ADD, TP S$15.50, S$11.71 close
OCBC’s robust CET-1 of c.15% remains a key tool, whether for M&As or to cushion against asset quality deterioration. Clarity on capital management plans are a rerating catalyst.
United Overseas Bank ADD, TP S$35.60, S$26.13 close
We believe write-backs of management overlays would be unlikely until Covid-19 truly blows over. The credit quality of UOB’s moratorium portfolio remains healthy. Its key risk of asset quality concerns from its SME and ASEAN portfolio have been well contained, in our view.
Turning it up
- Pricing in Fed fund futures of c.4.6% by mid-2023 and likely slower loan growth ahead, we estimate c.1-4% EPS upside across banks in FY22-24F.
- Escalating funding costs (given all-time high fixed deposit rates) and weakening borrower affordability are key risks to our thesis.
- Our stress tests using c.4.5% p.a. mortgage rates (currently c.3%) show that the average TDSR remains below 55% for those with public housing loans.
- We think that positive Fed rate hike momentum (and stronger NIM expansion ahead) will continue to support a sector rerating. DBS is our preferred pick.
Fed rates likely to rise towards c.4.6% by mid-2023
The Fed has taken unprecedented action, raising interest rates by 75bp to 3.25% in Sep 22 in its bid to reel in persistent inflation. This follows elevated core inflation readings, sparking fears of stagflation setting in. Including this hike, the Fed has raised its benchmark lending rate five times this year, with three of these being 75bp hikes. In Singapore, investors have correspondingly been holding their breath on a recession in the US spilling over into Asian economies, which has somewhat resulted in 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 NIMs.
We raise EPS across banks by c.1-4% in FY23-24F
With the Fed’s markedly firmer stance of committing to rate hikes until inflation moderates, the Fed fund futures now imply a c.4.3% rate by end-2022 (vs. c.3.7% at end-Aug 22) before rising to c.4.6% by mid-2023 (vs. c.3.9% at end-Aug 22). These rates are noticeably higher that the c.3.6% peak rate we assumed as inputs into our 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 c.5-7% we factored in for FY23F. Factoring in forward Fed rate expectations (NIMs +c.30-50bp yoy in FY23F) and weaker growth (c.4-5% in FY23F) (Fig 4), we raise Singapore banks’ EPS by c.1-4% in FY22-24F. In tandem, we believe that sequential NIM expansion will peak around 4Q22F (vs. 3Q22F previously).
Stress tests show that borrowers may hold up well at 4.5% rates
Risks to our estimated earnings upside include a sharper-than-anticipated rise in funding costs from attrition from CASA into fixed deposits (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 (<1% of gross loans), we think that SMEs (c.6-13% of gross loans) could be a segment at risk if trade sentiment weakens. Our stress test of household balances in SG (Fig 7 and 8) has found that all households servicing a mortgage for public housing (except those in the bottom 10% income levels) will remain below the 55% total debt servicing ratio threshold, even at a 4.5% p.a. rates.
