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If you’ve followed our blog, you might have read our earlier article on the Singapore Banks:
- 13 September 2020: Why We Have Started Buying Singapore Banks (DBS, OCBC, UOB)
In that earlier article, we summarized our bullish view on the sector, having made comparisons between the operating and valuation metrics of the Singapore Banks then versus the 2008-09 crisis period.
And since publishing that article, the Singapore Banks have rallied by 20%!
Given the price rally and with updated data from 3Q20 results announced in November, we now ask ourselves what the current risk-reward looks like for DBS, OCBC and UOB.
Disclaimer: This represents our personal investment views and should not be relied upon for your investment decisions. Please do your own due diligence.
The InvestQuest View:
The Good: Operating metrics of the Singapore Banks are holding up decently. Net interest margins seem to be bottoming and loan loss provisions taken earlier are looking overly conservative relative to actual loan losses. We should see a meaningful earnings uplift in 2021 because of that, particularly for DBS and OCBC.
The Bad: After a 20% rally, valuations are starting to look fairly priced. Extension of the MAS dividend cap for banks is a medium-term risk.
What to do? Like every other Singaporean, we do have DBS and OCBC shares in our portfolio. We believe that there is still a longer-term upside potential but the sector is looking overbought on some of the shorter-term technical indicators. As a result, we had taken a conservative approach and tactically trimmed our holdings in the last two weeks.
Our Preferred SG Bank? OCBC. It provides a good balance of relative cheapness (P/B of 0.94x is at a 20% P/B discount to DBS’s 1.19x), potentially lower loan losses (loans under moratorium at 5% of loan book vs UOB’s 10%), and in our view, more front-loading of loan loss provisions compared to UOB (which may result in a faster profit turnaround in 2021).
Summary
1) Operating metrics are decent given the situation
2) Valuations look fair
3) Dividends are sustainable with room to grow
4) Limited upside to analyst target prices
5) Profitability and Valuations of Global Banks vs Singapore Banks
1) Operating metrics are decent given the situation
3Q Operating Income is down 9% year-on-year
To assess the profitability of the Singapore banks, we personally prefer to look at their Operating Income. Operating Income EXCLUDES loan loss provisions expensed by the banks. We prefer to exclude loan loss provisions for now, as we will be analyzing that in greater detail later.
On a sector level, the 3Q2020 Operating Income of DBS, OCBC and UOB declined 9% compared to a year ago (see chart below). This is a result of:
- Net Interest Margin (NIM) compression: Sector NIM is at 1.53% on average across DBS/OCBC/UOB (a steep decline from 1.81% in the prior year period)
- Uninspiring loan book growth: +5% for DBS, +2% for OCBC and UOB, relative to the prior year period
All things considered, the profit hit from the pandemic hasn’t been too disastrous for the Singapore banks. The operating outlook is definitely looking up from here, as banks’ management are expecting net interest margins to stabilize, and preemptive loan loss provisions made are sufficient to cover actual loan losses should they materialize.
Net interest margins are expected to stabilize
In the below chart, we have plotted the net interest margin (NIM) for Singapore Banks over the past 15 years. As of the latest quarter, average sector NIMs have hit a trough of 1.53%.
The outlook for net interest margins seem to be pretty neutral. While the recent decline in net interest margins (NIM) is concerning, the pace of decline seems to be abating.
During DBS’s 3Q results announcement, management mentioned that the net interest margin for DBS is expected to stabilize between 1.45% and 1.50% in the coming year (3Q2020 actual: 1.53%), with mid-single-digit loan growth and double-digit growth in fee income for 2021.
Loan Loss Provisions likely to decline sequentially, providing an earnings tailwind
Non-performing loans (NPL) refers to loans that are in default or are deemed to be close to default. In the chart below, we show the average NPL ratio across the three banks in the past 15 years.
The average NPL ratio across the three banks was 1.57% as of 3Q20 and interestingly, we have yet to see a meaningfully increase of NPLs since the start of 2020. For reference, during the 2008-2009 financial crisis, we saw a 1 percentage point increase in NPL ratios.
It is still a question mark if we will see a spike in loan defaults once government support measures gradually wind down but analysts have been generally quite positive, with some encouraging datapoints from Malaysia, after it ended its automatic loan moratorium period as of 30 September.
We expect loan provision expenses to continue its downward trend in the coming quarters. This view is based on Management’s guidance on loan loss provisions for 2020-21 and our tally of what has been expensed so far by each bank. We have included relevant details below:
DBS:
- Management guided for provisions to come in at between S$3bn and S$5bn. Of this projected amount, DBS has already expensed S$2.5bn this year, approximately 0.65% of the bank’s total loan book.
