Citi Research analyst Tan Yong Hong has downgraded Singapore’s three major banks to “underweight” as Citi economists expect 225 basis points (bps) of rate cuts by the US Federal Reserve in 10 months and see recent data as first signs of US economic contraction.
In an Aug 5 note, Tan downgraded DBS Group Holdings, Oversea-Chinese Banking Corporation (OCBC) and United Overseas Bank U11 (UOB) to “sell”, saying investors should “unwind their overweight positions”.
Tan says past bullishness was supported by the higher-for-longer outlook, capital management upside and the strong US dollar outlook.
Tan’s report follows UOB and OCBC’s financial results for 1HFY2024 ended June 30 last week, and DBS will release its results on Aug 7. Even ahead of DBS’s announcement, Tan prefers DBS, followed by OCBC and UOB, in that order, based on their total shareholder returns.
New rates view
Citi’s new house view on rate cuts casts uncertainties on the earnings outlook. The sharp increase in US rate cuts expectations in FY2024, from 50bps to 125bps of cuts, should drive earnings downgrade, says Tan.
“We now expect 10bps net interest margin (NIM) contractions, each in 2025 and 2026. Lower long-term rates, which the Fed has upgraded to 2.6% in March and 2.8% in June, is a more material downgrade for target prices,” writes Tan.
Every 100bps rate cut impacts earnings per share (EPS) by 6%-7% and return on equity (ROE) by 80bps to 100bps.
Hong Kong CRE concerns
See also: OCBC posts record 1HFY2024 net profit of $3.93 bil, up 9% y-o-y; 2QFY2024 net profit falls 2% q-o-q
UOB and OCBC’s results reignited Hong Kong commercial real estate (CRE) concerns, says Tan, with regional banks reporting higher Hong Kong non-performing loans (NPL).
Also, higher transaction volumes in FY2025 could serve as new reference points for property valuations, says Tan.
OCBC’s NPL ratio fell to 0.9% from 1.0% in the previous quarter and 1.1% in the prior year. UOB’s NPL ratio stayed at 1.5%.
Tan sees asset quality risks on global slowdown and falling property valuation in Hong Kong. “We still expect benign provisions (25bps for sector), which is significantly below past downturns. Every 10bps higher credit costs lower EPS by 3%-4% and ROE by 40bps to 60bps.”
Dividend ‘protected’
The US 10-year bond yield is down 70bps from a peak in July, which historically is well-correlated with Singapore banks’ price-to-book (P/B), says Tan. “”On dividends, we assume dividend per share (DPS) is protected by robust capital positions.”
Within banks’ results, Tan sees slower fee income growth. “We earlier expected an increase in wealth churn (fees over assets under management) but this is at risk with softer sentiments. Slower growth hurts cards and other fees. Every 10% cut in fees lowers EPS by 2% to 4% and ROE by 30bps to 50bps.”
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Hold off bottom-fishing
According to Tan, Singapore’s banks take 133 to 308 days to bottom, based on past downturns.
The three banks saw tailwinds from higher-for-longer rates year to date, but that could be at risk, he reiterates.
Notably, Tan prefers the “buy”-rated SGX over the three local banks. “DBS has seen most selling due to relative overweight, but as the market's conviction for rate cuts increases, the sector should underperform.”
As at 12.32pm, shares in DBS are trading $1.78 lower, or 5.04% down, at $33.53; while shares in OCBC are 57 cents lower, or 3.85% down, at $14.23; and shares in UOB are $1.49 lower, or 4.68% down, at $30.34.
