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Difficulty: Moderate

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Update: We have since published a more updated article on the Singapore Banks on 3rd December 2020. See here for details.

The InvestQuest’s View: For investors with a medium to long-term horizon, we believe that the Singapore Bank stocks are attractive due to the following reasons.

1. Valuations are very cheap on a P/B basis and fair on a P/E basis.
2. Dividends are unlikely to fall further, as they can be sustained even with the current levels of depressed profits.
3. Net interest margins are expected to stabilize near current levels, with flattish loan growth.
4. DBS and OCBC have been aggressive in expensing bad debt provisions, which will probably help with an earnings rebound in 2021.
5. Macro factors such as a steepening yield curve and market rotation from growth to value stocks will be additional catalysts if they materialize.

On which Singapore Bank is the most attractive, it depends on your investment thesis:

1. If you are more optimistic about China’s economy, go with DBS as it has a 27% sales exposure to Greater China (versus OCBC at 14% and UOB at 9%)
2. If you are looking for the cheapest valuations, go for OCBC which offers the lowest P/B multiple of 0.79x (versus DBS at 0.97x and UOB at 0.86x)
3. If you are looking for the highest dividend yield, go for UOB which has a 4.0% dividend yield for expected 2020 full-year distributions (versus DBS at 3.6% and OCBC at 3.7%)

Disclaimer: IQ owns DBS and OCBC shares.

Disclaimer: The views expressed below are our own and should not be relied upon for making your investment decisions. Please do your own due diligence!

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Introduction

Looking back to the previous financial crisis of 2008-09, many of us would have regretted not having bought more cyclical stocks to profit from the ensuing recovery.

Twelve years on, with the three local banks (DBS, OCBC and UOB) trading at 35-40% below their 2018 price highs, it does warrant a rethink if nibbling into the local bank stocks now is a good investment strategy.

In this article, we attempt to make comparisons of the operating and valuation metrics of the Singapore Banks now versus 2008-09 in guiding our investment decision.

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(Optional) Before we get started: Know the Key Differences between DBS, OCBC and UOB

Many view the Singapore Bank stocks as a single bloc. Would it surprise you that the difference in past 3 year total returns between DBS and OCBC is 29%?

In summary, the key differences among the three banks are:

1. DBS has the most Greater China exposure and was an early mover to upgrade its digital platform
2. UOB has the most South Asia exposure (mainly Indonesia, Thailand and Malaysia)
3. OCBC has the largest Retail & Wealth Management segment due to its Private Banking subsidiary Bank of Singapore and its 88% stake in Great Eastern.

The first chart below shows the proportion of revenue derived by the different business lines across the three banks, while the second chart below shows the proportion of revenue derived by the different geographies that the banks operate in.

While we have figures for 1H2020, we decided to use full year 2019 data for the charts below, as it gives a better representation of the banks’ operations in a “normalized” economic environment.

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1) Valuations are very cheap

1A) Price-to-Book is Really 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 cheap from a P/B perspective. The sector trades at 0.87x P/B, a large discount to its 13-year average of 1.3x. The current P/B is also relatively in-line with the P/B troughs experienced during the various market pullbacks in the past 13 years (see chart below).

1B) Price to Earnings is Fair

The below chart shows the average 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 an average P/E of 9.4x on a trailing 12-month basis. However, to factor in the current economic backdrop, we use full-year 2020 earnings estimates instead, implying a P/E of 11.6x, not too far off its historical average of 11.8x.

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2) Dividends are unlikely to fall further

The average dividend yield for the three banks for projected full-year 2020 now stands at 3.8%, in line with the historical average over the past 13 years. This already factors in MAS’s guidance to cap 2020 dividends at 60% of what was paid out in 2019.

