NIM-led earnings growth of banks to ease
The main message from the management of the three local banks for the results season for FY2022 ended December 2022 is that the biggest increase in net interest margins (NIM) may be behind us. This is due to two reasons. First off, the Federal Reserve’s main interest rate hikes are over. Economists are expecting two more hikes, which could take the Fed Funds Rate (FFR) to as high as 5.5%. As at Feb 27, the FFR is at 4.5%–4.75%. But the increase from 25 basis points (bps) to 4.75% is unlikely to be repeated. Meanwhile, banks are paying more for fixed deposits as customers move monies from lowcost Casa (current account savings account) to costlier fixed deposits.
Secondly, the “pass-through” rate, which is the correlation between FFR and local borrowing rates such as Sora, is beginning to diverge. For much of last year, the pass-through to local rates was almost 100% until around 4Q2022. As an example, the risk-free rates of US treasuries and Singapore Government Securities had a strong correlation until around September 2022 after which they diverged in absolute values. Their trends, however, remain well correlated (see Chart 1).
For FY2022, the three local banks reported double-digit NIM-driven net profit growth as a result mainly of rising interest rates and firmer NIMs. DBS Group Holdings reported a 20% rise in FY2022 net profit to $8.19 billion; Oversea-Chinese Banking Corp’s (OCBC) net profit rose 18% to $5.75 billion; United Overseas Bank’s (UOB) net profit rose 12% to $4.57 billion but would have risen 18% to $4.82 billion excluding one-time costs for its Citigroup acquisition, mainly due to Malaysian stamp duty.
Lowering NIM expectations
The outlook for 2023 is perhaps summed up best by Eugene Tarzimanov, vice-president and senior credit officer at Moody’s Investors Service. He says: “DBS, OCBC and UOB wrapped up 2022 on a solid note, with materially higher profits and stable or improved loan quality. The three banks will further improve their profitability in 2023, yet the pace of change will be less significant than last year because of growing funding and operating costs.”
Fitch Ratings concurs: “We expect funding costs to catch up in 2023 with NIMs peaking in the middle of the year, followed by some margin moderation in 2H2023.”
Despite rising NIMs for all three banks during 2022, their management is guiding lower 2023 NIMs compared with 4Q2022 NIMs and exit NIMs.
On Feb 24, Helen Wong, group CEO of OCBC, guided for a NIM of 2.1% this year. This is despite reporting a NIM and exit NIM of 2.31%
and 2.34% in 4Q2022 respectively.
In her presentation, DBS’s group CFO Chng Sok Hui says: “We expect both the group’s and commercial book’s net interest income as well as net interest margin to continue rising in the coming quarters from high interest rates and the lagged repricing of fixed-rate assets.”
DBS has separated the reporting of its treasury business and that of its commercial book to improve the transparency of the performance trends. NIM from its commercial book and blended NIM was 2.61% and 2.05% in 4Q2022 respectively.
While DBS’s NIM in 2023 is likely to be higher than the blended 2.05% reported for FY2022, DBS group CEO Piyush Gupta says he expects a NIM of around 5 bps–7 bps below an earlier guidance of 2.25% for this year.
Says Gupta in the Feb 13 results briefing: “Last quarter, we guided for the group net interest margin
to peak at around 2.25%. I think there is a 5 bps–7 bps downside risk from that earlier guidance. Major headwinds include outflows to T-bills and a faster-than-expected strengthening of the Singapore dollar. Additionally, higher funding costs in treasury markets dragged down the group’s net interest margin. Tailwinds to net interest margin include the lagged repricing of about $180 billion of assets, two-thirds of which will reprice over the next three years. While peak NIM will probably be a tad below 2.20%, our average NIM for the year will be north of 2.10%.”
Elsewhere, UOB’s management has guided for a NIM of 2.2% this year. In 4Q2022, UOB’s NIM expanded by 27 bps to reach 2.22%. “Citigroup added 8 bps to this increase,” notes UOB’s group CFO Lee Wai Fai. According to him, Thailand’s margins expanded by 99 bps. “We expect NIM to go up before coming down as the Fed will keep rates more elevated. But we expect the surge in NIM to ease in the coming quarter,” says Lee.
Much will depend on the Fed. “If interest rates are elevated from 5% to 5.5%, our margin will have some upside but the pace will be slower,” he adds.
