Singapore banks have ample capital for higher dividends, so keep watch for upcoming dividends in their FY2022 ended December results arriving from mid-February, writes DBS Group Research analyst Lim Rui Wen.

In a Feb 1 note, Lim maintains &ldquo positive&rdquo on Singapore banks, with &ldquo buy&rdquo calls on United Overseas Bank (UOB) and Oversea-Chinese Banking Corporation (OCBC) and target prices of $34.20 and $15 respectively.

&ldquo DBS management has previously acknowledged its capacity to return more capital to shareholders and pay more dividends, with dividend changes typically carried out at the year-end,&rdquo says Lim.

Lim adds: &ldquo Though OCBC does not have a track record of giving out special dividends, its common equity tier-1 (CET-1) ratio of 14.4% as at 3QFY2022 represents ample capacity to pay higher dividends.&rdquo

Net interest margin (NIM) expansion will start to moderate during 4QFY2022, says Lim. &ldquo 3QFY2022 NIMs reached high watermark levels, as the interest rate hikes were the highest seen in two decades. Singapore banks&rsquo NIM expansion will start to moderate from 4QFY2022 amid an ongoing repricing of deposits, as CASA [current account, savings account] and fixed deposits both saw big increases during the quarter.&rdquo

UOB will see NIM uplift from the consolidation of Citi, says Lim. &ldquo DBS/OCBC/UOB saw 32bps/35bps/28bps q-o-q expansions during 3QFY2022 to 1.90%/2.06%/1.95%, a high watermark for Singapore banks in the last two decades as interest rates continue to be on the rise.&rdquo

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A &ldquo faster-than-expected&rdquo increase in the cost of deposits will be the key critical factor to watch in our opinion, says Lim. &ldquo Nonetheless, Singapore banks continue to be beneficiaries of the rate hikes, with improving NIMs.&rdquo

Credit costs normalising

The credit environment has continued to be largely benign, says Lim, as economies re-emerge from the pandemic.

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OCBC guided during its 3QFY2022 results for 15-20 basis points (bps) credit costs for FY2022, implying 30 bps credit costs in 4QFY2022, notes Lim. &ldquo However, we believe actual credit costs will be lower than the guidance. We expect some provisions to be booked in 4QFY2022 across the banks, including general provisions for macroeconomic variable updates and/or specific provisions.&rdquo

Lim believes resilient earnings performance and a good dividend yield of 5%, with the potential for higher dividends, will continue to support valuations in FY2023. &ldquo We expect sector earnings growth of 10% with prudent cost management. Singapore banks continue to have a high provisions buffer to cushion any unexpected credit deterioration should a sharper-than-expected economic slowdown play out.&rdquo

Cost of funds ticks up

Cost of funds ticked up more significantly during 4Q22, notes Lim. &ldquo There have been more significant increases of more than 100 bps for Singapore banks&rsquo fixed deposit rates during 4QFY2022, in part contributing to some of the CASA outflow.&rdquo

DBS, OCBC and UOB also raised interest rates on their flagship CASA accounts by up to 60 bps, 280 bps and 285 bps respectively during 4QFY2022.

As such, a faster pace in the rise of the cost of deposits will start to show, says Lim. &ldquo The CASA ratio has declined across Singapore banks and the trend will continue into 4QFY2022, as the banks also continue to see CASA outflow to alternative higher yielding instruments such as fixed deposits, T-bills, and Singapore Savings Bonds, among others.&rdquo

Thus a &ldquo faster-than-expected increase&rdquo in the cost of deposits will be the key critical factor to watch, says Lim.

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Loan growth likely weak

Across the banking system, November 2022 continued to see loan growth decline by 1.9% m-o-m, after declining 2.5% m-o-m in October 2022.

While Singapore banks have grown their loan books ahead of the industry&rsquo s growth, Lim believes some of the pullback is in part due to the paying down of loans amid the higher interest rate environment on top of more cautious demand.

As of 3QFY2022, year-to-date loan growth across DBS, OCBC and UOB are 4.9%, 4.5% and 4.1% respectively. &ldquo We expect 4QFY2022 loan growth across Singapore banks to be weak and believe loans will grow at a mid-single-digit rate going into FY2023.&rdquo

Non-interest income is likely weak due to seasonal effects, adds Lim. &ldquo We expect 4QFY2022 non-interest income to be weaker q-o-q, driven by seasonal effects contributing to the weakness of wealth management income, partially offset by improved card fees.&rdquo

Lim notes that UOB had an &ldquo exceptional&rdquo trading quarter of $370 million during 3QFY2022. &ldquo We expect this to normalise during 4QFY2022 to the $200 million levels as previously guided for. Further, [OCBC 87%-owned subsidiary] Great Eastern Holdings is likely to see a negative mark-to-market impact from its bond portfolio due to yield movements.&rdquo

As at 2.33pm, shares in DBS are trading 31 cents higher, or 0.88% up, at $35.39 while shares in UOB are trading 35 cents higher, or 1.18% up, at $29.98 and shares in OCBC are trading 6 cents higher, or 0.47% up, at $12.94.