4 Considerations before Buying Banking Stocks August 28, 2017
Banking can be a risky business. This business is exposed to business cycles from various sectors. The oil price rout between June 2014 to January 2015 eventually forced our local banks to write off bad loans related to the distressed oil and gas sector. Stock prices of local banks tumbled more than 30% as a result of rising bad loans concerns. Ironically, bank stock prices recovered since then while crude oil price is still trading around US$50 per barrel. Stock prices of OCBC and DBS are hovering near their all-time high. Before you get bullish and want to invest your hard-earned money into bank stocks, here are some considerations for you:
1. Price Volatility
Volatility signifies risk. All 3 local banks have a beta of above 1, with DBS having the highest at 1.38, according to data from the Financial Times as of 21 Aug 17. In the case of DBS, every 1% market rise or fall is likely to result in a 1.38% fluctuation in DBS stock price. Given the price volatility, investors should demand a higher rate of return for their investments in local banks.
2. Loan Book Composition
The loan book composition can give investors a sense of the risk that banks are taking to generate interest income.
Based on 2Q17 financial statements
UOB is more Singapore-centric as Singapore-based loans account for more than 50% of their loan book. Housing loans exposure also ranked the highest amongst the local banks. All things being equal, it is reasonable to assume that UOB has the lowest loan default risk given Singapore’s stable political landscape and housing loans are typically secured by underlying properties. Of course, analysing the loan books is much more onerous than simply focusing on geographical & industry breakdowns. Limited information is available for public to conduct a detailed assessment of banks’ loan books.
3. Non-Performing Loan (NPL) Coverage Ratio
The NPL coverage ratio defines the allowance that banks set aside to cover their non-performing loans. Banks’ current earnings can be boosted by setting aside lesser allowances. As of 2Q17, all three banks showed a year-on-year increase in NPL.UOB had the highest NPL coverage of 113.9%. DBS and OCBC had lower NPL coverages of 100% and 101% respectively. Based on these figures, it is more likely for DBS and OCBC to set aside funds to improve their NPL coverages moving forward, which will eventually weigh on their expense ratio and net income.
4. Loan / Deposit Ratio (LDR)
All things being equal, banks with a higher LDR will generate higher net interest income. An investor will want the bank to grow its loans and deposits while keeping a healthy LDR (80% to 90% according to Forbes).
Based on 2Q17 financial statements
Combining the abovementioned considerations and traditional fundamental ratios (e.g. P/B, P/E) will give investors a better sense of the risks and potential rewards they are buying into. Generally, share prices of banks with higher risk profile tend to outperform in a positive economic environment and underperform during risk averse periods. Investors who want exposure to Singapore banking sector at lower volatility can consider buying into SPDR STI ETF (Stock quote: ES3) or Nikko AM STI ETF (Stock quote: G3B). These ETFs have more than 30% weightage in Singapore banking sector while offering diversification to other industries.
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About the author
Chiang Jin Liang
Jin Liang is currently providing dealing services to over 8000 trading accounts and is part of the POEMS Dealing, the core in-house dealing department of Phillip Securities Pte Ltd.
Jin Liang believes in applying both fundamental and technical analysis in equities investing. He likes companies that can grow their earnings, stay relevant in an ever-changing landscape and focus on investor relations. Jin Liang frequently conducts educational seminars with the objective of imparting financial knowledge to the general public.
Jin Liang holds a Bachelor Degree in Electrical Engineering from Nanyang Technological University (NTU) and passed Level II of the Chartered financial Analyst (CFA) exam.