• Maintain OVERWEIGHT, Top Picks: DBS and OCBC Bank. After much volatility between April and September, Singapore banks (SG Banks) are approaching the end of 2022 with a decent 7% gain in share prices, outpacing the STI’s 4% rise. While 2023 is expected to be a challenging year, we believe banks should continue to outperform the broader market, given the prospects of ROE improvement being driven by a further NIM expansion.

• A marked slowdown in 2023. The Ministry of Trade and Industry (MTI)  expects GDP growth to cool down to 0.5-2.5% in 2023, from 3.5% in 2022F – with the challenging global environment expected to weigh heavily on  Singapore’s export-oriented sectors. The US 10-Year Treasury (UST-10Yr)  yield has inverted, down 77bps to 3.45% since mid-Nov 2022, signalling expectations of an impending US recession. RHB economists expect the  Singapore economy to moderate slightly to 3.0% in 2023, from 3.7% in 2022.  Although this is not the base case, RHB economists believe the balance of risks is tilted towards a technical recession in 2023.

• Demand for credit softening. The uncertain 2023 outlook, we believe, may see businesses turning cautious on their investment plans and households tightening their belts. This will likely accelerate the softening in loan demand,  and suggests downside risks to our FY23F loan growth forecast of 5.0% YoY  (FY22F: +5.8%). SG Banks have seen a moderation in their lending business,  with growth at 6% (annualised) in 9M22 vs +9.6% in 2021.

• Tailwinds from NIM expansion. As expected, banks are seeing attrition in  CASA deposits, with the recent rise in fixed deposit (FD) rates. While the intense deposit competition and declining CASA deposits would mean higher funding costs ahead, tailwinds from hikes in the Federal Funds Rate (FFR) in  2H22 and 1H23 should lift net interest income (NII) further in FY23. For 9M22,  sector NIM expanded by 20bps YoY. We believe DBS, which had a higher  CASA ratio of 60.3% at end-3Q22, would be better positioned to deliver NIM  improvement. UOB’s CASA ratio stood at 49.8% while OCBC’s was 56.1%.

• Credit cost slightly higher. Due to the COVID-19 health crisis, banks’ loan portfolios are now well seasoned. Sector NPL ratio has improved to 1.29% in  3Q22 from a high of 1.57% in 1Q20, and stress tests indicate that asset quality will be resilient, even at interest rates of 6-7%. Still, banks are staying prudent,  preferring not to release management overlays built up to ensure they have strong provision buffers to absorb any potential deterioration in asset quality.  As at end-3Q22, non-performing assets coverage stood at a high 120% for  DBS, 108% for OCBC and 98% for UOB. We have conservatively pencilled in higher credit cost of 19bps for FY23F, compared to 14bps for FY22F.

• Capital strong. SG Banks are well-positioned to weather the external headwinds. Aside from having a very comfortable provision coverage, banks also have robust capital buffers. As at end-3Q22, DBS’ CET-1 ratio stood at  13.8% (14.4% for OCBC and 12.8% for UOB). This should enable banks to  keep to their dividend payout plans.

• Sector earnings to grow 20% YoY in FY23F, buoyed by further NIM  expansion and a moderate rebound in non-II that would comfortably cushion  the uptick in credit cost. This would lift sector ROE to 13.6%, from 12.0% in  FY22F. Key downside risks to our investment view are: i) A sharper-than-expected downturn in global economies, ii) escalation of the Russia-Ukraine war that would further disrupt commodity exports and intensify inflationary pressures, as well as a iii) a significant deterioration in asset quality.

Source: RHB Securities Research - 9 Dec 2022