There’s a palpable feeling of optimism in the air.
The dark clouds that once swirled around the global economy have begun to dissipate, allowing a ray of sunshine to creep through.
As more countries see their COVID-19 vaccination rates climb, the recovery should gather even more steam.
Amid this backdrop, our local banks, namely DBS Group (SGX: D05), United Overseas Bank Ltd (SGX: U11), or UOB, and OCBC Ltd (SGX: O39), have seen their share prices rise on this optimism.
All three banks are edging close to their 52-week highs, with DBS at S$31.37, UOB at S$26.88, and OCBC hitting the S$12 mark.
Although sentiment remains ebullient, investors may be wondering if the banks’ share prices have run ahead of their fundamentals.
Could the pandemic still throw curveballs at these lenders?
Or are the banks worthy of purchase even at current valuations?
Rising interest rates
Both the US and UK are poised to raise interest rates soon.
Inflation has been rearing its ugly head, thus forcing central banks in the two countries to act sooner rather than later.
The prospect of higher rates may dampen corporate spending as debt becomes more expensive.
However, banks will benefit as they are now able to lend at higher rates while keeping deposit rates lower for longer.
Net interest margins (NIMs) appear to have bottomed out in the second quarter of 2021 (2Q2021) and should be poised to rise in the coming quarters.
There’s also a silver lining to rising inflation — it signals that the nascent recovery is gaining momentum.
With higher demand for goods and services and increased consumer spending, businesses should also enjoy higher profits and cash flows.
The combination of all this means that the propensity for businesses to borrow should also increase in tandem, offsetting the effect of higher rates.
The economic engine stirs
This brings us to our next point — as the economic climate improves, more businesses will be willing to borrow to fund their expansion plans.
Banks make money not just by lending at higher rates, but also by growing their loan books.
All three banks reported a year on year increase in their loan books for 2Q2021.
This growth should continue as businesses enjoy a fillip and are more willing to commit to acquisitions or organic growth.
Expect to see the banks report healthy year on year loan growth for the third quarter and beyond unless there is an adverse shift in the pandemic’s trajectory.
A reduction in bad loans
Yet another benefit of rising economic sentiment is that businesses face less stress in servicing their existing loans.
This positive development translates to less bad debts on banks’ books, resulting in lower levels of allowances made.
In fact, DBS has already reversed some of its prior allowances as conditions improve.
A closely-watched financial metric is the non-performing loans (NPL) ratio.
This ratio measures the proportion of a bank’s loans that are deemed bad and irrecoverable.
NPL ratios are expected to remain stable or even improve slightly as businesses receive a breath of fresh air.
That said, more loan moratoriums may also be set to expire soon.
This is an aspect that needs to be watched closely as these moratoriums may understate the true extent of their client’s financial woes.
The central bank had, in June this year, provided extended support to industries that continued to be adversely impacted by the pandemic.
These businesses may take more time to transition to full loan repayments.
Views from the head honchos
The CEOs of the banks have alluded to the better conditions in the last quarter.
Their views are important as they have eyes and ears on the ground and can gather insights as to whether businesses are prospering or struggling.
Their sanguine assessment gives hope that the recovery is truly in full swing.
Investors can then look forward to more good news as all three banks embark on strategic initiatives to grow their business.
Get Smart: New 52-week highs possible
There’s a lot to look forward to when the three banks report their earnings in early November.
Interest rates are poised to rise while economic activity is picking up.
Should the banks report higher earnings, their share prices may continue to scale new heights.
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Disclaimer: Royston Yang owns shares of DBS Group.