Banks - With high expectations, it is easy to disappoint
- With valuations trading ahead on expected earnings recovery in CY17-18, the banks took the opportunity to take high SPs for oil & gas loans in 4Q16, which hurt ROEs.
- We are watchful of banks’ exposure to highly geared oil & gas names and SMEs.
- The Singapore SME NPL ratio has risen to 2.1%, a level not seen since GFC.
- The banks are trading at 1.1x CY17 P/BV, which implies ROE of 11% - a level only possible with zero oil & gas provisions, sharp rise in reference rates or chunky fees.
- Maintain Underweight. UOB replaces DBS as our top pick; OCBC is least preferred.
ROEs fell to 8-9% in 4Q16; UOB outperformed peers
- The common feature in the 4Q16 results was high specific provisions (SP) for oil & gas on new NPLs (DBS) and write-down of collateral values (OCBC, UOB). This brought ROEs down to 8-9%, levels not seen since the GFC.
- While 4Q16 results disappointed at DBS (-15% qoq, -9% yoy) and OCBC (-16% qoq, -18% yoy), UOB was the relative outperformer (-6% qoq, -11% yoy) on a S$311m general provision writeback, with coverage ratio still highest at 116% (DBS: 97%, OCBC: 100%).
Two key reasons why NIMs could remain subdued
- The confidence in 2-3 Fed rate hikes in 2017 has lifted the banks’ valuations on expected pass through to NIMs, but we beg to differ. We think NIMs could remain flattish yoy in 2017 as:
- Customer loan yields remain under pressure from competition for high quality lending to corporates and for mortgages.
- Movements in the USD/SGD are the key determinant of SIBOR/SOR; market expectations of a gradual 4% appreciation of the USD/SGD in 2017 could cap upside to S$ rates despite higher Fed funds rates.
Oil & gas – who could be next to go under?
- We are watchful of the banks’ exposure to oil & gas companies with:
- high net gearing,
- bonds due in 2017-18, and
- no ties to a larger conglomerate.
- These include Ausgroup (DBS), Ezra (DBS, OCBC, UOB), Nam Cheong (DBS) and Pacific Radiance (DBS, OCBC, UOB), whose total bank borrowings amount to S$2.3bn.
- While some of these names could already be in NPLs, provisions could remain high as their high debt/PP&E means recoverability of loans through collateral is low.
Keeping a close eye on Singapore SME asset quality
- A difficult revenue growth environment, expectations of lower profitability and rising interest rates could spell trouble for SME asset quality. SMEs form 14-20% of the banks’ loan books, with Singapore SMEs making up 7%.
- According to MAS data, the NPL ratio for loans to Singapore SMEs has risen to 2.1% in 1H16 (1H15: 1.3%), a level not seen since the GFC (2008: 2.6%, 2009: 1.9%).
- Our sensitivity analysis suggests that for every 1% pt rise in the Singapore SME NPL ratio, FY17F net profit would fall by 4-5%.
Provisions could remain high and put pressure on profits
- Recall that in 2016, DBS and UOB did large GP writebacks in periods when SPs were high. However, with GP/loans ratio at MAS’s minimum of 1% for DBS and OCBC, there is no room for further GP writebacks. Also, with the banks aiming to keep a coverage ratio floor of 100%, an equal amount of provisions would have to be made for every new NPL. The only exception is UOB which has GP/loans ratio at 1.2% and coverage ratio of 116%. These make us more comfortable in the face of worsening asset quality.
Maintain sector Underweight
- The sector is trading at 1.1x CY17 P/BV, though NIMs could see little upside and provisions could remain high, resulting in limited earnings growth and muted ROEs of 9- 10% in 2017.
- Current valuations imply a return of ROE to 11%, which is only possible with zero oil & gas provisions, a sharp rise in reference rates or chunky fees.
- Our order of preference changes to UOB, DBS, OCBC.
- Risks to our Underweight call include a spike in SIBOR/SOR and sustained near-term recovery in oil price above US$70/bbl.
DBS Group HOLD, TP S$17.66, S$18.82 close
- DBS tends to lag peers on seeing the impact of loan repricing on NIMs, which could lead to NIMs staying subdued in 1H17.
- What worries us is management sees weakness in another S$1.1bn of upstream oil & gas loans that have not been taken in as NPLs. Provisions could also remain high for oil & gas.
OCBC REDUCE, TP S$8.83, S$9.53 close
- OCBC has seen a sharp pickup in loans past due but not impaired in 2H16, which could be an indication of worsening asset quality to come.
- OCBC also lacks the general provision (GP) reserve buffer that its peers have, which means new provisions have to be made for every new NPL, directly hurting earnings.
United Overseas Bank HOLD, TP S$20.37, S$21.56 close
- UOB replaces DBS as our sector top pick, for its relatively safer disposition in the oil & gas sector following its large write-down of collateral values.
- Its highest allowance coverage ratio of 116% also lends most comfort and earnings protection amid deteriorating asset quality.