Banks - CIMB Research 2016-11-02: Beware of the speed bump ahead

Banks - CIMB Research 2016-11-02: Beware of the speed bump ahead OCBC OVERSEA-CHINESE BANKING CORP O39.SI  DBS DBS GROUP HOLDINGS LTD D05.SI  UOB UNITED OVERSEAS BANK LTD U11.SI 

Banks - Beware of the speed bump ahead

  • The 3Q16 earnings season was characterised by higher NPLs and falling coverage ratios as more oil & gas loans turned sour, partially offset by higher non-NII.
  • UOB and DBS guided for new NPA formation to slow in 4Q, though SPs could remain elevated. Surprisingly, OCBC guided for the biggest upside in NPL ratio.
  • Despite the anticipated Fed hikes ahead, the impact on NIMs could be muted as the correlation between SIBOR/SOR and the Fed funds rate is no longer as tight.
  • Maintain Underweight, in view of a weak 4Q as provisions could remain elevated in a seasonally weak quarter. Our order of preference changes to DBS, UOB, OCBC.



Results overview 


DBS the true outperformer in 3Q 

  • On the headline, DBS’s and OCBC’s 3Q16 net profit outperformed expectations, while UOB’s was in line
  • However, OCBC’s earnings beat was largely driven by contributions from its insurance arm, GEH, which saw unrealised mark-to-market gains at its non-par fund on better performance in its bond and equity portfolios amid market volatility post-Brexit. Excluding GEH, OCBC’s core banking profit fell by 3% qoq and 8% yoy. 
  • We view DBS as the only bank to recognise quality earnings beat in 3Q, as impressive efforts to control costs and broad-based non-NII growth more than offset lower NII and higher provisions. 
  • UOB outperformed on the NII line as we expected, as it was the only bank to see NIM expansion on lower funding cost, but this took a back seat as concerns centered on worsening asset quality from oil & gas and falling coverage ratios across the three banks.

Update on oil & gas exposure 

  • Exposure to the oil & gas sector remained broadly flat to slightly down qoq. As at end-3Q, total exposure to the sector stood at S$20bn/S$14.1bn/S$13.2bn (US$14bn/US$10.1bn/US$9.5bn) for DBS/OCBC/UOB (2Q: S$23bn/S$14.3bn/ S$14.0bn). 
  • Loans to the upstream oil & gas sector were at S$6bn/S$5bn /S$4bn (2Q: S$6bn/S$6bn/S$4bn), representing 2% of loans (2Q: 2%/3%/2%). 
  • The bulk of new NPA formation in 3Q16 came from oil & gas – DBS: c.50% or c.S$500m, OCBC: 43% or S$230m, UOB: majority of S$780m.


Outlook and guidance 


Limited NIM upside in the near term; similar loan growth trends in 2017 as 2016 

  • DBS and UOB are on track to see mid-single digit loan growth in 2016, while OCBC could see low-single digit growth in constant currency terms. The banks have guided for similar figures in 2017, with loan growth mainly from funding corporates and funds’ overseas investments, and to a smaller extent, drawdown of mortgages. 
  • While the market consensus view is for a Fed rate hike in Dec and multiple hikes in 2017, the banks have been reluctant to guide for higher NIMs, as the correlation between the SIBOR/SOR and the Fed funds rate has lowered in recent times. The SIBOR/SOR has also continued to fall despite the recent pickup in US$ LIBOR with changes in money market rules.
  • DBS expects a further 4-5bp NIM downside in 4Q16, while OCBC and UOB expect NIMs to be flattish with an upward bias if the spread between SIBOR and SOR narrows, and if there is a Fed hike in Dec.

Higher NPL ratio in 2017 

  • DBS and UOB expect the worst of the oil & gas troubles to be over, as most of the vulnerable exposure they have identified earlier have either been classified as NPLs or they are in active conversations with the corporates to refinance the loans (i.e. extend the duration of the loans to be more in line with the useful life of the assets). DBS has guided for its NPL ratio to inch up but not exceed 1.4% in 4Q16 and 1.5% in 2017. UOB has guided for new NPA formation to return to the usual S$400m-500m level in 4Q16, close to half the level it saw in 3Q.
  • Meanwhile, though OCBC was the earliest to recognise oil & gas NPLs in 3Q15, it still expects more NPLs from the sector as troubles continue to deepen. As such, it has guided that its NPL ratio could go up to just below the 1.8% it saw during the GFC (3Q16: 1.2%), which translates into a potential S$1.3bn in net new NPLs.