In our view, dividend payouts are at sustainable levels, even with the economy as it is. For context, in 2019, DBS, OCBC and UOB each paid out approx. 50% of net profits as dividends. Using the depressed net profit figures from 1H2020, a 50% dividend payout ratio would have implied 1H2020 dividend payouts of:

• DBS: 47.5 cents versus 51 cents actual distribution
• OCBC: 16 cents versus 15.9 cents actual distribution
• UOB: 46.5 cents versus 39 cents actual distribution

We conclude that the banks are not overstretching themselves to maintain the dividend payouts. Specifically, DBS had been relatively optimistic on their ability to raise dividends next year. We highlight a quote from their CEO Piyush Gupta during the 2Q earnings call for research analysts.

MAS has guided us to hold dividends at 60% of last year’s level until the first quarter of next year. Without this guidance we would have been able to maintain the dividend. If the situation worsens beyond what we anticipate then we will revisit our thinking around dividends, but if events follow expectations, we have the capacity to raise dividends next year.

Piyush Gupta, CEO of DBS

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.

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3) Net interest margins are expected to stabilize

The recent decline in net interest margins (NIM) is concerning. In the below chart, we have plotted the average NIM over the past 15 years. As of the latest quarter, average NIMs have hit a trough of 1.57%.

With loan growth also relatively flat this year, it will fall to non-interest income streams such as trading and investments to fill the gap.

Going forward, the outlook for net interest margins across the three banks is mixed but overall, sector NIMs should remain around/just slightly under the current level for the coming quarters.

We highlight Management comments during the latest 2Q results that we find relevant:

• DBS: We expect a further decline in NIM in the second half to around 1.60%. As our housing portfolio gradually reprices, we expect NIM to bottom out at around 1.50%.
• OCBC: Guidance for full year net interest margin in the mid-to-high 1.5% range and flat loan growth remain
• UOB: Some upside to NIM in 2H20 after hitting trough levels

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4) DBS and OCBC have been aggressive in expensing bad debt provisions

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.

Current average NPLs of 1.57% have yet to see a meaningfully increase since the start of 2020, which in our view could be partially due to the government support measures that have been implemented. As these support programs wind down, we should expect NPL ratios to rise gradually. For reference, during the 2008-2009 financial crisis, we saw a 1 percentage point increase in NPL ratios.

In anticipation of rising amount of non-performing loans, our local banks have already starting taking preemptive measures by setting aside loan loss provisions in 1H2020. We think that these provisions are on track due to the following considerations:

• At the height of the 08-09 Financial Crisis between Jun-08 to Jun-10, the three Singapore Banks expensed provisions for bad debt amounting to S$5.5bn, 1.7% of their combined aggregate loan book at that time.
• If we assume that provisions for bad debt (as a % of aggregate total loans) will be similar this time around, we should expect ~S$15.8 billion to be expensed in 2020-21. We compute this by using the current combined aggregate loan book of the three local banks at S$929 billion * 1.7%. So far, S$4bn has been expensed in 1H2020 by the three banks.

We highlight Management’s guidance on loan loss provisions below (and what has been expensed so far by each bank in the sub-bullet point):

• DBS: Provisions are expected to come in at between $3 billion and $5 billion.
  • Of this amount, DBS has expensed S$1.9 billion in 1H20 (0.51% of total loans).
• OCBC: Maintaining credit cost estimate of 1%-1.3% over two years 2020 – 2021 (IQ: this would be approx. S$2.7 to S$3.5 billion). Gross NPL ratio at 2.5% – 3.5% incorporating impact from withdrawal of government sponsored relief programs.
  • Of this amount, OCBC has expensed S$1.3 billion in 1H20 (0.49% of total loans).
• UOB: Credit costs likely to remain around 2Q20 levels (IQ: this was approx. S$400 million), with more preemptive allowances to cushion anticipated asset quality weaknesses.
  • UOB has expensed S$0.7 billion in 1H20 (0.26% of total loans).
  • Among the 3 banks, UOB had approx. S$160m and S$260mm LESS defaulted loan exposure to Hin Leong, compared to OCBC and DBS respectively, which may partially explain their lower bad debt provisions.

