If you own bank stocks, it may be best to hang on to them. In The Edge Singapore’s Year-End Investment Forum, market experts expect the local banks to continue to outperform. Some analysts have turned cautious, but not those at DBS Group Research or Morgan Stanley.
Banks are increasingly viewed as the “Trump Trade” in this time zone. Incoming US president Donald Trump’s main policies on the campaign trail were implementing tariffs and deporting immigrants. Both are likely to drive up inflation. Corporate tax cuts to as low as 15% are also believed to be implemented, but the proposal may need to go through Congress like any new trade policy with Canada and Mexico.
All these policies are likely to be inflationary, giving the Federal Reserve less room to manoeuvre on cutting the Federal Funds Rate (FFR). Nonetheless, market strategists and economists expect further FFR cuts to land rates below 4% in 2025.
In this time zone, Singapore’s Straits Times Index (STI) has been the second-best performer after the Taiwan Stock Exchange Index this year. Of course, both indices were eclipsed by the S&P 500 and the Nasdaq Composite Index. Interestingly, based on Bloomberg data, for the year to Dec 3, DBS Group Holdings has outperformed the STI, regional indices, S&P 500 and even Nasdaq.
In order of performance, including dividends reinvested, DBS is the star performer, followed by Oversea-Chinese Banking Corporation (OCBC), United Overseas Bank (UOB), Nasdaq, S&P 500 and STI. The banks’ outperformance, including all three doing better than Nasdaq, begs the question: Are the banks overvalued?
Nick Lord, banking analyst at Morgan Stanley, says: “I don’t think the banks are overvalued. [But] the environment could be more tricky next year [as] we have interest rates coming down.”
See also: ‘60/40’ is not a ‘bad thing’ for investors while Gupta’s retirement is ‘best thing’ for DBS shares
The local banks’ earnings outlook has several moving parts that affect their capital, dividends and book value. The banks are not cheap based on their historic book value. In fact, based on their five-year historic price-to-book ratios (see charts), DBS and OCBC are approaching their mean + 2 s.d. (standard deviations).
See also: W Capital Markets' valuation doubles to $42 mil with new fundraise
Well managed risks
“The banks have hedged a lot of their risk and they are expecting a pickup in loan growth next year. The reason [for this] is because of an expected decline in interest rates. It’s also true that there have been repayments in the early part of this year,” Lord explains.
The banks have managed their securities book such that duration, yields and expiries complement their loan book.
During DBS’s results briefing on Nov 7, group CFO Chng Sok Hui said: “We have been quite sensible. When rates were on the way up, our sensitivity was $18 million to $20 million per basis point (bp), and then on the way down, it was $4 million. The monthly process at the group asset liability management (ALM) committee aligns everybody on how we want to take interest rate risk, which is why for the $55 billion that is maturing in 2025 if rates end up higher than previously expected, there is room to get a further yield lift. ”
At UOB, group CFO Lee Wai Fai said on Nov 8: “We have published that we are now less sensitive. Every 25 bps will affect around 6% of margins in the region of $18 million. We have also repositioned our portfolio. If rate cuts are not as deep, it will be beneficial to the market. I agree with the view that some of the actions that have been proposed [by the incoming US administration] are inflationary and inflation might not come down as much. We are watching the 10-year US Treasury yields, but the market always moves ahead.”
Why UOB is a ‘buy’
To stay ahead of Singapore and the region’s corporate and economic trends, click here for Latest Section
Morgan Stanley is neutral on DBS and OCBC but has a buy on UOB. Why? “We don’t think the markets have fully appreciated the benefits UOB will get as it integrates the Citigroup business and strengthens its overall position as an Asean banking business,” Lord says.
Indeed, since the banks announced their 3QFY2024 results ended Sept 30 in the week of Nov 4–8, UOB’s share price is up 14.4% as at Dec 4 compared to DBS’s 13.6% gain and OCBC’s 7.3% increase. DBS, which pays its dividends quarterly, maintains its quarterly dividend at 54 cents per share, unchanged q-o-q but up 22.7% y-o-y. OCBC and UOB pay dividends half-yearly.
