Sunday, July 31, 2016

Which Of The 3 Local Banks Should You Buy?

Banks are increasingly difficult to analyse because of the various business nature and regulatory compliance requirements which needs to be monitored.

I am not adept at analyzing banks because I do not have an in-depth understanding of the industry. If I made any mistake here, please forgive and do point out to me. I am still learning to understand the industry and will hopefully get better over time.

Folks who invest in the 3 local banks do so because they are the main core of STI components. If you track their returns respectively, you'd see a lot of similar correlation between the two. Hence, I believe many folks who bought into banks do so because they believe MAS is regulating them efficiently and sufficiently.

I've drawn up the basic lists of a few of the important factors when I do look into banks as an investment. These are not extensive in nature because there are so much more one has to look beyond and understand on the industry before they can be on top of their game.

Net Interest Margin (NIM)

For those who are not familiar with NIM, they are simply measuring how successful the banks are at investing the funds after taking into account the expenses on the same investment.

Customer deposits which the bank gets from folks like you and me are being reinvested at a higher return, and the margin measures the spread difference.

Among the 3 banks, NIM % is highest for DBS, which inched slightly over the other 2 banks. Having said that, DBS has yet to report their Q2 and I am expecting them to drop by a similar 10 basis point at least.

For UOB, we need to watch out on the latest Q2 performance as NIM has declined by 11 basis point yoy and 10 basis point qoq on the back of declining interest rate environment.

For OCBC, the NIM has performed better by declining less at 7 basis point qoq and have actually inched slightly up by 1 basis point yoy.

Non-Performing Loan (NPL)

NPL is an important component of banks due to the nature of the industry they are operating in. In short, NPL measures the bad debt unrecoverable amount which the banks are measuring against the Loans and Advances less provision for general and specific allowances they've made.

Among the 3 banks, NPL % is lowest for OCBC.

The provision for allowances is one which I think is severely overlooked by many because a bank can continue not to make any provision but they have to take the hit when the storm comes. At the opposite end, a prudent management can provision for general or specific allowances, on the back of a potential storm before they come. Notice the difference.

For instance, DBS has made lesser provision for allowances against their oil and gas exposure as compared to OCBC and UOB, who have made further general provision in Q1 and Q2 2016.

NPL% inched up during 2008 GFC

For the purpose of this exercise, I've further broken down the exposure mainly on two most commonly discussed: 1.) China; and 2.) Oil & Gas.

Do note that the exposure was not done based on NPL but rather as a total loans less allowances they've made on the back of these exposures.

OCBC and DBS are banks that have a greater exposure to Hongkong and Greater China due to the growth strategy that they are pursuing. For example, OCBC has a wealth strategy management to tap onto the Chinese market through Wing Hang. For UOB, they have a greater exposure on the rest of the South East Asia.

On exposure to O&G, UOB has again emerged as the winner as they have the least exposure to these industries. We are of course assuming that the O&G exposure is bad here. It could be the other way round when the cycle turns.

Capital Adequacy Ratio

For those who are not familiar with the Basel III arrangements, there are the respective regulatory minimal adequacy for banks to keep. Common Equity Tier 1, Tier 1 and Total CAR has a minimum adequacy regulatory of 6.5%, 8% and 10%. There is also a need to keep a capital conservation buffer of 2.5% which will slowly be phased transitionally from 2016 to 2019. This increases the requirement for banks to beef up their capital balance sheet in order to get stronger and pass the "stressed test" the banks are required to take from time to time.

Out of the 3 local banks, OCBC has currently the strongest CAR at 17.5%, which is well above the minimum regulatory requirement. The other 2 banks are not far off either.

This also explains why OCBC is currently discontinuing to offer the scrip dividend while UOB is enticing a 10% scrip dividend in order to increase their capital adequacy. I see scrip dividends issued by these banks more as a disadvantage to shareholders over time.


Moving on to valuations, it appears quite evidently that DBS emerged as the winner when we are valuing them in terms of price to earnings and price to book. Nevertheless, the key is still in ensuring if DBS has taken the conservative path to impairing their bad loans appropriately. If they don't and the crap hits the fans, it'll come back to haunt them like what happened to Deutsche Bank right now.

