Bank - 2017 Sector Outlook ~ There is hope
- NIM expansion phase in FY17 on rising interest rates; keeping tab on slow loan growth.
- Bulk of NPL issues should be over but there are still lingering concerns albeit on a smaller scale; relatively high credit costs and NPL ratios to prevail for another 1-2 quarters.
- Prefer OCBC (BUY, TP S$10.30) over UOB (HOLD, TP S$21.80).
Rising rates, higher NIM.
- With rate hikes almost a certainty in the coming quarters, the Singapore banks are almost surely to deliver higher NIM. We have imputed 8-10bps rise in NIM for FY17F. Our sensitivity analysis suggests that every additional 25bps increase SIBOR/SOR translates approximately to a 6bps increase in NIM (ceteris paribus), and will lift earnings by another 4%.
- Loan growth however will likely remain sluggish at low single digits, limiting net interest income growth.
Bulk of the NPL issues behind us; but there are still lingering concerns.
- The Ministry of Trade and Industry announced enhanced support measures for the oil and gas sector in the form of new incremental loan facilities from SPRING Singapore and IE Singapore to Singapore-based industry players. We believe this has brought some relief to companies which are experiencing tight cash flow, and hence extend some respite to banks in terms of NPL incidences.
- However, we remain watchful on some spillover effects to the construction sector and loans to individuals in the near term should the macro environment remain sluggish and unemployment levels become a concern. As such, credit costs may remain relatively elevated in FY17 (vs 5-year historical trends) albeit lower than FY16’s.
- Possible earnings surprises could emerge if asset quality recovers quicker than expected in FY17. Every 5bps decline in credit cost will lift earnings by 3%.
In need for a more sustainable earnings and growth trends.
- A more sustainable earnings and growth trends to watch would be what banks can do over the longer term, especially in the wealth management space. The banks’ regional agenda remains intact.
Over-optimism on rate hike impact.
- The Singapore banks’ share prices have had a good rally since Trump’s victory and with more certainty of rate hikes.
- This is even before any real numbers have filtered through. A more sustainable earnings and growth trends to watch would be what banks can do over the longer term, especially in the wealth management space. The banks’ regional agenda remains intact.
Prolonged tail risk to NPL issues.
- The market appears to be disregarding any downside risk to further NPL issues. There may be some tail risk to NPL issues albeit on a smaller scale given the sluggish economy. Every 5bps increase in credit cost will drift earnings down by 3%.
Valuation & Stock Picks
Trading at a discount to regional peers.
- Singapore banks have been trading at a discount by virtue of lower NIM and growth prospects vs ASEAN peers. The Singapore banks were shunned since early 2016 and it has been a consensus underweight call vs ASEAN peers because it lacked catalysts, coupled with NPL issues it dabbled with for the large part of 2016. But with more certainty of rate hikes, Singapore banks have reemerged on investors’ radars.
- The Singapore banks have rallied over a month because of this. We believe there is still another leg to go, albeit not a significant jump further from here.
- Rising NIM which will drive earnings higher in 2017 is the key catalyst for the share price performance of the Singapore banks.
Prefer OCBC to UOB.
- OCBC would be our preferred bet for three reasons:
- its ability to maintain lower-than-peers credit cost trends,
- it serves as a better wealth management play, and
- possible earnings surprises from its insurance business in a rising interest rate environment
- UOB has kept its buffer for NPLs but it still lacks the allure for a wealth management play; higher NIMs should drive earnings – HOLD; TP at S$21.80, maintain HOLD. Our forecasts are now above consensus estimates for FY17-18F.