- S$13.5bn of SME loans are under moratorium, equating to 5% of total loans. For context, as part of Covid-relief measures, MAS is allowing SMEs to take more time to pay back their loans (“loans under moratorium”).
OCBC:
- Management guided for credit costs of 1% to 1.3% (S$2.7bn to S$3.5bn based on our estimates), and gross NPL ratio between 2.5% and 3.5%. Of this amount, OCBC has expensed S$1.8bn this year, approximately 0.65% of the bank’s total loan book.
- 5% of loans (approx. S$13.6bn) are under moratorium. This is down from 10% of loan book in the previous quarter.
UOB:
- UOB has expensed S$1.2bn of credit costs this year, about 0.41% of its total loan book.
- Loans under moratorium fell to 10% of the bank’s loan book, from 16% in the previous quarter
In our view, DBS and OCBC have been more aggressive in provisioning for bad debt than UOB. As a result, in the coming quarters, we believe it’s probable to see credit costs declining sequentially more for DBS and OCBC, offering an earnings boost.
2) Valuations look fair
Price-to-Book is slightly cheap
The below chart shows the average Price-to-Book ratio of the three local banks, using data from the past 13 years. We chose to show an average of the three banks rather than the three banks separately, as it makes for a more understandable chart.
Singapore Banks are trading slightly cheap from a P/B perspective. The sector trades at 1.02x P/B (it was 0.87x when we published our previous article), but still at a discount to its 13-year average of 1.28x. Given that net interest margins are still expected to remain relatively depressed in the near-term, we believe that a sector P/B of 1.1x is appropriate.
Forward Price-to-Earnings is fair
The below chart shows the average forward P/E ratio of the three local banks, using data from the past 13 years.
Valuations are merely fair from a P/E perspective. The Singapore Banks currently trade at a 2021 forward P/E of 11.2x, a slight premium to the 10.6x historical average.
3) Dividends are sustainable with room to grow
According to Bloomberg estimates, the average dividend yield for the Singapore banks for full-year 2021 is projected to be 4.4%, in line with the historical average over the past 13 years (see below chart).
Due to the pandemic, MAS had implemented a dividend cap on the Singapore Banks earlier this year, urging the banks not to pay more than 60% of 2019 dividends for 2020. There is a risk that this dividend cap may be extended into 2021, though clarification on this would likely be made known only in mid-2021. If the dividend cap is extended, we estimate that the 2021 average dividend yield on the Singapore Banks would be 3.2%.
In our view, current dividends are at sustainable levels. For context, the earnings per share (EPS) for JUST the first 9 months of 2020 is already higher than the dividend paid out for FY 2019, for each of the three banks.
- DBS: S$1.46 9M20 EPS vs S$1.23 FY2019 dividend
- OCBC: S$0.56 9M20 EPS vs S$0.53 FY2019 dividend
- UOB: S$1.33 9M20 EPS vs S$1.30 FY2019 dividend
We conclude that the banks are not overstretching themselves to maintain the dividend payouts. From 2021 onwards, we see a good chance of the three banks raising their dividends, especially if MAS decides not to extend the dividend cap policy on the Singapore Banks.
4) Limited upside to analyst target prices
We have listed the analyst ratings and target prices for DBS, OCBC and UOB in the table below. We have only included analyst targets that have been updated from November onwards.
The consensus view among analysts is that the Singapore Banks are fairly priced. The median implied upside for DBS, OCBC and UOB from current price levels are -1.5%, +0.8% and +3.6% respectively.
5) Profitability and Valuations of Global Banks vs Singapore Banks
In the below chart, we compare how Singapore Banks rank among Global Banks in terms of profitability (using forward ROE as a guide) and valuations (using P/B ratio as a guide).
On these metrics, Singapore Banks are scoring decently and in our view, are fairly valued vs global banking peers.
The InvestQuest View:
The Good: Operating metrics of the Singapore Banks are holding up decently. Net interest margins seem to be bottoming and loan loss provisions taken earlier are looking overly conservative relative to actual loan losses. We should see a meaningful earnings uplift in 2021 because of that, particularly for DBS and OCBC.
The Bad: After a 20% rally, valuations are starting to look fairly priced. Extension of the MAS dividend cap for banks is a medium-term risk.
What to do? Like every other Singaporean, we do have DBS and OCBC shares in our portfolio. We believe that there is still a longer-term upside potential but the sector is looking overbought on some of the shorter-term technical indicators. As a result, we had taken a conservative approach and tactically trimmed our holdings in the last two weeks.
Our Preferred SG Bank? OCBC. It provides a good balance of relative cheapness (P/B of 0.94x is at a 20% P/B discount to DBS’s 1.19x), potentially lower loan losses (loans under moratorium at 5% of loan book vs UOB’s 10%), and more front-loading of loan loss provisions compared to UOB (which may result in a faster profit turnaround in 2021).
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