Raising sector to Overweight.
WITH short-term rates expected to bounce in early 2015, a new re-rating wave could be unleashed as early as H2-14. The earnings upswing may be powerful after several years of depression in net interest margin.
We project 3-month Singapore dollar Sibor to rise to 1.0 per cent by end-2015 and to 2.0 per cent by end-2016 (currently 0.4 per cent). We fine-tuned our forecasts for FY13-15 (and introduced FY16 forecasts) and used P/E as our prime valuation guide (instead of P/BV).
DBS still our top pick; UOB raised to BUY.
We rank DBS highly as it is well positioned to benefit the most from a higher interest rate given its strong deposit franchise and liquid balance sheet.
The on-going transformation at DBS should support a higher medium-term ROE profile. We foresee DBS enjoying the strongest EPS CAGR of 15.6 per cent over FY13-16.
We also upgraded UOB to BUY on the following merits: (1) its large exposure to the resilient ASEAN market allows it to capture Asian consumer affluence; (2) management's discipline in previous acquisition bids suggests low risk of overpaying for Wing Hang; and (3) cheaper P/E valuation.
OCBC is our least preferred - rated at HOLD - for its volatile earnings profile, and risk of overpaying for Wing Hang.
In this report, we take a closer look at asset quality and liquidity to address concerns arising from a rapid 17.4 per cent loan compound annual growth rate (CAGR) since September 2010.
We conclude that industry asset quality should remain resilient because:
(1) the majority of the loan growth came from the traditionally safer housing loans and short-term US dollar trade loans;
(2) strong household balance sheets;
(3) decent corporate balance sheets; and
(4) a growing economy.
In reality, Singapore dollar liquidity remains ample with loan to deposit ratio (LDR) of 82 per cent. Stripping out non-Singapore dollar loans from the domestic banking unit's loans, the Singapore dollar LDR was in the region of 82 per cent at end-September 2013, paced by DBS (73 per cent), OCBC (84 per cent) and UOB (92 per cent).
While US dollar LDR is high (132.6 per cent for DBS; 109.9 per cent for OCBC; and 84.4 per cent for UOB), the risk of a US dollar crunch (US dollar loans accounted for 25.8 per cent of our universe's total loans at end-Sept 2013) is minimised by the use of commercial papers and currency swaps.
These short-term trade loans can be run down quickly in the face of a liquidity crunch. Furthermore, Singapore banks have proven to be able to raise substantial US dollar deposits. DBS's US dollar deposits jumped 24.4 per cent q-o-q in Q3-13.
What's ahead for 2014?
As we head into 2014, we expect the market to focus on three key issues:
(1) Asset-quality risk. After several years of strong loan growth amid soaring real-estate prices, every now and then, there is concern over credit quality erosion. Asset quality has remained surprisingly strong over the past three years, as reflected in the low credit charges and non-performing loan (NPL) ratio. Any credit quality slippage would dampen earnings growth.
(2) Liquidity risk. With domestic banking unit (DBU) loan-to-deposit ratio (LDR) at 101.8 per cent at end-Sept 2013, system liquidity is at its tightest since Oct 1998.
This carries two key negative implications: (a) loan growth could be curbed, and (b) there may be irrational competition for deposits.
(3) Direction of net interest margin trend. The industry net interest margin (NIM) has been on a consistent decline over the past few years as interest rates remained depressed. With a higher probability of a tapering of quantitative easing sometime in 2014, the key question is whether the industry NIM would start to trend upwards.
Singapore banks: NEUTRAL
DBS: Buy, UOB: Buy, OCBC: Hold
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