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Local Banks Poised For Gains?
Perspective | 22 November 2010
By: Xavier Lim
Articles (51) Profile

While the broader market has been trending up since the start of 2010, the 3 big local banks have generally stayed out of the rally. Shares of laggards DBS Group Holdings (DBS) and United Overseas Bank (UOB) have been in the red over the last 10 months, despite the STI surging around 10% as at 19 Nov-10. Not surprisingly, this was probably due to the fact that many investors and money managers have been avoiding banks’ shares. Investors are still scared that if global economies were to go into a double-dip or deflation, then the credit quality will worsen and in turn inflict a significant negative impact on banks.

Nevertheless, Oversea-Chinese Banking Corporation (OCBC) has been stealing the spotlight recently; its share price has soared more than 8% (as at 19 Nov-10) over the past few days since it reported its 3Q10 performance. This move has caused a lot of investors to wonder, will the other 2 banks’ shares follow suit and turn around in coming months? Let us find out together!

3Q10 Earnings Speak For Themselves

OCBC earned $570 million in 3Q10, an increase of 27% from $450 million a year ago and its profit of $0.173 a share easily topped estimates. The gains were thanks to higher net interest income, strong fee and commission income, and lower credit losses. In addition, OCBC’s loan book has expanded much faster than the industry average to compensate for decline in net interest margin. Its listed subsidiary, Great Eastern Holdings (GEH) also did not disappoint investors, contributing significantly to the bank’s improved results with net profit contribution increasing 146% quarter-on-quarter to $137 million in 3Q10, and 16% year-on-year to $340 million in 9M10.

The Bank of Singapore (BS), which was acquired in January this year, has also contributed to the better-than-expected 3Q10 results. OCBC’s fee and commission income soared 37% to $260 million for the nine months of 2010, partly attributed to the contributions from BS. The better performance was also underpinned by improvement in wealth management income, which more than doubled to $50 million, coupled with strong growth in investment banking, loan-related and trade-related income.

UOB saw its 3Q10 earnings rose 37.5%, and its total income grew 11.1% to $1.468 billion year-on-year respectively, driven by higher fee and commission income and improved trading and investment income. However, the bank posted lower net interest income due to decline in interest margin. Net interest margins appear to be under pressure on intense competition and look likely to stay so, especially in this current low interest rate environment.

Nevertheless, UOB’s net customer loans enjoyed 3.2% increase for 3Q10 to $107.1 billion as at 30 Sep-10, bringing its year-to-date loan growth to 8%. UOB had a tier-1 ratio of 15.1% and core tier-1 ratio of 13% in 3Q10. Citigroup upgraded UOB’s rating to Hold with a target price of $19 from $17.80.

DBS posted a better-than-expected 3Q10 net profit of $722m, a 28% improvement over the same period last year. Total income increased by 15% to $1.809 billion. The results were underpinned by continued loan growth and sustained customer-driven non-interest income flows. Net customer loans, on the other hands, rose 1.2% quarter-on-quarter, but was lower than its 2 rivals, while net interest income fell 5% to $1.079 billion. Although non-interest income fell 2% quarter-on-quarter, with fee income falling 5% as a fall in loan-related fees, DBS managed to increase its investment banking revenues to partially offset the decline in non-interest income.

The bank also cited improvement in its DBS Hong Kong’s earnings that jumped almost 3 times attributed to a significant decline of 41% in expenses as compensation for Constellation note holders were booked in last quarter. However, earnings from its Singapore operations fell 20% quarter-on-quarter to $431 million. OCBC Investment Research rated DBS with a Buy and fair value estimate of $16.

Continue To Perform Better In The Long-Term

It is no secret that Ben Shalom Bernanke, Chairman of the United States Federal Reserve (Fed) will reverse course on the federal funds rate and bring it up from its rock-bottom levels sooner or later. This move may actually benefit the 3 local big banks. As the Fed pushes up rates, banks will actually be able to increase their net interest income profit margin. Yes, it is true that higher interest rates could discourage lending and weigh on banks, however, a hike in rate can be viewed as a “positive signal” that the economy may have bottomed out and is set to recover.

It is noteworthy that credit markets are improving on both consumer and business level, which is a great sign for banks since it means better earnings and fees from lending. Moreover, the most recent round of earnings reports have shown that there were fewer bad loans for banks to write down. It is little wonder why the International Monetary Fund has predicted that the world economy will expand 4.8% this year and 4.2% in 20011.

Therefore, an improvement in the economy will result in consistent declines in bad loans, and this will result in huge increases in bank earnings. But even if we are going to experience a slow-growth recovery, these banks are still decent places to be invested. Don’t wait until the institutional buyers bid up prices before you buy into bank stocks as you would want to be ahead of the surge.

Armed with an arsenal of investment knowledge, Xavier is the Senior Research Editor at Shares Investment.

Please click here for more information about this author.

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