Non-interest income recovery the next growth lever for local banks: CLSA

Non-interest income is roughly a third of total income for the banks.

Singapore’s banks all reported record 1QFY2023 ended March, but the outlook is more moderate, say CLSA analysts Neel Sinha and Lin Daxin.

Net interest margin (NIM), in particular, was a mixed bag in the most recent quarter, add the analysts in a May 11 note. “NIMs look to be flattening out sooner than we expected and management guidance from the briefings seems to indicate the same as the federal funds rate (FFR) rate hike trajectory has changed a bit from the quarter ago and the fixed deposit rates on the funding side are now catching up.”

DBS D05 group NIM was at 2.12%, up 7 basis points (bps) q-o-q, though the commercial book NIM was much higher at 2.69%, up 8bps. “This was broadly in line with our expectations despite the weak Hong Kong Interbank Offered Rate (HIBOR) rate environment, to which the bank has quite a bit of exposure,” say Sinha and Lin.

Meanwhile, Oversea-Chinese Banking Corp (OCBC) O39 NIM was marginally down 1bps q-o-q from HIBOR weakness to 2.30% as well as the fixed deposit funding cost increase with some deposit competition taking place in the quarter. “This was slightly lower than our expectation by 3bps-4bps,” say the CLSA analysts.

Finally, United Overseas Bank (UOB) U11 was the negative surprise at 8bps down to 2.14% and this was largely due to a tactical fixed-deposit gathering drive, which raised funding cost at the expense of NIM. “UOB has the lowest Casa [current account and savings account] ratio in deposits and the fixed deposit (FD) raising drive did have the desired effect with Casa now stable q-o-q at 48%,” write Sinha and Lin.

While the CLSA analysts have “buy” ratings on all three banks, they prefer DBS, UOB and OCBC, in that order, citing price action from the past three months. “Furthermore, UOB has slightly higher leverage to leverage in the small- and medium-sized enterprise (SME) sector, a space that has not really seen much loan recovery, and we expect that to be a late-2023 event. On the dividend front, DBS has the highest potential for another special dividend this year.”

CLSA has a target price of $43.14 on DBS, $16.20 on OCBC and $39.70 on UOB.

Meanwhile, UOB Kay Hian Research analyst Jonathan Koh has “buy” calls out for DBS and OCBC with target prices of $41 and $17.32 respectively.

“Although NIM has plateaued, Singapore banks will benefit from the expanded NIM on a full-year basis in 2023. Shareholders will be rewarded with higher dividends in tandem with the strong earnings growths of 15% for DBS and 17% for OCBC in 2023,” says Koh in a May 11 note.

Koh forecasts DBS and OCBC 2023 dividend yields of 5.3% and 6.1% respectively.

Non-interest income recovery the next lever

Non-interest income is roughly a third of total income for the banks, of which wealth management fees are a large component given Singapore’s status as a regional wealth management centre. “Typically wealth management fees were around 15%-18% of total revenue pre-pandemic,” say Sinha and Lin.

This has been soft over the past year with successive q-o-q declines as market volatility and a risk-off appetite drove investors to sit on the sidelines, they add. “On a y-o-y basis, we saw 30%-40% declines leading up to 4QFY2022 vs levels in 4QFY2021.”

That said, the analysts’ earlier thesis that wealth fees would start recovering in 2H2023 after the rate hike cycle ends has come a bit sooner than expected. DBS noted a 40% q-o-q jump in wealth fees, OCBC at 37% and UOB at 27%, from a relatively depressed base last year.

Wealth asset under management (AUM) has grown at low-single-digit levels even through 2022; this quarter saw $6 billion in net new money for both DBS and UOB and some $12 billion for OCBC. “We see more upside here through 2023 although at a more moderated pace compared to 1QFY2023,” note Sinha and Lin.

Other areas of non-interest income are flat or growing q-o-q at a modest pace for all three banks, add the analysts. “[The] only observation on this front was a very high level of trading and investment income at UOB, largely non-customer-related driven, from opportunistic liquidity management activities, which we think will likely not be sustainable over coming quarters.”

Asset quality resilient 

The three banks maintain that there are no signs of stress in asset quality from their bottom-up risk evaluation models.

Non-performing loan (NPL) ratios continued to remain benign with DBS at 1.1% in 4QFY2022 (down 10bps q-o-q), OCBC at 1.2% (flat q-o-q) and UOB at 1.6% (up 10bps q-o-q).

“The potential tail risks on asset quality from the government-led loan moratorium programmes in Asean ex-Singapore now seem to have largely faded as have the risks of any China property-related exposure; both factors were a concern for investors last year. NPA coverage remains at healthy levels for the three banks at 98%-122% at end-4QFY2022,” write Sinha and Lin.

“Despite the headwinds on a NIM expansion peak and slower loan growth, the non-interest income segment has recovered a bit quicker than expected and we expect the trajectory to continue by roughly mid-single-digit levels on the back of the better-than-expected 2022 results and adjustments related to management guidance for the year,” say the CLSA analysts. “Return on equity should hit decade highs in 2023 before moderating by a couple of percentage points or less heading into 2024/2025, by our estimates.”

Asset-quality trend to see 'modest normalisation' in 2HFY2023: Bloomberg

Bloomberg Intelligence analyst Rena Kwok notes that the benign asset-quality trend of Singapore banks could see "modest normalisation" in the second half of the year. This comes amid rising headwinds with the recovery in non-performing assets (NPA) and new formation of NPAs as "important to watch", says Kwok. Nonperforming loan (NPL) ratios may also stay benign in the 2HFY2023, she adds.

"The continued efforts by the lenders to increase management overlay look sufficient to buffer possible credit risks. While systemic stresses in their loan books are unlikely, pockets of stress might creep up from riskier segments such as unsecured retail and SMEs in external-focused sectors," says Kwok.

Meanwhile, the impact of defaults on unsecured retail loans among the three banks appears to be limited despite headwinds. "[This is] given these loans' meager share of lenders' books, their broadly improving risk profile and the regulatory caps on rates," says Kwok.

Citi's retail loans, which have a healthy risk profile may not raise the risk of UOB's unsecured retail loans much as well, she adds.

"With the consolidation of Citi's retail loans, the average probability of default (PD) of UOB's qualifying revolving retail exposure (QRRE) -- comprising revolving, unsecured, and uncommitted retail loans, based on its advanced internal rating-based model under Basel rules -- was the highest among peers in 4QFY2022 at 2.5% (and comparable to 4QFY2020). OCBC's unsecured retail loans, with about $6 billion in exposure at default, had the lowest PD of 1.1%," she points out.

Finally, credit losses from Singapore banks' loans to SMEs appear to be manageable. This reflects the improving credit quality nurtured by "tight underwriting", says Kwok, although she notes that "pockets of stress" may creep up from borrowers in external-reliant sectors as global growth slows.

On May 17, shares in DBS closed 39 cents lower, or 1.26% down, at $30.57; while shares in OCBC closed 13 cents lower, or 1.06% down, at $12.13; and shares in UOB closed 42 cents lower, or 1.51% down, at $27.47.

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