UOB - DBS Research 2017-11-03: Wow After The Woe

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UNITED OVERSEAS BANK LTD U11.SI

UOB - Wow After The Woe

• 3Q17 results reaffirm our positive stance; NIM and loan growth were better than expected.
• Asset quality woes should see an end from here.
• Three critical factors to watch going forward:
  1. property market recovery,
  2. NIM improvement,
  3. end to its asset quality woes.
• Maintain BUY; TP lifted to S$27.50 after further positive earnings revisions on NIM and loan growth.

Reiterating positive signals; maintain BUY. 

• UOB’s 3Q17 earnings reaffirms our positive stance on the bank with NIM and loan growth picking up strongly, better than what we had expected.
• With probably the last leg in classifying NPLs from the oil & gas stress, we believe UOB should enter FY18 on a cleaner state. We reiterate our three catalysts for the stock:
  1. The property market recovery bodes well for UOB as it is perceived to be a proxy - UOB has the largest proportion of property-related loans vs peers; this should see loan growth improve as early as 3Q17.
  2. Imminent NIM improvement albeit backloaded; SIBOR/SOR finally edged up more visibly over the quarter which should see some repricing as early as 3Q17. The repricing effect typically takes approximately up to 90 days and as such, firmer NIM levels could be expected in 4Q17, spilling over to FY18.
  3. While asset quality concerns may still linger, the quantum of new NPLs (9M17 vs 9M16) has eased; the end to asset quality woes should warrant a re-rating, which we believe would be the case in FY18.

Where we differ. Staying above consensus. 

• Our earnings remain above consensus after our additional 2-4% FY17-19F earnings upgrade with a further boost to NIM and loan growth. Our TP is also at the higher end of consensus.

Potential catalyst: A better year ahead. 

• With asset quality issues largely dealt with by end FY17, we should expect a better year ahead. There would likely be another large NPL classification in 4Q17, this should mark the end of massive asset quality upsets.
• Further improvement in NIM and more importantly, a pickup in loan growth due to the recovery of the property market should support earnings strongly. 
• Separately, with the implementation of IFRS9, banks may no longer be able to continuously build up general provisions; this could pose upside risk to UOB’s FY18-19F earnings from its sticky 32-bp credit cost guidance.

Valuation

Maintain BUY, TP raised further to S$27.50. 

• Our revised TP of S$27.50 is based on the Gordon Growth Model (11% ROE, 4% growth and 9.5% cost of equity), equivalent to 1.3x FY18 P/BV, almost at its 10-year average P/BV multiple.

Key Risks to Our View

• Relapse in NIM and asset quality trends. A relapse in SIBOR movement could also pose risks to our NIM forecast. If NPL issues start to spread further from here, more specific provisions might be required.

WHAT’S NEW - Reaffirmed positive signals 

3Q17 results highlights:

Trumping expectations; better-than-expected NIM and loan growth in 3Q17. 

• UOB’s 3Q17 net profit came in at S$883m (+5% q-o-q, +12% y-o-y). Earnings were driven by strong top-line growth with improved NIM (+4bps q-o-q, +10bps yo-y) and strong loan growth (+3% q-o-q, +8% y-o-y). 
• YTD loan growth stood at 5.6%, ahead our FY17 forecast. The improved NIM arose from a combination of better loan pricing in Singapore as well as better utilisation of its excess funds, in which it has lengthened its portfolio duration.
• Deposits also grew strongly at 3% q-o-q, +7% y-o-y. Non-interest income was flat overall. Stronger fee income from loan-related fees and wealth management was offset by lower gains from investment securities. 
• Expenses were lower q-o-q but higher y-o-y from staff costs. Because of strong revenues, cost-to-income ratio eased to 43.5%.

Higher provisions and NPL, but expected. 

• Provisions were higher q-o-q and y-o-y. Specific provisions were 25% higher q-o-q although lower y-o-y while the bank continued to release general provisions. UOB articulated that its general allowance reserves of S$2.6bn is above the expected credit loss requirements under the new FRS109 which will take effect from 1 January 2018. 
• NPL ratio rose to 1.6%. New NPLs shot up to S$799m (2Q17: S$537m; 3Q16 S$424m), of which half was from the oil & gas sector, and within this, 90% of this was related to one large account. There was a small commodity-related account classified in Indonesia.
• UOB's oil & gas exposure stood at 5% of total loans as at end-3Q17. Loan loss coverage stood at 108%, highest among peers.

Strong capital levels. 

• Capital ratios stood firm with fully loaded CET1 ratio at 13.8% and Total CAR at 17.8%. No dividends were declared this quarter. 
• UOB saw its risk-weighted assets edge lower as a result of a recalibration of its foreign exchange risk. This was partially offset by a redemption of its old-style Tier-2 subordinated debt.

Mixed regional operations. 

• Regionally, its operations were mixed with its Malaysian operations showing a slight decline q-o-q from higher provisions, Thai operations were better, Indonesian operations were loss making mainly due to high provisions, while its Greater China operations were stable. Its Malaysian operations remain the second largest profit contributor after Singapore.

Outlook: 

A better year ahead. 

• With asset quality issues largely to be dealt with by end-FY17, we should expect a better year ahead. There would likely be another large NPL classification in 4Q17, but this should mark the end of massive asset quality upsets. Further improvement in NIM and more importantly, a pickup in loan growth due to the recovery of the property market should support earnings strongly.
• Separately, with the implementation of IFRS9, banks may no longer be able to continuously build up general provisions; this could pose upside risk to UOB’s FY18-19F earnings from its sticky 32-bp credit cost guidance.

