Singapore’s  loan growth tepid at 2.08% YoY (April: 1.37% YoY)

Latest statistics from MAS showed sluggish loan growth of 2.08% YoY for May. Business loans growth of 3.71% YoY offset contraction in consumer loans growth of 0.39% (Figure 1). B&C loans growth remained robust at 12.9% YoY due to the drawdown of loans from existing projects in the pipeline. We expect property cooling measures to hit B&C loan growth near end 2019. Consumer loans (Figure 1) contracted for the second consecutive month, hammered by persistent weakness in housing loans growth of -0.39% YoY, curbed by property cooling measures and high interest rates. We posit loan growth for the Singapore banks to slow to 4-6% for FY2019e (2018: 7-11%) due to headwinds from property cooling measures and slowing global trade and regional loans.

Deposits – Tighter liquidity conditions with contracting CASA growth

Fixed deposits continue to surge, growing 22.0% YoY, outpacing overall deposits growth of 7.4% YoY as banks continue to compete for deposits by offering attractive interest rates, lifting 3m SIBOR above the 2% level, a level last seen during the previous Fed rate hike cycle between 2004-2006. CASA deposits contracted 1.1% YoY, the slowest in 3 years (Figure 2). When interest rates are high, the Singapore dollar fixed deposits are usually highly sought after by investors redirecting their funds into higher yielding investments.

With a higher proportion of fixed deposits in the deposits mix, the cost of fund rises, making it a constant challenge for banks to manage costs well enough to achieve NIM expansion. However, we expect competition for fixed deposits to taper off in the 2H19 and funding pressure to ease since no more rate hikes are expected in 2019 in the U.S.

3M SIBOR stable at 2.002%, while 3M SOR dipped 22 bps to 1.833%

Meanwhile, the savings rate in Singapore remained unchanged at 0.16% (Figure 4). However, we believe the pause in interest rate hikes limits the upside for NIM expansion. As we reach the end of the interest rate cycle, 2Q19 results may be the last NIM rally for the year. We still expect the banks to deliver full year NIM improvements due to the lagged effect of loan repricing, albeit at a lower magnitude of around 4 bps in FY19e.

MAS’ Monetary Policy – Exchange Rate Management

The interbank interest rate in Singapore is primarily determined by movements in the US interest rate adjusted for the expected change in the Singapore-US Dollar exchange rate.

Singapore’s domestic interest rates such as S$ Swap Offer Rate (SOR) or S$ Singapore Interbank Offered Rate (SIBOR) generally track global interest rates, notably the US$ London Inter-bank Offered Rate (LIBOR) because the US is a key trading partner of Singapore. However, domestic interest rates can be at a discount (premium) to global interest rates when the S$ is expected to appreciate (depreciate) against other currencies (Figure 6). A weaker Singdollar and expectations of more depreciation will push local interest rates higher, affecting home loans and all other consumer and business loans. Hence there is a misconception that Singapore interest rates will decline in accordance to US $ LIBOR. For example, if MAS adopts a dovish exchange rate policy, Singapore’s interest rates may, in fact increase.

Volatility – a very favourable backdrop for derivatives

With increased volatility due to trade uncertainties and geopolitical tensions investors tend to hedge more, and SGX’s derivative business is expected to benefit from heightened volatility. SGX’s diversity of products sets it apart from other domestic-centric exchanges because the majority of SGX’s customers are international clients with high demand to hedge their risks in the global market. With the resurgence of trade war uncertainties, SGX’s DDAV (Derivatives daily average volume) spiked 54% YoY in May.

Hong Kong’s loans growth recovered slightly to 3.1% YoY in May (April: 0.5% YoY)

Hong Kong’s loan demand remained cautious due to high interest rates and lingering trade tensions. Hong Kong’s May residential sales and purchase value and volume rose 11.9% and 4.9% MoM respectively. Home prices in Hong Kong recovered back to the peak levels last seen in July 2018 (Figure 12). Meanwhile, 3-month HIBOR shot up by 32.1bps to 2.456% (Figure 9). Higher interest rates should support the banking sector’s profitability.

Investment Actions

Maintain the Singapore Banking Sector at Overweight. While the trade war affects investor sentiments in the near term, we believe the banks’ healthy fundamentals remain intact to withstand risks and deliver growth on a sustained basis.

Operating environment remains stable despite slowing regional growth. Asset quality is benign although SME portfolio might face some stress from slowing trade flows (Figure 13). Increasing diversification of the banks’ business into more stable fee income (loan, credit card, wealth management etc) to reduce proportion of earnings arising from volatile revenue streams (trading income, investment gains etc). Better cost management and low provisions should also provide uplift to ROEs. The banking sector provides an attractive dividend yield support of c.5%, secured by strong capital ratios.

With the expectation of at least one rate cut this year, we expect downside risks to NIM to materialise in FY20 because it takes time for loans to be repriced to lower rates.

UOB remains as our top pick mainly because of its exposure to trade war effects being relatively muted as compared to its peers. As of 1Q19, UOB’s profit before tax arising from Greater China and Hong Kong loans is 10% (DBS: 29% and OCBC: 19%) (Figure 14).