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JP Morgan Raises Red Flag Over Local Banks
Aspire, Hot Picks | 30 April 2015
By: Lim Si Jie
Articles (169) Profile

Singapore’s banking sector stocks returned 18.5 percent while the Straits Times Index (STI) only returned 12 percent in the past 12 months.

However, JP Morgan is expecting “negative revisions and range-bound share prices in next three to six months” considering that the US Federal Reserve’s first interest rate increase is being postponed.

Furthermore, non-performing loans (NPLs) in the unsecured consumer books are at risk of moving up faster than expected.

Fed Unlikely To Raise Rates

Source: Bloomberg

The main driver of the banking sector outperforming the market was due to expectations that Fed will be raising interest rates soon. However, as the expectations of Fed tightening have lowered, analysts are having qualms about the banking sector’s performance.

According to Bloomberg, the probability of a rate hike in June Federal Open Market Committee (FOMC) meeting has moved from 24 percent two months ago to seven percent.

Correlation Between SOR and SIBOR

On 20th March, The 3M Swap Offer Rate (SOR) declined 18 basis points (BPs) in tandem with the analysts doubts about the interest rate increase in June.

JP Morgan points out that the weakening SOR “should lead to lower SIBOR” as both of these rates are means of accessing the Singapore Dollar’s funding.

According to JP Morgan, the effect of SOR/SIBOR movements in the last few months is “expected to show up starting 2Q15,” as asset yields usually lag behind by three to six months.

Source: Bloomberg

Source: Bloomberg

Negative Impact Of Rising NPLs

The Monetary Authority of Singapore (MAS) recently released data about borrowers with high leverage. The second cohort of highly indebted borrowers will have their credits suspended from 1 June 2015 onwards.

The main purpose is to limit unsecured borrowing to ensure borrowers would not loan a sum more than their annual income. However, this might negatively impact NPLs in the near term.

Source: JP Morgan’s estimates, Bloomberg

DBS: Tactical Downgrade to Neutral

The key driver for the stock’s 28 percent rally in last 12 months was expectations of rising rates. With SOR falling by 18 BPs in last 3 weeks, that driver is no longer sustainable. The sharp decline in 3M SOR should act as a catalyst for weaker stock price.

JP Morgan highlighted that DBS has been holding up “despite consensus estimates lowering.” JP Morgan warns that the downside risk is higher once consensus shift towards a more neutral outlook after the Q1 results.

There might be panic selling of stocks as optimism starts to diminish and JP Morgan expects DBS start trading in line with its earnings trend, thus capping further upside.

Verdict: Neutral, Price Target S$20.50

OCBC: Under-Valued Stock With Organic Growth Potential

Despite the general sentiments of the banking sector to underperform, JP Morgan believes that OCBC remains the “most under-appreciated” stock. OCBC is now best positioned among Singapore banks to pursue organic growth, after its Wing Hang deal and rights issue.

The bank has managed to build up its CASA franchise in the last eight years of low rates (44.6 percent vs. 28.8 percent in 2007), which JP Morgan expects to lead to better than expected Net Interest Margins (NIM) in a rising rate environment.

JP Morgan expects OCBC to reach an 11.5 to 12 percent Common Equity Tier 1 (CET1) over the next five to seven quarters. At the same time, 2015-16 Street Earnings Per Share (EPS) forecasts will likely move up as the rate sensitivity of NIMs gets factored into valuations. Ongoing consolidation in Wealth Management will also lead to better profits in the long run for OCBC.

Verdict: Overweight, Price Target S$12.00

UOB: Lower Your Holdings

Real estate loans make up 40 percent of UOB’s books. With real estate loans and mortgages decelerating, and signs of asset quality issues showing on developers’ books, JP Morgan expects Year-To-Date (YTD) underperformance to persist.

Considering credit costs have increased, the increase in interest income will be offset by debt servicing burden for borrowers. As such, the net gains from higher interest rates will be rather limited.

If UOB does not even benefit from higher SOR/SIBOR, what would happen if SOR/SIBOR falls? Thus, JP Morgan recommends “trimming (down on holdings) on every rally.”

Verdict: Underweight, Price Target S$21.50

Si Jie is no stranger to investing having started his journey at a young age. He is heavily influenced by acclaimed investors such as Benjamin Graham, Peter Lynch, and John Rothchild.

Please click here for more information about this author.

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