Singapore Banking - UOB Kay Hian 2016-03-10: The Beginning Of The Return To Normalcy

Singapore Banking - UOB Kay Hian 2016-03-10: The Beginning Of The Return To Normalcy OCBC OVERSEA-CHINESE BANKING CORP O39.SI  DBS GROUP HOLDINGS LTD D05.SI 

Banking – Singapore The Beginning Of The Return To Normalcy 

  • Share prices of banks started correcting on 11 Aug 15 after the PBOC introduced a new market-oriented reference rate mechanism, which triggered the depreciation of the renminbi and concerns over competitive devaluation across ASEAN countries. 
  • Sentiments on banks should recover now that the renminbi is no longer under attack. 
  • Top picks are OCBC and DBS. Maintain OVERWEIGHT. 


WHAT’S NEW 


• Fear of competitive devaluation has largely played out. 

  • The correction of share prices of Singapore banks started on 11 Aug 15, the day Singaporeans returned to work after celebrating their 50th National Day. The renminbi depreciated 2.7% on that fateful day as the People’s Bank of China (PBOC) introduced a new regime to make the exchange rate more market-oriented. Its reference rate mechanism for the renminbi was changed to incorporate the previous day’s spot exchange rate, demand and supply in the foreign exchange market and changes in major currencies. 
  • Banks’ share prices were in the doldrums as investors feared the depreciation of renminbi would trigger competitive devaluation and dampen the outlook of manufacturing sectors across ASEAN countries. The situation has since changed. 

• China has strengthened control to stem capital outflows. 

  • China has stepped up administrative measures to control capital outflows. The State Administration of Foreign Exchange (SAFE) has instructed banks to ramp up checks and scrutiny on foreign exchange transactions to prevent illegitimate transfers. 
  • The amount of US dollars that individuals and companies could buy was curtailed. The process for foreign companies to remit profits back to their home countries was made more stringent and burdensome. 

• The PBOC has tightened the noose on currency speculators. 

  • It has instructed mainland banks to increase the interest rates for renminbi loans taken in Hong Kong. It also imposed a 20% cash deposit on the forward sale of the renminbi. 

• These efforts appear to be working. 

  • The speculative attack on the renminbi is effectively over: 
    1. the gap between exchange rates for offshore and onshore renminbi had closed in February; and 
    2. the drop in China’s foreign exchange reserve was only US$28.6b in February compared with US$99.5b in January. 
  • The PBOC could have already withdrawn from intervention in the foreign exchange market. 

• Rationale behind China’s capital outflows. 

  • According to a study by Robert McCauley and Chang Shu of Bank of International Settlements (BIS) entitled “Dollars and Renminbi Flowed Out Of China”, the recent capital outflows from China were a result of shrinkage of the offshore renminbi market and Chinese companies paying down their foreign currency debts. 
  • In 3Q15, China experienced capital outflows of US$163b. Three quarters of the outflows can be explained by the reduction of offshore renminbi (US$80b) and Chinese companies repaying foreign currency debts (US$41b). The study uses BIS’ international banking statistics reported by banks outside of China. 


ACTION 


Maintain OVERWEIGHT. 

  • Investors are currently overly pessimistic. We believe the current share prices for banks have already imputed a crisis of severity similar to the Global Financial Crisis (GFC). A crisis mentality is prevalent. 
  • The economy is headed for a cyclical slowdown. We expect loan growth to be anaemic at a low single-digit of 3% for 2016 and 5% for 2017. Singapore banks are well capitalised and would be able to weather the upcoming credit cycle without cash calls and any reduction in their usual dividend payout. 

DBS Group Holdings (BUY/S$15.23/Target: S$17.48) 

  • DBS’ share price has fallen 8.7% ytd, the most among the three banks. The stabilisation in the renminbi and recovery in prices of crude oil are positive for DBS. DBS' fully loaded CET-1 CAR is 12.4% as of Dec 15, the highest among the three banks. 
  • DBS trades at 2016F P/B of 0.93x (GFC: 0.67x) after assuming deterioration in asset quality of similar magnitude to the GFC. The stock provides a dividend yield of 3.9%. 
  • Our target price of S$17.48 is based on 2016F PB of 1.06x, which is derived from the Gordon Growth Model (ROE: 8.3% (average 2016F-18F), COE: 7.8% and Growth: 0%). 

Oversea-Chinese Banking Corp (BUY/S$8.73/Target: S$9.98) 

  • OCBC is the only banking counter that has outperformed FSSTI by 1.7% on a ytd basis. 
  • Management is conservative and proactive in managing its exposure to the Oil & Gas (O&G) sector. It has restructured S$822m of loans extended to the O&G sector and recognised them as NPLs. We estimate NPL ratio for the O&G sector at 6.6%. 
  • OCBC’s fully loaded CET-1 CAR has caught up with peers at 11.8%. 
  • OCBC trades at 2016F P/B of 1.04x (GFC: 0.83x) after assuming deterioration in asset quality of similar magnitude to the GFC. The stock provides a dividend yield of 4.1%. 
  • Our target price of S$9.98 is based on 2016F PB of 1.19x, which is derived from the Gordon Growth Model (ROE: 9.3% (average of 2016F-18F), COE: 7.8% and Growth: 0%). 

United Overseas Bank (NOT RATED/S$18.40) 

  • UOB has the least exposure to the O&G sector. Loans extended to the O&G sector amounted to S$8b, compared with DBS’ S$17b and OCBC’s $12b. 
  • UOB 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 0.93x (GFC: 0.67x) and OCBC at 1.04x (GFC: 0.83x). Thus, downside is limited as valuations are near trough levels of the GFC. 

ASSUMPTION CHANGES 

  • We maintain our earnings forecasts for DBS and OCBC. 

RISKS 

  • A further economic slowdown and political risks in regional countries.





Jonathan Koh CFA UOB Kay Hian | http://research.uobkayhian.com/ 2016-03-10
UOB Kay Hian SGX Stock Analyst Report BUY Maintain BUY 9.98 Same 9.98
BUY Maintain BUY 17.48 Same 17.48


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