The share prices for the three local banks have dropped by more than 10% since the start of 2020. Investors are wondering what is happening and what should they do during this period. In this article, I will analyse the three local banks, DBS, OCBC and UOB, with 5 key criteria and determine which is the best investment among them.
Overview of the Business and Geographical Segments
Although they are all local banks, each of them has different composition in business segment and geographical exposure. As we all know, global interest rate will be having multiple rounds of interest rate cut and hence lower interest margin for the banks. So, a bank with lower exposure to net – interest income tends to be more stable in earnings.
OCBC has the lowest net – interest income among the three banks. Its earnings will be less sensitive to interest rate.
In terms of geographical exposure, a bank that has less exposure to the Greater China should be more stable in earnings, given that the China economy has been severely affected by Covid-19.
UOB has the lowest income exposure to the Greater China among the three banks. It should be be less affected by the slowdown in China.
FY19 Financial Results
Although the share prices for the banks are dropping, all the three banks actually reported better financial results for FY2019.
In terms of earnings, DBS reported highest increase in net profit as compared to the year before and OCBC’s net profit margin is the highest among all the banks.
With higher earnings reported, all three banks have declared higher dividends for FY2019. Based on share prices on 9 March 2020, UOB dividend yield is the highest at 6% while OCBC has the lowest dividend payout ratio at 46.49%.
| Company | YoY Net Profit Change | Net Profit Margin | Dividend Yield (9 Mar 20 prices) | Dividend Payout Ratio |
| DBS | +15% | 44% | 5.8%(price $21.15) | 50% |
| OCBC | +8% | 45% | 5.6% (price $9.52) | 46% |
| UOB | +8% | 43% | 6.0% (price $21.50) | 51% |
Financial Stability
As many investors are concerned about an economic slowdown, investors have to ensure that banks have strong financial stability to withstand the economic impact for years to come.
For banks, we have to use capital adequacy ratio instead of debt to equity ratio. Capital adequacy ratio (CAR) is critical to ensure that a bank has enough cushion to absorb a reasonable amount of losses before it becomes insolvent.
Monetary Authority of Singapore (MAS) has set the minimum CAR at 10%. All three banks have quite a fair bit of buffer from the MAS guidelines. UOB has the highest CAR at 17.40%. This shows that Singapore banks should be able to absorb losses from non-performing loans (NPL). For NPL ratio, all three banks have the same ratio at 1.50%.
| Company | Capital Adequacy Ratio (CAR) | Non-Performing Loans (NPL) |
| DBS | 16.7% | 1.5% |
| OCBC | 16.8% | 1.5% |
| UOB | 17.4% | 1.5% |
Relative valuation
Given the current price correction, it is good that we can identify if any of the banks are trading at low valuations and hence good prices to enter. For banks, I prefer to use relative price-to-book valuation and compare to their historical average. The key idea is that in the long run, the valuation should move back to historical average level because of mean reversion effects in the markets.
| Current Price (9 Mar 2020) | Price at Average PB | Upside / Downside | |
| DBS | $21.15 | $23.00 | +8.7% |
| OCBC | $9.52 | $14.01 | +47.2% |
| UOB | $21.50 | $29.03 | +35.0% |
Based on the share prices at 9 March 2020, all three banks are trading at price-to-book ratios lower than the historical average.
Risks
Given the current COVID – 19 situation, investors should expect slower growth in loan book and banking business. Lower interest rate environment should lower the interest income for the banks as net interest margin is likely to be compressed. Non-performing loan ratio may see an increase if the economic slowdown last for an extended period.
Putting all together
While there are many pros and cons for each each of the banks, it will be easier if we use a point system to determine which bank has better fundamentals and valuation.
Here’s how the point system work: for the bank with best ratio, it will be awarded with 1 point. For the bank with second best ratio will be given 2 points and the worst ratio will be given 3 points. Bank with the lowest overall points will be the best one to invest in and the award goes to… OCBC!
Disclaimer: The analysis here is purely based on my personal view. This does not constitute financial advice. Read responsibly. The author has invested in one of the banks.
totally upside down.