Singapore banks are likely to remain “stronger for longer” amid expectations of rate cuts, says CLSA analyst Neel Sinha. CLSA is now expecting rate cuts to take place a bit earlier than the fourth quarter of this year.
All three banks have reported record profits in recent years due to higher net interest margins (NIMs) due to the higher interest rate environment.
While the banks would be the most sensitive to rate cuts, the cuts would also suggest that inflation is under control and that corporates can start picking up any investments in the business again, Sinha notes.
US Federal Reserve (US Fed) chair Jerome Powell said, on July 16, that the country’s economic data in the 2Q2024 has offered confidence that inflation is getting closer to the central bank’s 2% goal.
US Fed Governor Adriana Kugler also noted that a rate cut would be appropriate “later this year” while former Fed official Robert Kaplan says the path for a rate cut in September is “pretty clear”.
On July 31, the US Fed’s Federal Open Market Committee (FOMC) kept its benchmark rate within the range of 5.25% to 5.5%.
Fees and loan growth to offset lower NIMs
As interest rate cuts start filtering through on the banks’ assets books, investors can expect to see the repricing come through very quickly, says Sinha in an online interview with The Edge Singapore on June 11. The liabilities book, however, may see a lag because some of the funding costs may be fixed deposits.
“You have to wait for the fixed deposits to roll over and reprice so on the way up the lag helps, on the way down, it doesn’t,” he says.
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The offset to these, he adds, are fees and loan growth, which have been “quite soft”.
“We never really saw [any strong economic growth], as the region started recovering from the pandemic period, we were slapped with rate cuts, which kind of curbed the growth prospects,” he says.
“So, fees have not recovered; loan growth is quite anaemic. As you see some softening in NIMs, these two should provide the offset,” he adds.
On fee growth, Sinha notes that loan-related fees may see growth due to a pick-up in loans. However, trade loans have not picked up yet as China’s economy is still going through a soft patch.
“Even working capital loans have not picked up. Mortgages, as you know, in Singapore, the markets are still fairly soft from the various cooling measures,” he says.
The banks’ wealth fees which used to account for 12% to 14% of the bank’s total non-interest income, is also another growth area amid the rate cuts.
While all three banks’ assets under management (AUM) have continued to grow, their fees have been stagnant, reflecting an “interesting” dynamic, notes Sinha. “That’s because investors are sitting on the sidelines. There is risk aversion in a high-rate, high inflation environment. But one of the banks mentioned that they’re beginning to see [more activity] in the capital markets again.”
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For FY2024, Sinha expects two out of the three banks to report new all-time record profits.
Among the three Singapore banks, the analyst anticipates DBS Group Holdings and Oversea-Chinese Banking Corporation (OCBC) to report y-o-y growths for the FY2024 while United Overseas Bank U11 (UOB) may see a 1% y-o-y drop.
To Sinha, the three banks will still see “very strong” years, with the banks’ 1QFY2024 results, which surpassed CLSA’s and the Street’s estimates, demonstrating that already.
REITs, industrials and internet sector to watch next
With all three banks’ shares currently at all-time highs, Sinha notes that the sector, which is “reasonably over-owned”, has been a place to hide during the pandemic.
“The banks have been particularly OCBC and DBS have been very proactive with capital management, so dividends have been a good source of income for investors,” says Sinha. “But my sense is, most people are overweight on the sector. So towards the latter part of the year is when I would think about a tactical shift to REITs, because the sector’s performance has not been great. Valuations are below the long-term mean.”
After going through a few quarters of a higher-rate environment for most REITs, the risks of cap rate expansion are out of the way, the analyst notes.
“Any REIT that needed to do fundraising has already done it, barring a couple of them – about two, to three of them – where the gearing is still high. It remains to be seen if they’re just going to wait it out till the rates start coming down so they can fix the balance sheet or will they sell some assets to lower the gearing.”
While Sinha is generally positive on the overall REIT sector, he is also “fairly positive” on the industrials sector as well, because lower rates typically lead to better business confidence with more capital expenditure (capex) spending and expansion plans that corporates embark on.
Within this space, he recommends investors stick with the large cap names for now, such as CapitaLand Ascendas REIT A17U (CLAR), because those are the ones with the best balance sheets.
“Because as rates come down, then the next thing that the market will start thinking about is what acquisitions can they do. If you have headroom and gearing, then, as rates are falling, you can make new accretive acquisitions. The small REITs will not have that flexibility just yet,” he says.
In terms of pecking order, Sinha prefers the industrial REIT sub-sector, followed by retail REITs. On the other hand, the analyst is still “quite cautious” on the office REIT sub-sector as some of the largest tenants are cutting back, coupled with more supply coming in.
Finally, the internet sector is another one to watch, particularly US-listed Grab and Sea.
“Grab and Sea has gone through a very rocky road since 2022, and most of 2023. Sea’s had a reasonably good recovery. Grab is not as strong but on track to profitability too next year. I think the newfound profitability mantra that these companies have adopted is beginning to go down well with investors,” says Sinha.
While the analyst remains “overweight” on Singapore banks for now, that depends on how their share prices perform in the next year.
“Intuitively you think, next year, you should be ‘neutral’ and go ‘overweight’ with REITs. But if people start taking profits and pile them into REITs much earlier, the banks have a share price retracement, then the upside potential widens,” he says. “That is a call we need to make in the second half of the year, depending on the price performance of the sector [and] and whether we continue to remain ‘overweight’ or not.”
