The increase in interest rates led by the Federal Reserve signals a generally healthy economy which should bode well with the banking sector. The current environment is still encouraging for investments as well as consumption. This would lead to growing needs for more loans to finance spending.
Rising Bond Yields
Government bonds have seen an increase in yield in many countries due to changes happening in the US.
Firstly, as the US passed its historic tax cuts to lower corporate tax rate from 35 percent to the current 21 percent, the US government would experience a shortfall in government revenue which would burgeon its already-existing budget deficit. In turn, the US government would need to issue more debt to finance spendings.
In addition, trade woes between US and China, is causing Chinese government to cut down on demand for US treasury bills and bonds. This further accelerated the rise in bond yields as bondholders demand a higher required rate of return.
That is not withstanding the fact that, rising US interest rate will make it harder to service the huge debt pile that the US government has accumulated. To compensate for the increase in risk, 10-year US government bond yield has already increased by 58 basis points to 2.99 percent.
All these factors have resulted in increased yield of not just the US treasury bills and bonds but also other government bonds around the world. The effects also spilled over to Singapore, with the 10-year Singapore government bond yield rising significantly by 58 basis points to 2.58 percent.
Pricing Power For Corporate Loans
In the US, investment grade corporate bonds has seen an increase in yield of 77 basis points to 4.02 percent while junk grade bonds saw an increase in yield of 63 basis points to 6.35 percent. That said, rising yield for corporate bonds give the banks more pricing power for corporate loans.
Rising SIBOR And SOR
Widespread expectation that the Fed will accelerate hiking US interest rate will keep the US Dollar buoyant.
As witnessed in 2H14 and 2015, the rise in strength of the US Dollar is usually a booster for higher swap offer rate, which has a positive knock-on impact on Singapore Interbank Offer Rate (SIBOR). This would augur well for domestic interest rates and hence for the credit rate spread for banks.
Which Bank Stocks To Buy?
DBS Group Holdings’ (DBS) management has expressed confidence that it will achieve a return on equity of 12.5 percent for this year. It is also trading at an “attractive dividend yield of 4.2 percent based on dividend per share of $1.20 for 2018” according to UOB Kay Hian.
UOB Kay Hian has a buy call on the stock with a target price of $35.50. DBS is changing hands at $26.99.
Apart from rising interest rate spread, Oversea-Chinese Banking Corporation (OCBC) is also expected to receive a booster from its divestment of Great Eastern Life Malaysia, after the latter’s IPO this year. OCBC stands to see a divestment gain of $608 million which will boost the bank’s performance, albeit in a one-off manner. The bank is also waiting for regulatory clearance from Hong Kong for it to divest its stake in Hong Kong Life Insurance for the equivalent of $425.9 million this year.
UOBKH has a buy call on OCBC and a target price of $16.50. OCBC is now trading at $11.78 per share.