Higher funding costs
“There has been a noticeable shift from Casa to term deposits in the second half of 2022 as depositors sought higher yields,” Fitch Ratings says. DBS’s Casa as a ratio of total funding fell to 55% in 4Q2022 compared to 68.6% a year ago, OCBC’s Casa ratio is down to 51.8% compared to 63.3% a year ago while UOB’s is down to 47.6% from 56.2% a year ago. Liquidity, including in US dollars, remains comfortable at all three banks, Fitch adds.
Wong of OCBC says: “We’ll continue to look at how we manage our funding costs. Our funding costs have gone up quite a bit last year on an overall blended basis because fixed deposit costs increased and wholesale funding costs on a blended basis caught up.”
“But at this late stage of this interest rate cycle, I think maybe the upside for the overall cost of funds shouldn’t be that much more,” she adds.
“We think the cost of funds will slowly catch up, but we are confident to close 2023 at current levels,” Lee says. Year on year, UOB’s costs of deposits rose from 46 bps to 95 bps. The overall cost of funds ended the full year at 1.07% but stood at 1.57% in 2H2022.
“Across the region, our cash management platform is driving higher digital adoption by corporate customers with significant growth in transaction volumes and cashless payments. This is one of the key factors that helped us stabilise Casa for our wholesale banking, generating the stability of funding under the business banking segment,” Lee says. He points out that UOB started attracting fixed deposits earlier than peers, and kept costs at 3.9%.
“The good news is we think that pace of growth is no longer rising and that gives us an indication that cost of funding will go up but not as sharp a pace as in 2022,” Lee adds.
Gupta of DBS says that the bank’s “deposit beta” (the rise in deposit costs) in 2022 was about 32%. The US dollar book caused the bulk of the gain as Singapore dollar deposit costs remain low, rising as little as 7%.
“Deposit beta was 60% for the US dollar and 22% for other currencies. Deposit betas accelerated in the fourth quarter. For the Singapore dollar, it increased to low double-digits. For the US dollar, it was at close to 80%. However, it has stabilised more recently,” Gupta explains. He expects a further rise in deposit costs by as much as 40%.
“Our assumption is that the Fed raises rates to about 5.25% and does not cut rates this year.
Similarly, we assume that Singdollar rates remain at current levels,” he adds. However, if the Fed raises rates beyond 5.25%, Gupta is guiding for even higher deposit costs.
JP Morgan turns cautious on DBS
According to a Feb 21 JP Morgan report, the days of recording large gains from the lag in deposit repricing are over. “Management comments during the 4Q2022 briefing suggest that the cost of funds was moving up about 30 bps for every 1% blended rate increase early last year but has now gone to almost 45 bps for every 1% rise by end of 2022. Going forward, if rates (USD and SGD) do move up, the cost of funds increase can be as high as 60%–65% of incremental [gains],” JP Morgan estimates.
Accordingly, the NIM increase thesis for DBS is close to over for this cycle, which is in line with higher Fed fund and Singapore dollar inter-bank rates, JP Morgan reckons.
Over and above the rise in costs, any further increase in the FFR could lead to a either real slowdown, a soft patch or even a recession. “If USD rates move up, the probability of economic slowdown would move up, leading to a much higher likelihood of provisions in 2023 and 2024. This combination of limited NIM upside but higher probability of provisions is skewing the risk-return trade-off for the stock,” JP Morgan warns, referring to DBS. But the challenges apply to all the local banks and possibly other banks including the likes of HSBC and Standard Chartered.
“In some senses, Singapore banks are high-beta plays on global rates and economic outlook. It appears that we have moved from early-cycle to late-cycle dynamics within 12 months, as the pace of rate hikes have been at an accelerated pace,” JP Morgan explains.
Fee income decline to abate
A shift in the pace of the interest rate hike cycle could be positive for fee income. As it happened, 2022 was not a good year for wealth management as investors were reluctant to wade into the market. In addition, many wealth management and private banking customers often use a modicum of debt to increase yields from investments. As a result, there was less activity in the markets. In addition, the local market had a dearth of large IPOs.
No surprise then that fee income tumbled for all three banks in 4Q2022 and FY2022. For the full year, DBS reported a 12% fall in net fee income to $3.09 billion as declines in wealth management and investment banking fees more than offset growth in other activities. UOB’s net fee income declined 9% to $2.14 billion in FY2022 as muted investor sentiments weighed down on wealth and fund management fees.