Last leg of oil & gas stress; aggressive provisions made. 

• UOB had previously identified up to S$3.7bn vulnerable accounts within the oil & gas space. Of which, the bank is comfortable with > S$1bn of its portfolio as these are from the national oil majors. Another > S$1bn lies with 6-7 obligors which are all familiar names; of this, there is one more big name which needs to be classified and provided for in 4Q17. After this, the coast should be largely cleared. 
• A look at UOB’s special mention loans (SML) which are only disclosed once a year in the annual report.  As at end-2016, the SMLs had risen mainly from the oil & gas exposures. As most, if not all, of these have been classified as NPLs, the SML by end-2017 should be much lower. 
• Management reiterated that they are comfortable with the level of provisions they have made and taking into account the coverage/collateral (which the bank has marked down by 70-80%), the question now lies in how much more it would want to set aside (aggressively) ahead before the implementation of IFRS9/SFRS109 which will take effect from 1 January 2018.

Improved loan growth outlook but still cautious on NIM.

• UOB’s 9M17 YTD loan growth already stands at 5.6%. We are raising our FY17 loan growth forecast to 6.2%. Judging from the loan momentum, there is even a chance UOB could outpace this. Our FY18-19F loan growth forecasts is now tuned up to 6% per year from 5% in light of a better operating environment. 
• UOB operates almost purely like a commercial bank (less reliant on capital markets), and it would need to compete in the loan space more aggressively vs peers. 
• Similarly for its wealth management business, which unlike peers, UOB targets the mass affluent space. Although its private banking business is small, we believe UOB will still be able to grow comfortably in the wealth management space. With competition a key consideration, NIM uplift, although should be expected, may be dampened. Even then, 9M17 YTD NIM has done well. 
• We have lifted our NIM forecast a little more, expecting the bank to end FY17 at 1.77% (+6bps y-o-y). We expect NIM to rise by 3bps each in FY18 and FY19. With our revised NIM and loan growth forecasts, our FY17-19 earnings are raised by another 2-4%.

Considerations post IFRS9/SFRS109. 

• Although the Monetary Authority of Singapore (MAS) has released the proposed amendment to regulatory requirements pertaining to credit loss under the IFRS9/SFRS109, UOB is still assessing considerations in dealing with its excess general provisions reserves. The considerations include how much the bank will need going forward post IFRS9/SFRS109, whether it should take advantage of its excess reserves and bump up specific provisions and whether it should transfer the excess into P/L or keep it in retained earnings. There are also tax implications it will need to consider. 
• We gauge that the impact would be neutral to mildly positive to capital and P/L. There will be more clarity in the next 4Q/FY17 briefing.

Current high capital levels; what can be done. 

• UOB’s capital ratios are by far the highest vs peers now. It will have to be sustainable core earnings that will be the key consideration to pay higher dividends. UOB’s strong capital position enables it to compete aggressively to grow its top line. At this juncture, management has not finalised plans to deploy excess capital.

Hengfeng Bank disposal. 

• UOB announced on 26 October that it will be disposing its 12% stake in Hengfeng Bank (Evergrowing Bank). It is in exclusive talks with Shangdong Lucion Investment Holdings (Lucion). Lucion is wholly-owned by Shandong Provincial State-owned Assets Supervision and Administration Commission and Shandong Provincial Council for Social Security. 
• Talks are still at preliminary stages and it is too early to speculate on the potential pricing. It is however safe to say that if and when this transaction is completed, it will be mildly positive to capital given that this investment carries a high risk-weight in its assets.

Board changes. 

• UOB announced Board changes on 2 November as part of its ongoing renewal and succession plan.
• The Board of Directors has nominated Mr Wong Kan Seng to succeed incumbent Independent Non-Executive Chairman Mr Hsieh Fu Hua who will be retiring next year. UOB said Chairman Emeritus Dr Wee Cho Yaw will also retire from the UOB Board at the Bank’s Annual General Meeting in April 2018 after six decades. 
• Dr Wee, who turns 89 next January, will relinquish all his Board responsibilities next April. He will retain his Chairman Emeritus title and will also be appointed Honorary Adviser to the Board.

Valuation and recommendation 

Maintain BUY, TP raised further to S$27.50. 

• Our revised TP of S$27.50 is based on the Gordon Growth Model (11% ROE, 4% growth and 9.5% cost of equity), equivalent to 1.3x FY18 P/BV, almost at its 10-year average P/BV multiple.

Three catalysts to watch. 

• We reiterate our three catalysts for the stock:
  1. The property market recovery bodes well for UOB as it is perceived to be a proxy for the bank's share price movement. UOB has the largest proportion of property-related loans vs peers; this should see loan growth improve as early as 3Q17.
  2. Imminent NIM improvement albeit backloaded; SIBOR/SOR finally edged up more visibly over the quarter which should see some repricing as early as 3Q17. The repricing effect typically takes approximately up to 90 days and as such, firmer NIM levels could be expected in 4Q17, spilling over to FY18.
  3. While asset quality concerns may still linger, the quantum of new NPLs (9M17 vs 9M16) has eased; the end to asset quality woes should warrant a rerating, which we believe would be the case in FY18.

Sue Lin LIM DBS Vickers | Singapore Research Team DBS Vickers | http://www.dbsvickers.com/ 2017-11-03

DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 27.50 Up 26.900