The share prices of Singapore’s three local banks turned volatile in early August due to concerns about an economic downturn in the US. Such a backdrop would cause the US Federal Reserve to cut its Federal Funds Rate (FFR) more aggressively than economists had expected.
As it turned out, the US and Japanese markets calmed down and recovered, sidestepping concerns of a larger-than-expected FFR cut to inject liquidity into the system.
The FFR is a benchmark for other short-term interest rates in the US and often globally. Singapore has no independent interest rate regime and relies on rates set by other central banks, primarily the Fed. A gradual decline in FFR would have a less drastic impact on the local banks’ net interest income (NII) than a sudden large cut of 50 basis points (bps).
As of Aug 21, the expectation is for a 25bps cut in September and possibly another 25bps cut in December.
Rising and declining interest rates are both double-edged swords for the local banks. As interest rates rise, banks usually re-price their loans faster than deposits. However, as the rising interest rate cycle matures, loan growth tapers off and banks usually face investor concerns over credit quality.
“A gradual interest rate decline is beneficial for commercial banks. Margins might be affected slightly, but we think that [the] volume of loans will rise,” says Lee Wai Fai, group CFO of United Overseas Bank U11 (UOB).
See also: OCBC turns defensive to ‘protect interest income’ as rate cuts loom
Speaking at UOB’s corporate day on Aug 14 in Kuala Lumpur, Lee says UOB could reap additional benefits from its regional franchise as the Fed reduces interest rates. This could cause the US dollar to weaken, reducing pressure on the exchange rates in Asean.
Notably, the ringgit and rupiah weakened significantly in 2H2023 and 1H2024 as the Singapore dollar strengthened, causing a translation effect for UOB, which reports in Singapore dollars. “A reduction in net interest margin (NIM) might not be as significant for Asean as for developed markets. Interest rates in Malaysia didn’t go up much,” Lee says.
See also: DBS appoints Tan Su Shan as deputy CEO, posts 2QFY2024 net profit of $2.8 bil
Even so, strengthening regional currencies and loan growth may not offset the entire impact of declining interest rates. Lee says UOB’s “main focus” is to transform its operating model from emphasising loans and interest-related functions to one supported by fee and treasury income.
The acquisition of Citigroup’s retail business in Malaysia, Thailand, Indonesia and Vietnam is part of this transformation, which has boosted UOB’s retail customers in the region to eight million.
UOB has started cross-selling products to Citi retail customers and the attrition rate has been lower than the 10% anticipated when the transaction was announced.
Among the plans is to leverage this acquisition to drive wealth and card income to comprise 50% of retail income by 2026. UOB aims to increase its private bank AUM to $145 billion by FY2026, from $88 billion in FY2023, and increase its relationship manager headcount to 400 from 278.
Lee also indicated that the bank plans to double its trade loans and aim for high-single-digit growth in current account and savings account (casa) deposits to 55% of deposits by FY2026 through new cash mandates.
Wholesale banking income will continue to be supported by recurring flows from transaction banking, cash management and treasury activities anchored by relationships.
“We hope to grow our Asean wholesale banking loans and income contributions by 20% and 25%, respectively,” Lee adds, on the bank’s targets for 2026.
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On the cost front, UOB is shifting its cost mix from staff to technology. The bank is also exploring offshoring some middle- and back-office functions to Kuala Lumpur.
For now and beyond
Over at Overseas-Chinese Banking Corporation (OCBC), the house view is for two rate cuts by the Fed this year and “possibly four to five next year”, says Kenneth Lai, OCBC’s head of global markets.
At an Aug 2 briefing on the bank’s results for 1HFY2024 ended June 30, OCBC group CEO Helen Wong said the bank is increasing exposure to fixed-rate loans and cash flow hedges to reduce balance sheet sensitivity to rate movement.
Wong says: “We haven’t seen high interest rates for so long, but, of course, one day it will come down. So, there are many things we’re looking at to protect our net interest margin, but also to protect NII.”
