The NIM Enigma

October 14, 2015 Singapore SECTOR RESEARCH | SEE PAGE 60 FOR IMPORTANT DISCLOSURES AND ANALYST CERTIFICATIONS Co. Reg No: 198700034E MICA (P) : 099/03/2012 Singapore Banks The NIM Enigma  Our quantitative tests of Singapore banks’ NIM sensitivity to SIBOR largely validate conventional thinking that firmer rates tend to fatten NIMs.  Rising rates benefit NIMs through the repricing interval, risk premium & yield curve. In Singapore, repricing and risk premium have stronger influence. But as delinquencies accompany higher credit risks, the incremental income from NIM expansion may be attenuated by credit costs.  Cut sector rating to Underweight from Overweight. Downgrade DBS & OCBC to Sell. Downgrade UOB to Hold but our preferred exposure to the sector. Dissecting NIMs: More Than Meets the Eye Banks’ net interest margins (NIMs) essentially comprise two components: customer margins and interbank margins. In our quantitative analysis, we tested the sensitivity of their customer NIMs to repricing risks, credit risks and yield-curve risks from firmer interest rates. We tested their interbank NIMs against the spread between SIBOR and LIBOR. Conclusion: banks’ asset-liability structures are sensitive to rate increases. Repricing assets/liabilities to a 50 bps rise in SIBOR would broaden group NIMs by 4.6-7.2 bps, ceteris paribus. And as credit spreads are volatile, NIMs could widen more if rate increases are driven by the risk premium ie an expansion of the credit-risk spread. For every 50 bps, NIMs could be widen 3.4-6.6 bps. But higher delinquencies could dilute any positive EPS impact. Debunking the Myth: Is DBS the Biggest Beneficiary? Contrary to market expectations, DBS may not be the biggest beneficiary of a rate hike in uncertain economic times. Rather we believe it to be UOB. We downgrade our sector rating to Underweight from Overweight. On this set of findings, we are reordering our recommendations. DBS and OCBC have been downgraded to SELLs from BUYs. UOB remains a HOLD; it is our preferred exposure to the sector. Important Corollary On Disintermediation A relevant corollary from our tests is that Singapore banks are facing serious disintermediation pressures. The evidence? The gap between their group NIMs and customer NIMs has been narrowing, suggesting that the banks are lowering their credit spreads to customers. This shrinks their returns from financial intermediation and marks a structural change for the sector. We believe this should be priced into the sector’s long-term valuations. Analyst Ng Wee Siang(65) 6231 5838ngweesiang@maybank-ke.com.sgNg Li Hiang(65) 6231 5840nglihiang@maybank-ke.com.sgStockMkt capRatingPriceTPUpside(USD'm)(LC)(LC)(%)15E16E15E16E15E16EDBS Group31,450.5Sell17.5115.90(9)10.710.51.11.03.43.4OCBC26,819.3Sell9.288.50(8)10.49.91.21.13.93.9United Overseas Bank22,947.9Hold19.9021.0069.79.41.11.03.83.8P/E (x)P/B (x)Dividend yld (%)(Downgrade) UNDERWEIGHT October 14, 2015 2 Singapore Banks Outline of the Study: October 14, 2015 3 Singapore Banks Investment Summary Rate hikes = wider margins? In our quantitative study, we tested Singapore banks’ NIM sensitivity to types of interest-rate risks that we deem relevant: repricing, credit, yield curve and the SIBOR-LIBOR spread. For simplicity, we use a multi-step multi-variable linear regression model based on historical data as a guide. Yes, better NIMs ... but only modestly. Banks’ asset and liability structures are sensitive to rate changes, facilitating NIM expansion. But from our test results, the impact is modest. Both assets and liabilities are parked at the short end, almost evenly matched in their sensitivity to rate changes. This implies that gaps in repricing intervals are small. While NIMs should expand because of higher returns from capital funds, the improvements may be limited. Overlooked credit spreads an important determinant of NIMs. We proxy credit spreads using the differential between US Baa bonds and SIBOR. OCBC and UOB showed a higher propensity to pass on higher risk premiums in an unfavourable lending environment. Between 4Q07 and 3Q09, OCBC/UOB customer NIMs were up an estimated 47bps to 2.66% and 38bps to 2.91% respectively, largely driven by heightened risk premiums. Customer NIMs were compressed to a low of ~1.68%-1.79% in 2014. But we note that a higher risk premium may also be accompanied by asset delinquencies. NIMs inversely correlated with yield curve; not many opportunities to ride the curve. Singapore’s inverted yield curve for most periods between 2Q04 and 2Q15 (see Figure 19) was inversely correlated with NIMs. We think this triggered severe margin compression and historically low NIMs. Althou