A potential break in "outperformance" pattern
With only one month remaining in 2015, the SG banks could underperform the STI for the first time since 2010. Despite delivering a better-than-consensus set of 3Q15 earnings, investors may have more concerns ahead as negative sentiment has largely overshadowed their defensive qualities and still steady fundamentals. Though loan growth may moderate with a continued normalization trend in asset quality deterioration, we currently do not see significant downside in earnings. Within SG banks, DBS remains our top pick.
Asset quality: pockets of deterioration offset by PA buffer during good times
We have seen few pockets of asset quality deterioration in recent quarters with signs of NPLs moving up from benign levels. But, so far the deterioration has not significantly affected earnings as the SG banks have consistently built up a provision buffer during the good times. Though current levels of credit cost (20bp to 35bp) are still at the lower end vs. historical average (sector: 40bps), we believe the forward trend should largely be steady and within our expectations. Due to active portfolio allowances, strong regulatory oversight, property price reflation and implementation of macro prudential measures, we believe asset quality deterioration should be different in this cycle.
Loan growth: further moderation offset by active ALM
Given the narrowing interest rate differentials between offshore and onshore Mainland China, renewed lending facilities at lower commodity prices and greater prudency from banks, the loan momentum has decelerated since the beginning of the year (from high-single to mid-single digit guidance). Currently, we have already factored in mid-single digit growth of 5% in FY16-17E when any further slowdown should have a manageable impact on earnings due to SG banks’ continued active ALM through non-renewal of expensive deposit funding, lengthening and more deployment into fixed income securities.
Which bank is therefore more defensive in this cycle?
The build-up of portfolio allowances should be seen as a defensive quality for the SG banks, as earnings should remain resilient even though the asset quality deterioration cycle has started to trend upwards. UOB’s portfolio allowance buffer is highest at 140bps (vs. DBS and OCBC of ~93bp in 3Q15), in part due to its higher EM exposure than peers. But, we believe investors may under-appreciate DBS’s defensive quality in this cycle as well. As DBS’s lending duration is much shorter (50% matured in <12 months), we believe it is more capable of managing deposit funding costs if loan growth continues to slow. And from the asset quality side, given the slowing Asian economy, the shorter duration should also allow greater flexibility to strengthen the underwriting requirement once lending matures.
Preference for DBS, followed by OCBC and UOB
We value SG banks using GGM. Currently trading at 1x P/B and 11.4% 2016E RoE, the SG banks’ valuations look undemanding compared with the historical mean (1.4x P/B). Key downside risks: severe property price declines, asset quality deterioration.
Aside from its defensive qualities as described above, we also like DBS due to its:
(1) most compelling P/B valuation vs. SG banking peers; and
(2) higher than peers’ exposure in developed markets (HK + SG); higher CASA franchise will position the bank to benefit at the start of the upward interest rate cycle. (Read Report)
Source : Deutsche Bank Markets Research