Wong has turned conservative on her NIM forecast for the year. While she maintains her previous guidance that FY2024 NIM should be “in the range of 2.20% to 2.25%”, Wong says the actual figure “could be at the lower end of our range”.
OCBC’s move to defend NII includes increasing its fixed-rate asset mix and introducing more hedges. Its efforts have lowered sensitivity to rates to $4 million per basis point, down from $5 million–$6 million in 1QFY2024 and $6 million–$7 million in 4QFY2023.
This means a one-percentage-point (1 ppt) decline in interest rates would have a $400 million impact on NII over 12 months, which could be offset by securities trading, fee income and wealth management fees, or higher loan growth.
Meanwhile, DBS group CEO Piyush Gupta assured investors the bank has built “resiliency” against a potential economic slowdown and lower interest rates.
Speaking at the bank’s most recent results briefing on Aug 7, where he also announced the appointment of his successor, Tan Su Shan, Gupta says DBS will make up for any loss in income through higher volume and double-digit growth in non-interest income. “That makes us reasonably well-positioned for the next year.”
Gupta is guiding for full-year NII growth of mid-single digits. Like OCBC, DBS has reduced its NII sensitivity to $4 million per bp of the FFR, down from $18 million–$20 million in 2021.
“While recent market volatility and ongoing geopolitical tensions have resulted in heightened uncertainty, we have built resilience against the risks of an economic slowdown and lower interest rates,” adds Gupta. “Our high general allowance reserves, reduced interest rate sensitivity, strong capital position and ample liquidity will position us to continue supporting customers and delivering shareholder returns.”
Spotlight on mortgages
Looking at the remainder of the year, Bloomberg Intelligence analyst Rena Kwok thinks growing fixed-rate mortgages will become a focus for banks in 2HFY2024 — given their “favourable” risk-return profile — to bolster NII growth.
In an Aug 19 note, Kwok says banks’ mortgage growth for 2024 could finish at “flat or low single digits”.
Drawdowns from a healthy loan pipeline built in the past few years may be partly offset by a slowdown in new mortgage bookings amid still elevated interest rates, the government’s cooling measures and selective buyers, given global economic unknowns.
Already, the Ministry of National Development (MND) and Housing Development Board (HDB) jointly announced on Aug 19 cooling measures for the resale market. Since Aug 20, the loan-to-value (LTV) limit for HDB housing loans has been lowered from 80% to 75%. This brings the LTV limit for HDB loans in line with loans granted by financial institutions, which remains at 75%.
Aside from loans to HDB owners, Bloomberg Intelligence analyst Ken Foong notes “healthy” demand for private residential units on “supply-demand dynamics” and “homes’ inflation-hedging power”.
“Buyer choosiness may be an offset, potentially capping price gains at 4% in 2024, moderating from 6.8% in 2023,” writes Foong in an Aug 7 report. “Launches were soaked up by demand in 1H2024 due to moderate pricing. Yet time is needed to run down inventory following a substantial pickup in launches in May and July 2023.”
According to Foong, units sold fell to a mean of 251 a month in 2Q2024. “There might be a pause for new launches as buyers tend to avoid purchases in the Hungry Ghost Month, falling in August this year. Several new projects are slated by end-2024, limiting price growth. However, some may be delayed to 2025 depending on market conditions.”
Kwok says DBS’s mortgages are least at risk among the three banks, should they arise. As of 2QFY2024, the average probability of default of DBS’s mortgages stood at 0.5%, the lowest among the three local banks. The probability of default is calculated using DBS’s advanced internal ratings-based model, which all local banks use and is built on Basel rules.
Singapore’s lenders have maintained PDs at less than 2% post-pandemic. Kwok believes they could continue to bolster their solid asset quality profiles for mortgages on tight underwriting, low LTV ratios, financially resilient households and macro-prudential steps to ensure a sustainable housing market.
Aside from mortgages, Singapore banks may prioritise containing funding costs to sustain interest margins amid anticipated lower long-term interest rates, says Kwok. “Strategies include repricing costlier fixed deposits, using domestic funding in key markets instead of forex swaps and acquiring stickier corporate working capital accounts and their deposits by boosting transaction banking capabilities.”
