Resiliency That Defies Gravity
The Fed has signalled another two rate hikes of 25bp each to bring Fed Funds Rate to 5.50% by end-23. Core inflation is receding very gradually and we expect interest rates to stay elevated till mid-24. Our top BUY pick is OCBC (Target: S$17.50) for its new dividend policy with payout ratio at 50%, focus on ASEAN and defensively low P/B of0.99x. We also like DBS (Target: S$41.50) for excellence in execution and consistently delivering good results. Maintain OVERWEIGHT.
• Higher interest rates for a longer time frame. The Fed kept interest rates unchanged at the FOMC meeting on 14 Jun 23 but signalled more upcoming rate hikes. The dot plot indicates another two rate hikes of 25bp each to bring Fed Funds Rate to 5.50% by end23. Fed chairman Jerome Powell said he does not anticipate core inflation to return to the Fed’s target of 2% until 2025, which suggests that interest rates could stay higher for a longer time frame. We expect interest rates to stay elevated till mid-24.
• US economy stays resilient despite the series of rate hikes. The US economy has weathered higher interest rates, tightening of liquidity and fallout from the collapse of three regional banks. Labour market remains too tight with unemployment rate still low at 3.6% in Jun 23, near the historical low of 3.4% recorded in Apr 23. Lately, new single-family home sales and new construction activities have also surged in May 23.
• Sensitivity analysis. We conducted a sensitivity analysis for the impact on 2025 financial performance, including net profit, ROE, DPS and dividend yield, from: a) fluctuation of Fed Funds Rate and NIM, and b) potential slowdown/recession and the resultant hit on credit costs. Assuming Fed Funds Rate at 5.50%, a deterioration of credit costs from 20bp to 90bp would cause DBS’ and OCBC’s net profit to drop 25.1% and 24.7% respectively. Assuming credit costs at 20bp, a cut in Fed Funds Rate from 5.50% to 4.50% would cause DBS’ and OCBC’s net profit to drop 6.1% and 5.1% respectively.
• Asset quality – Withstood test from COVID-19 pandemic. The three Singapore banks have weathered the COVID-19 pandemic with NPL ratio deteriorating on average by just 0.1ppt. DBS’ and OCBC’s NPL ratios have slipped 0.2ppt to a similar 1.1% over the past three quarters. Banks have ample management overlays for general provisions amounting to about S$2,100m for DBS, S$1,000m for OCBC and S$1,400m for UOB.
• Capital adequacy – Among the safest in the world. OCBC has the highest CET-1 CAR at 15.9% as of Mar 23, followed by DBS at 14.4%, far exceeding the minimum requirement of 9%. DBS is ranked 12th safest on a worldwide basis by Global Finance, followed by OCBC at 13th. Within Asia, the three Singapore banks are recognised as the top 3 safest ahead of banks in South Korea, Taiwan and Hong Kong.
• Maintain OVERWEIGHT. Banks provide attractive value proposition with low P/B of 1.14x, low PE of 8.1x and sustainably high yield of 5.9% for 2023. Our top BUY pick is OCBC (Target: S$17.50) for its new dividend policy with payout ratio at 50%, focus on ASEAN and defensively low P/B of 0.99x. We also like DBS (Target: S$41.50) for excellence in execution and consistently delivering good results.
• We trimmed our 2025 net profit forecast for DBS by 7% due to rate cuts of 100bp in 2H24 and credit costs of 31bp (previous: 22bp).
• We trimmed our 2025 net profit forecast for OCBC by 7% due to rate cuts of 100bp in 2H24 and credit costs of 32bp (previous: 23bp).
• Economic recovery driven by the reopening and easing of COVID-19 restrictions, including the ongoing reopening in China.
• Banks reviewing their dividend policy and paying more dividends.
• Escalation of the Russia-Ukraine war beyond Ukraine.
• Geopolitical tension and trade conflict between the US, EU and China.