• Stay OVERWEIGHT; United Overseas Bank (UOB) and DBS as Top Picks. All eyes are on the US Federal Reserve’s monetary tightening efforts, concerned over potential headwinds from aggressive rate hikes and rapid balance sheet reduction. Banks in Singapore are likely to see greater volatility given the stocks’ outperformance since late 2020. Still, with border reopening and rising rates having a positive impact on FY22F earnings and robust balance sheets, we believe bank stocks would grind higher in the months ahead.

• FOMC dot plot points to six more rate hikes in 2022. According to the Federal Open Market Committee (FOMC) dot plot, which the US central bank uses to signal its outlook path of interest rates, officials are expecting to raise the federal funds rate (FFR) six more times in 2022 (Figure 15). The median projections point to FFR of 1.875% by end-2022, which follows the 25bps increase to 0.50% on 16 Mar 2022, and 2.75% by end-2023. This suggests a total of seven rate hikes of 25bps or a cumulative 175bps. The recent steepening of the US 10-year Treasury yield also points to growing expectations for a sharper 50bps hike in the next FOMC meeting in early May.

• Are rate hikes fully priced in? Singapore’s benchmark interest rates, which are closely correlated to movements in the FFR, have risen since the start of this year (Figure 14). While excitement over the prospects of rising US interest rates sustained the rally in Singapore bank stocks (SG Banks) into Jan-Feb 2022 (Figures 1-4), the Russo-Ukrainian war has brought valuation multiples back to more decent levels (Figures 6-13). Since Jan 2009, SG Banks’ P/BV multiples have risen twice above +1SD historical mean – in mid- 2009 to end-2010 lifted mainly by robust GDP growth, and late-2017 to mid- 2018 on rise in interest rates. We believe SG Banks can grind higher in the months ahead on rise in FFR and border reopening having a positive impact on economic activities. We have pencilled in four rate hikes in our FY22F earnings, which are slightly ahead of consensus for DBS and OCBC.

• Will aggressive rate hikes impact loan growth? The FOMC dot plot suggests that Singapore benchmark rates would rise sharply in 2022, followed by a moderate increase in 2023. Still, we believe rates would likely remain lower than levels seen in 2006-07. We expect the higher interest rates to be well absorbed by the market helped by the improving economic prospects within the region. SG Banks are guiding for mid single-digit loan growth in FY22F, moderating from the high single-digit increase in FY21.

• Earnings sensitivity to rate hikes. Based on guidance provided by banks, every 25bps rise in interest rate would lift FY22F NIM by 7-8bps for DBS, 4- 5bps for OCBC and 3-4bps for UOB. This would translate to earnings uplift of 5% for DBS, and 3% for both OCBC and UOB.

• Key downside risks to our investment view are: i) Worsening geopolitical tensions between Ukraine and Russia, ii) sharply higher commodity prices and supply chain disruptions that would exacerbate global inflationary pressures and threaten the fragile economic recovery, and iii) resurgence of the COVID-19 pandemic.

Source: RHB Research - 7 Apr 2022