JP Morgan has downgraded DBS Group Holdings to “neutral” with an unchanged target price of $37 as it sees the group’s future earnings growth already priced in.

According to analyst Harsh Wardhan Modi, JP Morgan’s global economics team is anticipating a US recession in 2023, which has implications for growth in Asia.

“A probability-weighted outcome of growth/asset quality disappointment is priced in, but not enough, in our view,” says Modi.

As current accounts and savings account (CASA) depositors switch to fixed deposits, DBS’s higher cost of funds should increase faster than the street’s expectations, Modi reckons, and this may imply that net interest margin (NIM) expansion may be limited next year.

While the rate hike cycle may peak in 1Q2023, the elevated rates may increase the probability of asset quality risks. During a 3QFY2022 results briefing, DBS Group's CEO Piyush Gupta guided for credit costs of around 20 basis points in FY2023.

As a result, Modi says that DBS’s current valuation including its 1.7x price-to-book (P/B) ratio, and return on equity (ROE) expectations of 14% to 15% for FY2023 to FY2024 are priced in, as risks of a US recession become increasingly likely.

Accordingly, the analyst expects the stock to “stall”.

In the year-to-date, the bank has seen a positive increase in rates for the FY2022 to FY2024, which is led largely by NIM and rising net interest income.

“DBS is one of the most rate-sensitive banks in the region, due to [its] 94% Singapore dollar (SGD) CASA (66% all currency),” Modi writes. “However, NIM impact is likely to be weaker from here, as [its] COF is likely to shift higher. We expect NIM of 2.18% in FY2023.”

He adds that DBS’s returns in the next 12 to 18 months would be led largely by its dividend yield at 7% to 8% for the FY2023 to FY2024 and at its book value compound annual growth rate (CAGR) of 5%

“We do not expect a re-rating in the near term. If the bank is able to navigate the asset quality cycle well (which stays our base case), then the stock should meaningfully re-rate in FY2024-FY2025. Accordingly, we recommend investors to reduce [their] position, but stay invested,” he says.

Despite the downgrade, Modi notes that DBS has been “one of the best turnaround cases” in the region in the last decade.

“Most of the improvements were visible on the pre-provision operating profit (PPoP) line (better asset and liability management, lower fees volatility, treasury, wealth management, digital, branding, etc.) till FY2015-FY2016,” he says.

“The bank’s handling of asset quality in FY2020-FY2021 opens up the path for the stock to become part of core multi-decade portfolios, in our view,” he adds.

That said, among the Singapore banks, UOB remains Modi’s top pick based on valuations.

The analyst is keeping his “overweight” call on UOB as the stock offers value at 8.6x and 8.8x of its FY2023 and FY2024 P/E respectively and its FY2023 and FY2024 P/B of 1.10x and 1.03x respectively, along with its yield of 5.6%.

The Citi acquisition should at some 14 basis points to UOB’s full-year NIM, although it comes with higher asset quality risk, he points out.

On this, he expects to see “steady positive revisions” at UOB in the next six months, allowing for re-rating.

“[UOB’s] 4QFY2022 results will likely be messy, with integration costs, one-time adjustments and re-statements. Yet, clear FY2023 guidance and payout of close to 50% should be a positive for the stock,” he says.