How will Singapore banks fare in 2012?

The weak economic outlook is casting a shadow over the banking sector.

DBS forecasts loan growth to plummet to 8% in 2012, contrary to a strong 26% in 2011.

Here’s more from DBS:

Macro outlook turning soft

Domestic and external headwinds. The Singapore government’s forecast for 2012 GDP growth is at 1-3% (DBSV: 3.5%). Global economic conditions are expected to remain subdued in 2012, with the outlook clouded by increased uncertainty and financial volatility. The MAS says that the global economy and financial system are now at their most fragile state since the 2008/09 Global Financial Crisis.

Financial stability risks have increased significantly in 2H11 due to the European sovereign debt crisis. While Asia has remained resilient, there are potential spillover risks from the G3
economies.

Casting a shadow over the banking sector. Slower macro outlook would undoubtedly cast a shadow over the banking sector. Key risks lies in potential uptick in provisions and asset quality deterioration. We have raised provision charge-off rates in our assumptions but we are still not calling for a turn in the credit cycle as there are still visible signs of deterioration.

Business outlook turning cautious. Expectations of business prospects in 4Q11 and 1Q12 have softened considerably compared to the same period a year ago. From business expectation surveys, market participants are expecting credit conditions to tighten over the next 6 months. This can work both ways for banks. If banks are able to price up loans to reflect higher risks, NIM would improve, as in 2009. On the contrary, this could spell the beginning of asset quality issues if funding cost to corporates start to escalate. We have imputed the softening of credit demand in our assumptions, hence the slower loan growth forecast of 8% for 2012 vs 26% in 2011. We have not priced in higher credit spreads, but should that happen, there would be upside risks to our estimates.

Imminent bottomline pressures; 5% earnings growth for 2012. While pressures on NIM remain particularly on the funding side, the impact could be muted should lending spreads widen. However, we note that companies’ balance sheet are stronger now with less gearing, hence chances are lower for banks having the pricing power to raise loan spreads. But this should mean that asset quality will remain healthy and we maintain our stance that asset quality would remain stable. We are still not proponents of a turn in the credit cycle; we expect general provisions to moderate while specific provisions to gradually inch up. We are imputing an additional 5-10bps provision charge-off rate across the banks and further softening of non-interest income. All in, we project 5% core earnings growth for 2012 (2011: 6%) with average core ROEs to hover around 11% for 2012.

Low interest rate environment prolonged. The prolonged benign interest rate environment could take a toll on NIM although to a much lesser extent than before as SIBOR and SOR are already low (vs. 2008). Competition prevails but we would not discount the likelihood of higher credit spreads should recessionary risks emerge. Pressures could be offset by increased funding costs (regional operations and US$ funding) though we believe these would be largely ex-Singapore. Overall, we expect NIM to continue to dip a little and only start to rise in 2H13 when interest rates start to increase. For every 10bps increase in NIM, earnings could rise by 7-8%.

Loan growth unexciting into 2012. After months of accelerated loan growth, we believe it is about time the momentum starts to moderate. The first sign was seen in the Oct-11 loan statistics. Up to 3Q11, banks were growing at 27% y-o-y on average (22% 9M YTD). Loan growth lags GDP growth by 4-6 quarters. With GDP growth contracting in 2Q11, marginal positive in 3Q11 and an expected 3% contraction in 4Q11, loans should slow down considerably by the earliest 2Q-3Q12. We are forecasting loan growth, average of the three domestic banks, at 8% for 2012 contrary to a strong 26% in 2011.

Watch out for good entry points. To reiterate, our stress test indicates that higher provision charge-off rates and significantly lower loan growth would not derail the fundamental strength of the banks. In our view, investors should take the opportunity to accumulate Singapore banks when valuations decline substantially or are at over-sold positions.