Lenders can reassess their customer acquisition and deposit strategies by focusing on less interest rate-sensitive customers and implementing tiered interest rate structures, writes Kwok. This will enable them to garner high-quality deposits for sustainability and decrease funding costs.
For example, in May, UOB cut rates for its flagship savings accounts and introduced new balance tiers, which may prompt peers OCBC and DBS to follow.
Falling interest rates also offer an opportunity for these banks with costly capital structures to optimise by issuing debt and replacing expensive equity capital to improve shareholder returns. However, Kwok adds that its impact on credit may be mixed.
What analysts say
CGS International (CGSI) analysts Andrea Choong and Lim Siew Khee have “add” calls on UOB and OCBC and a “hold” call on DBS, citing rate cuts and valuation adjustments.
“As with peers, income generation will continue to be a priority over solely maintaining NIMs. DBS has been proactively positioning itself for impending FFR cuts by placing excess liquidity into longer-duration (3.5 years), fixed-rate, high-quality assets to sustain NII into FY2025- 2026,” write the CGSI analysts in an Aug 7 note.
Choong and Lim note that 150bps of FFR cuts could result in a $600 million reduction in DBS’s NII in FY2025.
Following the banks’ 1HFY2024 results and UOB’s corporate day presentation, the CGSI analysts trimmed their target price for UOB and DBS to $34.50 and $37.30, respectively, while keeping OCBC’s target price unchanged at $16.70.
As at the banks’ Aug 21 close price, OCBC could see the greatest upside among the three, at 16.5% to CGSI’s fair value estimate.
Citi Research analyst Tan Yong Hong prefers Malaysian banks over their Singaporean counterparts as the current rate cycle approaches its tail end. “Based on seven comparison areas, we conclude that Malaysian banks offer better upside.”
In his Aug 13 report, Tan notes that Malaysian banks are a unique beneficiary of easing rates with possible upside to loan growth from better corporate contribution.
The banks in Malaysia are also likely to see better fee income growth driven by better market sentiment and better asset quality with excess buffers from management overlays, among other factors.
In Singapore, the Citi analyst expects all three banks to report around 10bps of NIM contraction in FY2025 and FY2026.
“Lower long-term rates (which the Fed upgraded to 2.6% in March and to 2.8% in June) is a more material downgrade for target prices,” he writes. “We estimate each 100bps rate cut impacts EPS by 5%–6% and ROE by 60bps– 90bps, based on realised NIM sensitivity for DBS [and] OCBC.”
On Aug 5, Tan downgraded all three banks to “sell” after Citi economists projected 225bps of FFR cuts within 10 months. Unlike its Malaysian peers, Singapore banks will likely see asset quality risks amid a slowdown in the global economy, falling property valuations in Hong Kong and slower fee income growth.
“Earlier, we expected an increase in wealth churn (fees/AUM) but this is at risk with softer sentiment. Slower growth hurts cards/other fees. We estimate each 10% cut in fees lowers EPS by 2%-4% and ROE by 30bps-50bps,” he says.
Tan prefers DBS, OCBC and UOB, in that order, based on their total shareholder returns.
Meanwhile, a team of JPMorgan Equity Research analysts led by Harsh Wardhan Modi says DBS remains a “core part of portfolios” and the bank’s transition to a less-rate-sensitive bank is “quite commendable”.
This transition allows the bank to deliver “high pre-provision operating profit” levels for the next “two to three years” despite a potentially sharp rate cut cycle.
JP Morgan has an overweight recommendation for DBS with a $41 price target.
In a separate report dated Aug 2 — or before DBS’s 1HFY2024 results — JPMorgan says Singapore banks are at risk of being “relatively weak” in the near term, compared to some of the emerging market Asia banks, due to their exposure to Hong Kong commercial real estate.
Within Asean, JPMorgan’s top pick is instead Indonesia’s Bank Mandiri. — with additional reporting by Goola Warden and Felicia Tan
Photos: Bloomberg, Albert Chua/The Edge Singapore, DBS, UOB, Bloomberg
