Singapore Banks - Upside From Higher Terminal Interest Rates
- We expect the Fed Funds Rate to reach a peak of 5.0% by mid-23 and remain at elevated levels in 2H23. We expect DBS and OCBC to increase dividend by 17% and 7% respectively to S$1.68 and S$0.60 in 2023.
- BUY DBS (SGX:D05) (Target price: S$46.95) and OCBC (SGX:O39) (Target price: S$18.32) for 2023 dividend yield of 4.8%. Maintain OVERWEIGHT on SG banking sector.
Moderation in pace of rate hike.
- The Federal Open Market Committee (FOMC) has raised the target for Fed Funds Rate by 50bp to 4.25% on 14 Dec 22. This is a step down from a series of four consecutive 75bp hikes.
Too early to talk about rate cuts.
- The committee needs more evidence to be confident that inflation is on a sustained downward path. Fed Chair Jerome Powell broke down inflation into three buckets:
- inflation for goods has already eased as supply chain disruptions were resolved and demand shift to services,
- inflation for housing services is expected to ease in 2023 as rents for new leases have declined, and
- inflation for core services (non-housing) is expected to take a longer time to moderate due to high labour-content of 55%, elevated job vacancies and growth in wages.
- The committee expects core PCE inflation to recede gradually to 3.5% in 2023 and 2.5% in 2024.
Labour market is too tight.
- Demand substantially exceeds the supply of available workers. Companies are reluctant to lay off workers because it is difficult to hire new staff. The size of the labour force is affected by accelerated retirement and slowdown in immigration. There appears to be a structural shortage of about 4m workers.
Staying the course.
- Core PCE inflation at 4.7% in Nov 22 remains above the Fed’s long-term goal of 2%. Thus, there will be ongoing rate hikes to ensure that the stance of monetary policy is sufficiently restrictive to return inflation to 2% over time. The committee intends to maintain a restrictive policy for some time and cautioned against prematurely etary policy.
- Based on the Fed’s dot plot, the Fed Funds Rate would be cut by 100bp to 4.1% in 2024.
Upside from higher terminal interest rate.
- Fed chairman Jerome Powell has warned that the Fed has “some ways to go” in its efforts to tame inflation. He cautioned that the “terminal level” of interest rates (peak) could be higher than previously anticipated. Based on the Fed’s dot plot, the median projection for Fed Funds Rate is 5.1% by end-23, an increase of 50bp compared to the previous survey conducted in Sep 22.
- We expect the Fed to hike 50bp on 1 Feb 23 and taper to a 25bp hike on 22 Mar 23. The Fed Funds uld reach a peak of 5.0% by mid-23 (previous: 4.5%) and remain at elevated levels in 2H23.
Benefitting from reorientation of supply chain towards ASEAN countries.
- ASEAN countries have a large population of 680m and accounts for about 8% of global exports. Many multinational companies have adopted the China + 1 strategy and have plans to set up alternative production facilities within the ASEAN region. Malaysia, Thailand and Vietnam saw growth in inflow of FDI for manufacturing. Indonesia is receiving FDI for the processing of its mineral resources.
- OCBC and UOB benefits from reorientation of supply chain towards ASEAN countries.
Maintain OVERWEIGHT on SG Banks
- Banks benefit from the ongoing hikes in interest rates and NIM expansion on a full-year basis in 2023 with DBS most sensitive to higher interest rates. Shareholders would be rewarded with higher dividends in tandem with the strong growth in earnings.
- We expect DBS and OCBC to increase dividend by 17% and 7% respectively to S$1.68 ($0.42 per quarter) and S$0.60 ($0.30 each for 1H23 and 2H23) in 2023.
- BUY DBS (Target: S$46.95) and OCBC (Target: S$18.32) for 2023 dividend yield of 4.8%.
- We expect NIM to expand by 56bp to 2.33% in 2023 (previous: 47bp) and 5bp to 2.38% in 2024 (previous: 1bp). We forecast earnings growth of 21% in 2023 (previous: 17%) and 9% in 2024 (previous: 8%).
- We expect DBS to provide dividend of S$1.68 in 2023 and S$1.80 in 2024, which represents dividend payout ratio of 45% and 44% respectively. DBS provides dividend yield of 4.8% for 2023 and 5.2% for 2024. See DBS's Dividend History.
- We raised our DBS target price from S$45.00 to S$46.95 based on 1.98x 2023F P/B, derived from Gordon Growth model (ROE: 16.3%, COE: 8.5%, Growth: 0.5%).
- We expect NIM to expand by 34bp to 2.23% in 2023 (previous: 33bp) and remain stable at 2.22% in 2024 (previous: 1bp). We forecast earnings growth of 12% in 2023 (previous: 12%) and 4% in 2024 (previous: 5%).
- We expect OCBC to provide dividend of S$0.60 in 2023 and S$0.64 in 2024, which represents dividend payout ratio of 40% and 41% respectively. OCBC provides dividend yield of 4.8% for 2023 and 5.1% for 2024. See OCBC's Dividend History.
- We raised our OCBC target price from S$18.28 to S$18.32 based on 1.44x 2023F P/B, derived from the Gordon growth model (ROE: 12.0%, COE: 8.5%, Growth: 0.5%).
Catalysts for SG banks
- NIM expansion in 2023 driven by upcycle in interest rates.
- Economic recovery driven by the reopening and easing of COVID-19 restrictions.
- Banks pay more dividends as risks emanating from COVID-19 pandemic recede.
Risks for SG banks
- Escalation of the Russia-Ukraine War beyond Ukraine.
- Geopolitical tension and trade conflict between the US, China and Russia.
Jonathan KOH CFA UOB Kay Hian Research | https://research.uobkayhian.com/ 2023-01-06 2023-01-06
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