Higher interest rate has its good and bad. With the odds of the US Federal Reserve tapering its quantitative easing programme on the rise, interest rates are set to rise. The implications will manifest in banks’ net interest margin (NIM), asset quality and loan growth. In this report, we conduct a sensitivity analysis on earnings assuming a 1ppt change in loan growth, a 5bps rise in NIM and a 5bps increase in credit charge (as a proportion of net loans).

Most sensitive to NIM changes but less so to loan growth. Based on our estimates, every 5bps increase in NIM will raise FY14F-15F EPS of our universe by 4% on average. The earnings uplift is significant after the past few years of depressed NIMs. We believe DBS would benefit the most compared to its peers, given its strong deposit franchise. However, we would add that banks’ earnings are much less sensitive to a change in loan growth in the year the loans are disbursed because the additional interest income earned or lost will substantially be offset or cushioned by additional or lower collective impairment to be set aside as required by the regulators.

What about a 5bps increase in credit charge? The earnings impact ranges from 2.5% to 3.1%, with a slight variation from bank to bank. As a proportion of average net loans, our universe set aside an average credit charge-off of 24bps in 2012, the lowest since 2006. We expect credit charge-off to rise to 27bps in 2013 and 30bps in 2014, before improving to 28bps in 2015.

DBS is our top sector pick. Of the three Singapore banks under our coverage, we believe DBS is best positioned to take advantage of a rising interest rate environment, given its liquid balance sheet and strong deposit franchise with cheap funds accounting for 58.4% of total deposits. We have a BUY call on DBS with SGD19.70 TP, based on 14x FY14F core EPS, a slight premium to its rolling PER average since 2005.  

Source: Maybank Kim Eng Research - 18 Dec 2013