In terms of dividend yield, OCBC still emerged as one of the highest dividend paying bank with 4.19% yield.

Final Thoughts

I'd summarized the above with the following table which might be easier to compare across the 3 banks.

Summary - Done by B

A lot of people are buying into banks right now.

Personally, I feel that with the current valuations, banks are not as attractive as their valuation suggest because there are pretty evident scale that all their core business are taking a trend downwards. For instance, the loans growth, net interest income and others. In terms of how they are going to fare onward, there are also signs where the growth might be stalling in several geographical markets.

In order for banks to be attractive at this point, investors should at least not pay above P/BV above 1x which I feel is very much fair to richly valued. Unless you have a lot of warchest on the sideline or desperately wanted a bank exposure so much in your portfolio, my personal take is to wait further until a lot more crap hits the fans. You can be sure banks will be the first to react regardless of whatever bad news out there in the market.

If you had analyzed the banks' past 10 year valuations which will see them fare against the likes of GFC and the Euro crisis, you would notice that there are a lot of rooms for them to still fall. On the opposite end, we'd see these banks trade as high as 1.2x to 1.3x book value, so there are risks that one might miss out on the run should market goes crazy. Core business down but valuations up? Never say never.

I am tempted to cash in given my current warchest on banks but I'd rather swing high and hard when the right time comes than buy these banks at fair value right now. Somewhere along $8 will probably entice me to start my first round on OCBC, but I'd go slow because all it takes is just one right moment to hit all the jackpot home.


  1. Good valuation analysis on banking sector ! Also , most of the crisis caused by credit burst or banking,, price will be affected the most during these time ,,, and that may be good timing to pick ...cheers ,

    1. Hi STE

      Agree. A lot of news in this world will be directly correlated with banks performance so either way they will be the first line of defense. I think they are only going to be attractive during crisis period for contrarian play.

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  2. What is your take on Hong Leong Finance Bank?

    1. Sorry, i hv not delved too much into these financed company, though i understand they can be more lucrative.

  3. didnt realise OCBC stop their scrip!
    is this only for this round, or for the next few rounds as well?

    1. Hi FC

      They discontinue it for the interim, citing sufficient capital they require. I would expect this to be the norm from here unless for some reason they require additional capital.

  4. Does size matter (market cap as of Aug1)?

    DBS - 15.5B
    UOB - 18.3B
    OCBC - 8.6B

    1. Never really thought of this but yeah it could make the difference.


  5. Great run down on the basics of bank counters, appreciate the effort and share of knowledge. I've been nibbling OCBC for about 18 months using a Share Builders Plan(SBP). I particularly like OCBC for giving out cash div instead of scrip. The cash div helped little bit to the main warchest for bigger purchases.

    As you have mentioned, bank stocks will be taking a big hit with the O&G companies all getting all the bad press. Much as you said as well, when the crap hits the fan, it matters how much crap landed on each bank and what are the counter measures or provisions they can cover themselves.

    1. Its great to actually do a dca on banks. Im not sure whats the total return that one can get with banks over the long term, probably pretty mimic the sti index but with more volatility. Still its a pretty direct play...

  6. The all impt metric roe u have missed out.

    1. Read again. The roe metrics is inside the table.

  7. Thanks for sharing. great stuff

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  10. An Important Ratio - Return on Asset is not mentioned in the article.
    DBS - 1.03
    OCBC - 1.06
    UOB - 0.99

    This measures the efficiency on generating returns on its asset base. OCBC is the winner. Hence explain the higher price to book of OCBC. To simplify the comparison of these two ratio, I normalise ROA against P/B. (Divide ROA against P/B)

    1. Hi CS Lim

      Thanks for adding and the explanation. ROA is a very important ratio indeed.

      To add on to your points, the extended dupont roe is also essentially measuring the roa multiplied by the gearing the banks have.

  11. nice. personally, feel singapore and all 3 banks are underpriced, just will need time to resolve. cheers.

    1. Hi SMK

      I think they are pretty fairly valued now. They have so far been well managed.

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