Under group CEO Wee Ee Cheong, UOB has built an Asean banking business which was boosted by a complementary addition of Citigroup’s retail businesses in Malaysia, Thailand, Indonesia and Vietnam. The acquisition was announced in 2022 and UOB has been busy with integration over the past 12–15 months.
During the results briefing on Nov 8, Wee remained focused on Asean. “Supply chain shift has been attracting new FDIs [into Asean]. This could accelerate. Regional economies are growing strongly. I can feel and see the momentum.”
Wee reported healthy demand in UOB’s Asean markets across sectors and geographies. Despite uncertainties in the region following Trump’s election, Asean corporates are upgrading their IT systems “with the rise of the digital economy”, Wee says. The green economy is also a source of growth with demand for electric vehicles (EVs) and renewable energy, Wee adds.
The Citi acquisition provides UOB with a larger retail base. In 2022, Wee said the acquisition would double UOB’s customer base in Malaysia, Thailand, Indonesia and Vietnam to 5.3 million.
Wee says synergies from the Citi acquisition have kicked in, with cross-sell synergies bearing fruit, notably in current account and savings account (casa) penetration in all four markets.
UOB has been investing in standardising its regional IT platform for more than 10 years. It set up a foreign direct investment (FDI) advisory unit in 2011 to help companies expand in Asean and has supported more than 4,500 companies to expand into Asean. “We will continue to invest in building capabilities in our key Asean markets,” Wee reiterated.
Interest rates remain key
Although the three banks have expanded their non-interest income businesses, especially wealth management, net interest income remains their largest earnings contributor. In terms of net interest income to total income ratios, all three banks are above 60%. UOB’s is the highest at 66.7% followed by OCBC with 66% and DBS with 63.7%. When interest rates were lower, more than 40% of OCBC’s income was from non-interest income.
Lord explains: “In my framework, interest rates are important because they are a big driver of banks’ earnings estimates. But we’ve written research in the past which has demonstrated that there’s no clear consistent correlation between interest rates and bank share prices. Interest rates are a driver of bank earnings, but how much and why the bank share price moves really depends on [the impact of] interest rates [on the broader economy].”
Capital management
One of the attractive attributes of the local banks is their capital management strategies. “The earnings outlook looks pretty solid and you’ve got some pretty decent capital returns, which is supported by good yields,” Lord says. DBS is planning a share buyback and UOB has said that it will look at ways to return capital, he adds.
After implementing the final Basel III reforms, Singapore banks reported a 1.7%–2.4% Common Equity Tier 1 (CET-1) ratio uplift during 3Q2024, DBS Group Research observed. During the 3Q2024 results presentation, various capital management tools were discussed. “We believe investors continue to favour share buybacks, on top of higher dividends/dividend payout ratios,” the report says.
“DBS announced a $3 billion share buyback that will take place opportunistically over the next three years. UOB’s management was more confident of being more aggressive in capital management, with the possibility of announcing a share buyback plan upon releasing 4Q2024 results. As a result, DBS and UOB have continued to outperform OCBC by more than 6%, as OCBC management prefers dividends as a capital management tool over share buybacks as of 3Q24 results,” the DBS analysts say.
UOB is likely to give shareholders a special dividend to celebrate its 90th anniversary next year. Although most investors prefer dividends to share buybacks, some markets have a withholding tax on dividends which is why there are institutional investors who prefer share buybacks, CFO Lee says.
The DBS analysts believe that UOB has $1.3 billion to $2.5 billion of excess capital while OCBC has $2 billion of excess capital.
Goldilocks scenario?
Bank valuations suffered after the Global Financial Crisis, when interest rates were incredibly low and ranged between 2% and 40 basis points. “That clearly had an impact on the ability of banks to generate returns,” Lord says.
“I feel pretty comfortable in an environment where interest rates are moving in a 3% to 5% range. That is probably not going to impact credit quality significantly. Banks can continue to generate reasonably decent returns,” he adds.
Should interest rates ease in 2025, lower net interest margins (NIMs) would be offset by the growth in banks’ loans and wealth management business. “We’re in a reasonably decent operating environment. I would be more concerned if we were moving below that range. A year ago, in our bear case assumptions, we said rates would be 2.5%, which could be more problematic. Rate expectations have moved up, and we feel much more comfortable,” Lord says.
