The local banks are riding high on interest rate hikes.
Singapore’s three banks have been enjoying a roaring good time.
The trio reported record net profits during the recent fiscal 2022’s third quarter (3Q2022) earnings.
United Overseas Bank Ltd (SGX: U11), or UOB, saw its net profit jump 34% year on year to S$1.4 billion.
DBS Group (SGX: D05), being the next to announce its earnings, posted arecord net profit of S$2.2 billion.
Not to be outdone, OCBC Ltd (SGX: O39) chalked up a net profit of S$1.6 billion for 3Q2022, the highest in its history.
Despite the stellar performance, the share prices of all three banks have yet to surpass their all-time highs.
Looking ahead, investors may be curious to know if the share prices for all three banks can scale new heights.
Let’s dig deeper to see if this could happen.
Not quite there yet
DBS is hovering at around S$35, around 6.7% off its all-time high of S$37.50.
UOB and OCBC are a bit further off from their record highs compared with Singapore’s largest lender.
OCBC is trading 8.9% below its record-high of S$13.54 while UOB’s share price is 9.2% lower than its all-time high of S$33.33.
Incidentally, these highs were all achieved earlier this year in February after news broke of the US Federal Reserve’s intention to raise interest rates to combat decades-high inflation.
Inflation in the US was already creeping higher back in April 2021 at 4.2%.
The gauge of consumer prices broke past 6% in October last year and hit 7.9% in February, prompting the central bank to make its first move to raise interest rates in March.
A wave of higher NIMs
To understand why the banks touched an all-time high earlier this year, it’s necessary to understand the impact of higher interest rates on their business.
Simply put, a rise in overall interest rates allows banks to loan out money at higher rates.
As it takes time for deposit rates to catch up, the banks will then benefit from higher net interest margins (NIMs).
We saw this phenomenon in 3Q2022.
OCBC took the trophy with a NIM of 2.06%, while DBS and UOB reported a NIM of 1.9% and 1.95%, respectively.
Note that these NIMs were significantly higher than a year ago when the average NIM across the three banks was just 1.5%.
All three banks have also quantified the effects of a higher NIM on their net interest income (NII).
For every percentage point increase in benchmark interest rates, DBS, UOB and OCBC will enjoy a 22.5%, 9.4% and 11.9% uplift to their 2021 NII, respectively.
The good news for the lenders is that the US Federal Reserve is not done yet.
It still plans to continue raising interest rates well into 2023, albeit at smaller magnitudes than the four consecutive “jumbo” hikes of 0.75 percentage points each.
Earnings to head higher
The consensus seems to be that the banks will continue reporting sparkling sets of financial numbers in tandem with the continued rise in interest rates.
DBS expects its NIM to reach 2.25% by the middle of next year while OCBC reported that its fourth-quarter NIM was already above 2.1%.
And as markets slowly recover from the wave of pessimism, fund flows should also start trickling in, benefitting the banks’ asset and wealth management arms.
Fee income could witness a rebound and help to further boost bank earnings as we head into 2023.
Macroeconomic risks to be wary of
Share prices have a habit of tracking business performance.
Therefore, should the three banks report higher profits in the quarters ahead, there is a good chance that their share prices could also charge ahead and surpass their previous all-time highs.
That said, it’s important to note that macroeconomic risks continue to lurk.
A recession could be on the cards and such an event will significantly crimp consumer demand, resulting in weaker or even negative loan growth.
High inflation also poses a challenge for many businesses as consumers tighten their wallets and spend less.
As companies face dwindling demand, they will also hold back from expanding their operations and delay adding capacity.
High interest rates are no help here, pushing companies to be more conservative rather than binging on debt.
There is a heightened risk of businesses facing financial difficulties.
Should this happen, the banks may have to increase their provisions to account for potential bad loans.
Investors need to balance the good with the bad and be prepared to monitor the banks to see how things pan out.