Banks - CIMB Research 2016-02-23: Asset quality takes centre stage

Banks - CIMB Research 2016-02-23: Asset quality takes centre stage Singapore Banks DBS GROUP HOLDINGS LTD D05.SI  OVERSEA-CHINESE BANKING CORP O39.SI  UNITED OVERSEAS BANK LTD U11.SI 

Banks - Asset quality takes centre stage 

  • The banks’ 4Q15 results season centered on asset quality concerns, with particular focus on exposure to the oil & gas and commodities sectors, as well as China. 
  • We are most concerned with the banks’ exposure to upstream oil & gas names – DBS: S$12bn (6% of loans), OCBC: S$5.8bn (6%), UOB: S$3.8bn (4%). 
  • Even with aggressive provision forecast of 44-60bp vs guidance of 32-40bp in 2016, our ROEs still exceed COE, hence banks should trade above current valuations. 
  • Maintain Overweight. Our order of preference remains OCBC, DBS, UOB. 

■ Asset quality concerns on oil & gas, commodities, and China 

  • 4Q15 centered on asset quality issues, with concerns on the banks’ exposures to oil & gas, commodities, and China. 
  • Commodities exposure is diversified across the banks, with DBS having exposure to coal and iron/steel, while OCBC’s exposure is to traders and UOB to traders, agribusiness and metals/mining. 
  • On China, we are concerned with the banks’ onshore lending. While lending is mainly to SOEs, the slowdown in the manufacturing sector is likely to lead to broad-based asset quality deterioration. 

■ Upstream oil & gas the key concern 

  • We are most worried about the upstream oil & gas sector, of which DBS has the biggest exposure at S$12bn (4% of loans), followed by OCBC at S$5.8bn (3%), and UOB at S$3.8bn (2%). OCBC is the most conservative, having recognised S$822m of oil & gas loans as NPLs in 2015. UOB is concerned with 20% of its oil & gas exposure (S$2bn), but has yet to recognise them as NPLs. We discount DBS’s view that it will not see asset quality worsen in this portfolio in 2016, and expect credit losses if oil prices remain low. 

■ Still no crisis, even with aggressive provisioning assumptions 

  • We factor in credit costs of 44-60bp in 2016, above the banks’ guidance of 32-40bp. Even with our more aggressive provisioning assumptions, we find that the banks are still able to deliver ROEs above their cost of equity. 
  • The banks also have high provisioning coverage ratios: OCBC stands out for having the highest cumulative provision coverage to unsecured NPAs at 417% (DBS: 303%, UOB: 293%). 
  • We think this will provide a strong buffer amid the worsening credit cycle. 

■ Slowing loan growth, but higher NIMs will support NII growth 

  • After a slow finish to the year, the banks are guiding for low single-digit loan growth in 2016 amid an economic slowdown and falling demand for trade loans, though bright spots include sustained demand for Singapore mortgages and improving prospects in Indonesia. 
  • The key to NII growth, however, would hinge on NIM expansion as we saw in 4Q15. We expect NIMs to improve in 2016 vs. 2015 on better customer loan spreads. 

■ Order of preference remains OCBC, DBS, UOB 

  • Maintain Overweight, with the view that current prices have factored in a more bearish scenario than we expect. 
  • Even with our aggressive provisioning assumptions above the banks’ guidance, we find that ROEs are still able to meet cost of equity. 

Valuation and recommendation 

DBS (Add, TP: S$18.26) 

  • We maintain our Add call on DBS, with a GGM-based target price of S$18.26 (1.08x CY16 P/BV). 
  • Our main grouse with DBS is its larger-than-peer exposure to the risky upstream oil & gas sector, yet it maintains the view that this sector is unlikely to face asset quality issues in 2016. 
  • DBS also has a larger exposure than the other two banks to onshore China lending, which makes it most susceptible to a slowdown in the industrial and manufacturing sectors in China. That said, our Add call is premised on the fact that valuations are the cheapest among the three Singapore banks at 0.8x CY16 P/BV, though ROEs are still able to meet cost of equity at our bearish loan loss provisioning assumptions in FY16. 
  • DBS also has the added engine of its bancassurance deal with Manulife, which will give a boost to fee income starting 2016.

OCBC (Add, TP: S$10.01) 

  • We maintain an Add call on OCBC, with a GGM-based target price of S$10.01 (1.16x CY16 P/BV). OCBC remains our sector top pick for its: 
    1. lowest NPL ratio among peers despite having more conservative policies, in our view, 
    2. highest cumulative provision coverage to unsecured NPAs, 
    3. fully-loaded CET1 ratio that is now above UOB’s, 
    4. half the upstream oil & gas exposure of DBS, and 
    5. undemanding valuation of 0.9x CY16 P/BV. 
  • As the credit cycle starts, we expect OCBC to outperform given its most diversified exposure to the problem sectors and proactive NPL recognition and provisioning policies.

UOB (Hold, TP: S$19.31) 

  • We maintain a Hold call on UOB, with a GGM-based target price of S$19.31 (1.06x CY16 P/BV). 
  • UOB remains our least preferred in the sector for its: 
    1. highest NPL ratio among the three banks, 
    2. lowest fully-loaded CET1 ratio, 
    3. biggest exposure to developing ASEAN struggling with the aftermath of a commodities rout, and 
    4. highest valuation among peers despite these concerns. 

Kenneth NG CFA CIMB Securities | Jessalynn CHEN CIMB Securities | http://research.itradecimb.com/ 2016-02-23
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