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Morningstar | U.S. Fed More Dovish on Future Rate Hike; Prefer HSBC, OCBC, and BOCHK in Our Asia Bank Coverage

With the U.S. Federal Open Market Committee unanimously voting to maintain its target rate range at 2.25%-2.5% in its first official meeting of 2019, our U.S. team has assumed no interest rate hikes in 2019 and a single rate hike in mid-2020. The more dovish tone adopted by the Fed will see a slower increase in net interest margin for Hong Kong- and Singapore-based banks under our coverage. We continue to expect net interest margin to increase in 2019, albeit at a more tepid pace as loans are progressively repriced. Interbank rates in Singapore remain above last year’s level while interbank rates in Hong Kong declined materially in early 2019. The former should translate into greater margin improvement for the Singapore banks. With lower interbank rates in Hong Kong, banks with lower market share in deposit costs and more reliant on interbank borrowing may benefit, and this may translate into increased competition on margins. We leave our fair value estimates unchanged ahead of the Singapore banks' fourth-quarter results and Hong Kong banks' second-half results.

Within our Hong Kong bank coverage, our preference is narrow-moat-rated BOC Hong Kong, as we believe the risk to the bank’s expansion into Southeast Asia is priced into the stock's 23% discount to our fair value estimate. Narrow-moat OCBC remains our preferred pick for the Singapore banks as we expect the bank’s sizable wealth-management operation to underpin fee income growth. For two global banks with exposure to the Asia region, we prefer narrow-moat-rated HSBC over Standard Chartered, given the former’s higher level of profitability.

We expect banks in both regions to report slower loan growth. As expected, system loan growth has slowed, and we expect low- to mid-single-digit growth in 2019. In Hong Kong, system loan growth was 4.4% in 2018, mainly attributable to slower growth in trade loans and loans for use outside Hong Kong. The latter was up 2.1% compared with a high of 5.4% year to July. The slowdown in the second half was anticipated as business confidence faded on increased concerns about trade tensions between the U.S. and China. The residential real estate market also weakened in the second half of 2018, and before the Fed’s policy statement, we expected weakness to continue in 2019. However, a more dovish tone by the Fed will likely see a recovery in fixed-asset prices, including residential real estate markets in both transaction volume and prices. While we continue to see no change in the underlying fundamentals of the real estate market and affordability remaining an issue, favorable financing schemes offered by the developers see borrowers bypassing minimum loan/value limits and debt-service tests mandated by the Hong Kong Monetary Authority. In Singapore, preliminary data from the Monetary Authority of Singapore showed 3% loan growth for 2018 with stronger business loan growth of 4.1% offsetting slower consumer loan growth of 1.5%. The latter was expected and is mainly attributable to weaker mortgage growth, as tightening measures by MAS in July last year translated into a decline in transaction volume.

Fee and commission income are also expected to be weaker in the fourth quarter as more subdued investor sentiment saw lower equity turnover on both stock exchanges. Average daily equity turnover on the Singapore Exchange declined to below SGD 1 billion in the quarter, or 10% lower against last quarter and 14% against the same period last year. Similarly, equity turnover on the Hong Kong Stock Exchange fell 12% against the third quarter and 20% lower compared with the fourth quarter last year. We expect weaker equity turnover to translate into lower brokerage fees and demand for wealth-management products.

With regional economies remaining strong, we expect asset quality in general to be resilient, consistent with previous quarters this year. However, there will be some uptick in credit costs in the fourth quarter, given the extraordinary low level earlier this year. If the interest-rate environment persists at current low levels in 2019, we expect the level of nonperforming loans to remain benign, along with overall credit costs. However, our conservative forecasts have factored in steady increase in credit costs. Furthermore, a prudent level of provisioning is supported by well-capitalized and highly liquid balance sheets for the Asian banks.