The InvestQuest’s View: DBS and OCBC has 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 for DBS and OCBC, offering an earnings boost.

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5) Macro factors may benefit Singapore Banks

5A) Steepening of the yield curve

Banks are typically more profitable in a higher interest rate environment and also when the yield curve is steeper. A steep yield curve means that the interest rate for longer maturity bonds are much higher than for short maturity bonds.

In August, the US Federal Reserve announced a major policy shift, moving away from a 2% inflation rate target to an average inflation rate targeting 2%. This implies that the Fed will allow inflation to run higher than 2% before hiking short-term rates.

In our view, the new policy shift would result in the overnight Fed Fund rates staying low, with long maturity interest rates rising. This would benefit banks, as they pay out low short-term interest rates to depositors and receive income from longer maturity loans.

5B) Market Rotation from Growth to Value

Growth has significantly outperformed Value in 2020. The main stock market beneficiaries of the Covid-19 lockdown have been Technology and Healthcare-related sectors, both of which are growth-oriented sectors. Value stocks in contrast, which cover the likes of Financials and Energy, have been beaten down heavily.

If a successful vaccine or effective treatment for Covid-19 is developed, it is possible for market participants to rotate back into value stocks, on expectations of a normalized economy.

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6) The InvestQuest View: Which Singapore Bank Looks The Most Attractive?

For investors with a medium to long-term horizon like ourselves, we do think that the sector is relatively attractive. We briefly summarize our investment rationale below, details of which may be found in the earlier sections.

1. Valuations are very cheap on a P/B basis and fair on a P/E basis.
2. Dividends are unlikely to fall further, as they can be sustained even with the current levels of depressed profits.
3. Net interest margins are expected to stabilize near current levels, with flattish loan growth.
4. DBS and OCBC have been more aggressive in expensing bad debt provisions, which will probably help with an earnings rebound in 2021.
5. Macro factors such as a steepening yield curve and market rotation from growth to value stocks will be additional catalysts if they materialize.

On which Singapore Bank is the most attractive, it depends on your investment thesis:

• If you are more optimistic about China’s economy, go with DBS as it has a 27% sales exposure to Greater China (versus OCBC at 14% and UOB at 9%)
• If you are looking for the cheapest valuations, go for OCBC which offers the lowest P/B multiple of 0.79x (versus DBS at 0.97x and UOB at 0.86x).
• If you are looking for the highest dividend yield (under the MAS restrictions), go for UOB which has 4.0% dividend yield for full-year 2020 (versus DBS at 3.6% and OCBC at 3.7%)

Disclaimer: IQ owns DBS and OCBC shares.

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Appendix 1: Profitability and Valuations of Global Banks vs Singapore Banks

As global investors, we also should pay attention as to whether the Singapore Banks are trading attractively to global peers. The below chart shows the valuations and profitability of global banks, and how Singapore Banks (red dots) compare.

• On the horizontal x-axis, we have plotted the Price-to-Book ratios (a commonly used metric for stock valuations for the banking sector).
• On the vertical y-axis, we have plotted the Returns on Equity for the same banks, to illustrate their level of profitability.

Assuming P/B ratios are similar, stocks with higher ROEs would be more desirable. On this basis, stocks that are above the red dotted trend line may be considered relatively more attractive.

We make several interesting notes from the chart:

1. Singapore Banks are relatively more profitable among global peers, which warrants a valuation premium.
2. European and Japanese Banks are much less profitable (likely due to the negative interest rate environment) and this shows up in their “cheap” valuations.
3. China Banks rank among the highest in terms of profitability but suffer a valuation discount to global peers. This is largely due to a “credibility discount”, as some investors are less confident about the accuracy of the financial figures disclosed by the Chinese Banks. For example, the Big 4 State-owned Chinese Banks disclose lower ratios of non-performing loans compared to Singapore Banks, which is unbelievable for some.

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