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Analysts: Rates Hike Imminent; OCBC & DBS Top Picks
Aspire, Hot Picks | 27 July 2015
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By: Lim Si Jie
Articles (169) Profile

In the latest testimony to the House Financial Services Committee, Federal Reserve Chair Janet Yellen pointed out that should the US economy continue to improve, “conditions likely would make it appropriate at some point this year to raise the federal funds rate target”. Yellen’s reaffirmation of a possible rate hike this year is likely to buoy the banking sector.

Banking Sector Overweight

The three local banks are due to report their 2Q15 earnings in the coming weeks: DBS on 27 July, and OCBC and UOB on 31 July. Following a seasonally strong trading income, which boosted net profit last quarter, analysts expect earnings to be more normalised for 2Q15.

Key Investment Trends

The key focus areas for investors in 2Q15 continue to be Net Interest Margin (NIM), loan demand and asset quality given the likelihood of rate rise in the US and liquidity outflow risks in the ASEAN markets. Looking ahead, NIMs are expected to take an upward turn as interest rates rise.

Steady Improving NIMs Tied To SIBOR, Fed Rates

The three-month Singapore Interbank Offered Rate (SIBOR), which is the benchmark rate for most floating rate loans, has historically been closely tied to the Fed Funds Rate. However, the SIBOR has already started to move ahead of the Fed Funds Rate this year due to the strengthening of the US Dollar against the Singapore Dollar. Analysts are expecting the SIBOR to trend even higher from here, with the upcoming Fed rate hike.

Moreover, as China slows, the rest of Asia that relies on commodities and exports to China would be dragged down as well. This would lead to further weakening of Asian currencies against the Dollar, adding tailwinds to the SIBOR. In 1Q15, the banks have already recognised a three to four basis points (bps) improvement in NIMs from the rise in the SIBOR.

Loan Growth May Disappoint

Although the loan growth guidance was already lowered to mid-to-high single-digit for 2015, the run rate could further disappoint post 2Q15. Aside from Singapore, loan demand has slowed in other key geographical regions, including Hong Kong, India, Indonesia, Malaysia and Thailand, partly due to domestic weakness as well as banks being more prudent in view of rising asset quality risks.

The strength of the SGD during the quarter may also negatively affect loans denominated in other currencies. With more short-term catalysts in sight, DBS and OCBC are the top picks among local banks, followed by UOB.

DBS: Consistent Performer

DBS has consistently delivered on its bottom line with an average net profit of about S$1 billion per quarter since 2012. Traditionally, DBS has performed well when rates are higher. In addition, the recent volatility in the market is also likely to create opportunities for improving trading income.

Aside from having the best-in-sector CASA (Current-Account, Savings Account) and Singapore Dollar deposit franchise, DBS’s larger-than-peers Hong Kong platform should benefit from improved market sentiment, particularly in 2Q15. Its valuations are not expensive and it is currently trading close to its historical average Price-Earnings Ratio (PER) and at only 1.3 times book value.

The key downside risks for DBS are represented by its ASEAN exposure in India and Indonesia. Given that two percent of DBS’s profit before tax comes from South and Southeast Asia, the potential growth and asset quality concerns could negatively affect the bank’s earnings.

Other potential downside risks include a severe property price correction that could affect the asset quality of the bank.

Recommendation: TP $23.20, BUY

OCBC: Synergy From Overseas Expansion

Among the three local banks, OCBC had diversified most successfully. It had been able to increase the contribution of the offshore businesses, and expand geographic and business line contributions. Analysts expect most value coming from its offshore businesses, including a potential revaluation of its life assurance business. Synergies from OCBC’s Wing Hang Bank acquisition could also boost its wealth management business and provide greater fee income upside.

The key downside risks for OCBC are further NIM and credit quality deterioration. Its exposure to ex-Singapore ASEAN markets is a risk, accompanied with concerns over a slowdown in the ASEAN markets and potential liquidity outflow.

Recommendation: TP $12, BUY

UOB: Least Favourable Pick

Given that UOB has captured much of the NIM improvement in 1Q15, we believe the magnitude of increase is unlikely to be significant in 2Q15.

Moreover, UOB has the biggest exposure to both Singapore high-end mortgages and ASEAN, which places it in a weaker position in the event where Singapore property prices dip and ASEAN suffers from more defaults. That being said, analysts expect the dip in property prices to be short-lived if it does happen.

Further NIM and credit quality deterioration remains as the key downside risk for UOB. Its exposure to ex-Singapore ASEAN markets remains a risk too, with concerns over a slowdown in the ASEAN markets.

Recommendation: TP $26.05, HOLD

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.

Oversea-Chinese Banking Corp  10.690 +0.03 +0.28%   
Business: [FY18 Turnover] Global corporate/investment banking (35%), global consumer/private banking (34.8%), OCBC Wing Hang (11.5%), insurance (11%), global treasury & mkts (7.7%).

Insight: May-19, 1Q19 total income rose 14.7% driven by str... Read More
DBS Group Hldgs  24.590 +0.01 +0.04%   
Business: [FY18 Total Income] Institutional banking (43.7%), consumer banking/wealth management (42.9%), treasury markets and others (13.4%).

Insight: Apr-19, 1Q19 net profit rose 9% to a record $1.7b.... Read More


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