Watchful of SME exposure 

  • Besides oil & gas, the banks are watchful of other areas of the book that could be affected in a protracted downturn. 
  • The common segment across all banks is the SME book, as SMEs have less savings and limited access to liquidity in times of need, thus they are most likely to be affected in a downturn. 
  • DBS has also seen some stress in other commodities including steel and coal, and some weakness in India and China. 
  • OCBC has been monitoring its exposure to retailers and F&B players as they are most likely to be affected when discretionary spending is cut, and it is also watchful of its exposure to small trading companies as it is seeing a slowdown in China and Malaysia. 
  • UOB is seeing some stress in high-end mortgages for those that have over-leveraged, though the mass segment is still performing well.


Valuation and recommendation 


DBS (Hold, TP: S$15.40) 

  • We rate DBS a Hold, with a GGM-based target price of S$15.40 (0.86x CY17 P/BV). 
  • DBS impressed with its ability to see broad-based non-NII growth and flexibility to control costs in a period where asset quality saw weakness and required high provisions. 
  • With its NPL ratio unlikely to rise above 1.5% in 2017, its diversified loan and fee income growth, early rollout of a digital banking strategy and ongoing efforts to rationalise costs and reap efficiency gains, DBS has multiple levers to maintain earnings resilience. 
  • While we expect its provisions to stay elevated in 4Q as collateral values of offshore vessels could be written down, we think that all three banks could see similar trends. DBS’s share price has also been the most punished among the three banks since the Swiber incident, and we see little risk of such an incident repeating as the remaining chunky vulnerable oil & gas exposure has already been classified as an NPL in 3Q and the required provisions made. 
  • We see the least downside to valuations at 0.84x CY17 P/BV. 
  • DBS now replaces UOB as our top pick for exposure to the Singapore banks.

OCBC (Reduce, TP: S$8.18) 

  • We rate OCBC a Reduce, with a GGM-based target price of S$8.18 (0.91x CY17 P/BV). 
  • While peers have guided for oil & gas NPA formation to slow starting 4Q, OCBC guides that the worst of the oil & gas sector is not yet over and that the NPL ratio could go up to just below the 1.8% it saw during the GFC (3Q: 1.2%). 
  • While OCBC has been viewed by the market as the most conservative and proactive bank, recognising performing loans as NPLs (60% of oil & gas NPLs are still performing, i.e. at least paying interest at commercial terms) could be punitive to NII (as interest collected from loans classified as NPLs are not recorded as NII), coverage ratios and ultimately ROEs in the near term, until recoveries are made on the loans. OCBC is also the least sanguine on its loan growth outlook at low single digits, and ex-GEH, its core banking trends remain weak. 
  • We think GEH’s outstanding performance in 3Q16 is unlikely to repeat as the unrealised mark-to-market gains at its non-par fund was largely a function of the quarter’s market movements. 
  • We expect OCBC’s net profit to be hardest hit by slowing topline growth and higher provisions.

UOB (Hold, TP: S$18.42) 

  • We rate UOB a Hold, with a GGM-based target price of S$18.42 (0.92x CY17 P/BV). 
  • UOB has built a decent banking franchise and established a firm footing in the financial institutions (FI) business which should help to bolster loan growth. It has also taken on the least duration risk among the three banks, which leaves upside for it to recognise NIM expansion by deploying liquidity into higher yielding assets. 
  • UOB’s management also seems most certain that the worst of its oil & gas troubles are behind it, with most of its vulnerable exposure already classified as NPLs in 3Q. However, UOB’s share price has done well over the past quarter and valuations are no longer the most compelling. 
  • Amid a protracted downturn, UOB’s largest exposure to the SME segment (20% of loans) could also be a cause of worry, though still premature at this stage. 
  • We suggest a rotation into DBS for exposure to the Singapore banks.







Jessalynn CHEN CIMB Research | http://research.itradecimb.com/ 2016-11-02
CIMB Securities SGX Stock Analyst Report REDUCE Maintain REDUCE 8.18 Same 8.18
HOLD Maintain HOLD 15.40 Same 15.40
HOLD Maintain HOLD 18.42 Same 18.42




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