OCBC
OVERSEA-CHINESE BANKING CORP
O39.SI
DBS GROUP HOLDINGS LTD
D05.SI
Banking – Reverse Engineering To Work Out Implied Impact On Asset Quality
- Our analysis based on reverse engineering indicates that current share prices of DBS and OCBC imply that their NPL ratios could hit 2.9% each by end-17.
- We conclude that banks’ P/B values are near GFC trough levels, which means that downside is limited.
- Share prices appear to have factored in a financial crisis of severity similar to the GFC.
- Valuations are compellingly attractive with OCBC’s and UOB’s P/B values more than 2SD below long-term means.
WHAT’S NEW
- DBS and OCBC have underperformed, correcting 21.3% and 15.3% respectively on a ytd basis compared with 11.9% for the FSSTI.
- Based on current share prices and P/B multiples, we have worked out the implied expectations for potential damage to asset quality for banks.
Our methodology:
- Step 1: We utilise the Gordon-Growth Model (GGM) to derive the implied 2016F ROE for banks based on prevailing 2016F P/Bs. In our analysis, we have assumed that:
- Growth is zero till perpetuity given concerns over the slowdown of global economic growth.
- Cost of equity (COE) at 7.8% as we gauge beta at 1.0x, risk-free rate at 2.8% and equity risk premium for Singapore at 5.0%.
- We assume that existing payout for regular dividends is maintained. We expect DBS to pay 60 S cents/share and OCBC to pay 36 S cents/share.
- PB = (ROE - g)/(COE - g). If g = 0, P/B = ROE/COE and implied ROE = P/B x COE.
- Investors might have been myopic and could have over-reacted. While the lower ROE is short-term and is expected to last for only two years (2016 and 2017), sentiments are so depressed and investors so disillusioned that they perceive the lower ROE would persist till perpetuity.
- Step 2: We calculate the implied 2016F net profit based on the implied 2016F ROE.
- Step 3: We calculate the credit costs (specific provisions) which could be incurred in 2016 based on the implied 2016 net profit.
- Step 4: We assume that the higher credit costs recur for two consecutive years (2016 and 2017) and the banks fully provide for the formation of new NPLs. Based on these assumptions, we work out the NPL ratio for two years later with the end period in 2017.
ACTION
Investors already factoring in the worst.
- Based on our analysis, investors have factored in NPL ratios rising to 2.9% for both DBS and OCBC.
- During the Global Financial Crisis (GFC), DBS’ NPL ratio peaked at 2.9% while OCBC’s peaked at 1.7%. Thus, current share prices for banks have already imputed a financial crisis of severity similar to the GFC.
Valuations at trough.
- We made three observations with regards to valuations of banks:
- Downside likely to be limited. Banks’ share prices have taken a heavy bashing and valuations are near trough levels seen during the GFC. Investors appear to have already factored in a financial crisis in banks’ share prices.
- OCBC and UOB clearly oversold. OCBC (-2SD: 0.97x) and UOB (-2SD: 0.97x) are trading at more than 2SD below long-term means based on historical bands for P/Bs.
- Valuations were undemanding prior to current correction. Banks were trading at lofty valuations with average P/B at 1.42x for DBS, 1.68x for OCBC and 1.8x for UOB during 1H08. It took a massive correction of 45-52% before banks’ share prices troughed in 1Q09.
- Unlike during the GFC, banks’ valuations were undemanding in 1H15 and it took a smaller correction to move banks’ share prices to trough levels.
DBS Group Holdings (BUY/S$13.14/Target:S$17.80)
- We forecast earnings for DBS to decline by 30% to S$3,101m for 2016 and recover by 12% to S$3,487m for 2017.
- We expect NPL ratio to peak at 2.8% in mid-17 compared with 1.0% at end-15. The deterioration in asset quality arises from exposure to the O&G sector and corporate loans across the region. We have factored in higher credit costs of 73bp for 2016 (previous: 26bp) and 66bp for 2017 (previous: 23bp).
- DBS trades at 2016F P/B of 0.81x (GFC: 0.67x) even after assuming deterioration in asset quality of a similar magnitude to that seen during the GFC. The stock provides an attractive dividend yield of 4.6%.
- Our target price of S$17.80 is based on 1.1x P/B, which is derived from the GordonGrowth Model (ROE: 8.6% (average of 2016F, 2017F and 2018F), COE: 7.8% and Growth: 0.0%).
Oversea-Chinese Banking Corp (BUY/S$7.45/Target:S$9.80)
- We forecast earnings for OCBC to decline by 23% to S$2,967m for 2016 and recover by 12% to S$3,312m for 2017. We expect NPL ratio to peak at 2.6% at mid-17 compared with 1.0% at end-15. The deterioration in asset quality arises from exposure to the O&G sector and corporate loans across the region. We have factored in higher credit costs of 68bp for 2016 (previous: 22bp) and 59bp for 2017 (previously: 19bp).
- OCBC trades at 2016F P/B of 0.91x (GFC: 0.83x) even after assuming deterioration in asset quality of a similar magnitude to that seen during the GFC. The stock provides an attractive dividend yield of 4.8%.
- Our target price of S$9.80 is based on 1.21x P/B, which is derived from the Gordon Growth Model (ROE: 9.4% (average of 2016F, 2017F and 2018F), COE: 7.8% and Growth: 0.0%).
United Overseas Bank (NOT RATED/S$17.50)
- UOB has the least exposure to the O&G sector. It is more resilient and well positioned to weather the current credit cycle.
SECTOR CATALYSTS
- Economic growth has slowed in both Southeast Asia and China.
- DBS is trading at 2016F P/B of 0.81x (GFC: 0.67x) and OCBC at 0.91x (GFC: 0.83x). Thus, downside is limited as valuations are near trough levels of the GFC.
ASSUMPTION CHANGES
- We maintain our existing earnings forecast for DBS and OCBC.
RISKS
- Further economic slowdown and political risks in regional countries.
PEER COMPARISON
Previous Report:
Singapore Banking - UOB Kay Hian 2016-02-04: Fear Factor Brings Valuations Near GFC Troughs
Jonathan Koh CFA
UOB Kay Hian
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http://research.uobkayhian.com/
2016-02-12
UOB Kay Hian
SGX Stock
Analyst Report
9.80
Same
9.80
17.80
Same
17.80