OCBC’s net fee income in FY2022 was $1.85 billion, 18% lower than a year ago. The decline was largely from softer wealth management fees attributable to prevailing risk-off investment sentiments. This was partly offset by an increase in fees from loan- and trade-related activities.
Great Eastern impact
“If the interest rate cycle is coming to an end, we see upward potential for our wealth management fees. We’re thinking that non-interest income should have a more rapid growth in terms of percentage than net interest income,” Wong of OCBC says.
Moreover, if interest rates reach a plateau, the net profit of OCBC’s insurance subsidiary Great Eastern Holdings (GEH), which includes markto-market securities, could stabilise. In 2022, the yield curve inverted such that short-term rates such as six-month T-bills were higher than the three-, five-, 10- and 15-year rates. That caused lower total weighted new sales (TWNS) and a drop in non-operating profit.
“Insurance products tend to be longer-term in nature and it’s difficult to match yields on fixed deposits and T-bills. Industry sales for [single-premium] industry products came down,” says Ronnie Tan, group CFO at GEH. “We shifted the product mix away from savings type to regular premium and protection and this contributed to higher margins and higher NBEV (new business embedded value),” Tan adds.
During 4Q2022, the yield curve became a lot more inverted than the first three quarters of 2022, with 20-year rates lower than three- and five-year rates. “Our liabilities are long-term and more sensitive to 20-year rates rather than gain in assets which had less of a drop because of short-term rates and this caused a huge loss in 4Q2022,” Tan explains.
While interest rates continue to be volatile, if they reach a plateau or even dip in the second half of this year, GEH’s net profit could experience a rebound.
At DBS, Gupta expects double-digit fee income growth. “We are maintaining our guidance for mid-single-digit loan growth and double-digit fee income growth. I think China’s opening will benefit the macro environment. As we enter the first quarter of 2023, business volumes appear to be good and loan growth is robust.”
Fee growth is expected at UOB as well. “Fees could grow by double-digits as we come off from a low base, led by cards and wealth management businesses,” notes Wee Ee Cheong, group CEO at UOB.
UOB’s CFO Lee is estimating an additional $1 billion in income from its Citigroup acquisition comprising the latter’s retail businesses in Malaysia, Thailand, Indonesia and Vietnam.
Benign credit costs, higher dividends
Credit costs are expected to “normalise” this year. This implies that credit costs, as guided by management, stay at 15 bps–20 bps at DBS and OCBC, and 20 bps–25 bps at UOB. Both DBS and UOB have ample general provisioning and management overlays.
DBS’s management overlay is at $2 billion, and UOB’s is around $1.4 billion to $1.5 billion. OCBC declined to reveal its overlay but when asked if it is around $1 billion, Wong concurs. Management overlays are amounts kept aside for times of uncertainty, over and above the provisions for expected credit loss (ECL) required by banks’ macroeconomic variable (MEV) models.
Against the headwinds and tailwinds, the banks should still be able to report higher earnings this year, which implies higher dividends as all three are aligned in paying out around 50% of their net profit.
Fitch says: “The earnings of Singapore banks are expected to improve materially this year, as rising interest rates boost revenues, especially in the first half of the year. Singapore is the only Apac banking sector with an improving outlook for 2023, premised on higher margins and benign asset quality, despite a muted loan-growth forecast. This should support capital levels, notwithstanding our expectations of higher capital returns to shareholders.”
DBS and UOB have already indicated they will pay out around 50% of their net profit. Although OCBC was notable for paying out well below 50% of its net profit, on Feb 24, the bank raised its dividend for a full-year payout ratio of 53%. Wong says, “As we continue to review our capital position we want to give a clear direction forward. That is why we set out to change our dividend policy to target a [payout] of 50%. We have a three-year strategy we unveiled and we are expecting faster growth organically.”
Based on Bloomberg’s poll, all three banks are expected to report new highs in net profit in FY2023. The forecast for DBS’s mean net profit this year is $9.84 billion, up 20% y-o-y; OCBC is estimated to report $6.88 billion, up 19.7%; while UOB’s net profit for this year is estimated at $5.63 billion, up 23% y-o-y.
On valuations, based on the price-to-book charts (see Charts 2, 3 and 4), all three banks are trading above their price-to-book means, with DBS at the highest level. OCBC is trading closest to its mean and book value while UOB is somewhere in between the two.