Singapore Banking - UOB Kay Hian 2016-04-07: Back From The Brink

Singapore Banking - UOB Kay Hian 2016-04-07: Back From The Brink OCBC OVERSEA-CHINESE BANKING CORP O39.SI  DBS GROUP HOLDINGS LTD D05.SI 

Banking – Singapore: Back From The Brink

  • Systemic risks appear to have receded as threat from a massive devaluation of the renminbi has diminished and prices of crude oil have rebounded. 
  • Spreads for credit default swaps for Singapore banks have pulled back. 
  • We re-calibrate our NPL estimates from a bottom-up basis and restore our 2016 net profit forecasts for DBS by 31% and for OCBC by 18%. 
  • Valuations remain depressed and attractive at 0.89x 2016F P/B for DBS and 1.03x 2016F P/B for OCBC. 
  • Maintain OVERWEIGHT.


WHAT’S NEW


Crude oil prices have rebounded

  • Crude oil prices have rebounded by 58% to a high of US$41.45/bbl in March after hitting a bottom of US$26.20/bbl in February. However, a sustained recovery remains elusive and prices have slipped back to US$36.90/bbl currently.

IEA sees a turning point. 

  • The International Energy Agency (IEA) suggested crude oil prices could have “bottomed out” in its Oil Market Report dated 11 Mar 16. The biggest swing factor is non-OPEC production, which is starting to be affected by lower prices and past spending curbs. 
  • US production, driven by hydraulic fracturing of shale formations, is forecast to decline by 530kb/d, or 2.5% yoy, in 2016. 
  • The IEA has also downgraded the outlook for Brazil (corruption scandal) and Colombia (rebels’ attack on oil infrastructure). 
  • In total, non-OPEC production is expected to contract by 750kb/d, or 1.9% yoy, in 2016.
  • The gap between supply and demand is projected to narrow significantly from 1.9mb/d in 1Q16 and 1.5mb/d in 2Q16 to 0.2mb/d in both 3Q16 and 4Q16. However, the IEA is unsure if the desired balance in the oil market could be achieved in 2017.

 A 2-speed bond market. 


  • Bond yields for highly geared companies in the oil & gas (O&G) sector remain elevated. Yield to maturity (YTM) for Ezra (net debt/equity: 0.72x) and Swiber (net debt/equity: 1.53x) are extremely high at 13.8% and 53.4% respectively. 
  • On the other hand, diversified blue-chip conglomerates with a broader base of earnings and assets have seen their bond yields receding due to moderation in systemic risk. YTM for Keppel Corporation (net debt/equity: 0.51x) and Sembcorp Industries (net debt/equity: 0.63x) have eased to 3.2% and 4.7% respectively. 

 Bonds guaranteed by banks? 

  • DBS arranged Ezion’s S$120m 3.65% committed funding backed notes due 2020. UOB arranged Logindo’s S$50m 2.93% credit enhanced notes due 2020 (backed by standby letter of credit). The two bond issuances are, in a way, guaranteed and backed by DBS and UOB. We understand that Ezion and Logindo would have to pay for the committed funding and standby letter of credit. 
  • Our channel checks suggest that bonds with this feature are an exception rather than the norm in Singapore. 
  • Other than the two above instances, we are not aware of other bond issues from O&G companies structured in a similar fashion.


ACTION


 Back from the brink. 


  • Average spread for credit default swaps for Singapore banks has receded from recent peak of 180bp in February to the current 141bp. We believe systemic risk has moderated due to:
    1. Systemic risk that arises from speculation of a massive devaluation of the Chinese renminbi has diminished.
    2. Crude oil prices have bottomed and rebounded, easing the strain on banks’ exposure to the O&G sector.
  • Nevertheless, sentiment remains fragile due to slower global growth and geopolitical uncertainties over the outcome of a referendum on Brexit (23 May) and the US presidential election (8 November).

 Cautiously optimistic. 

  • Valuations are appealing at 0.89x P/B for DBS (more than 1SD below long-term mean) and 1.03x P/B for OCBC (almost 2SD below long-term mean). DBS and OCBC also provide attractive dividend yields of 4.0% and 4.1% respectively. We believe current share prices have factored in potential deterioration in asset quality from the O&G sector and impact of a broader slowdown in regional economies.
  • We re-examine the impact from the O&G sector and broader exposure to regional economies for Singapore banks.

DBS Group Holdings (BUY/S$15.03/Target: S$19.25).

  • We expect overall NPL ratio to increase from the current 0.9% to peak at 1.6% in 2Q17 (previously 2.8%), assuming:
    1. For exposure to the O&G sector, 20% of loans to offshore support services defaulted while 5% of loans to downstream customers defaulted.
    2. NPL ratio for loans to China increases from 0.6% to 2%.
  • We raise our net profit forecasts for DBS by 31% for 2016 and 20% for 2017.
  • DBS' fully loaded CET-1 CAR was 12.4% as of Dec 15, the highest among the three banks.
  • Our target price of S$19.25 is based on 1.14x P/B, derived from the Gordon Growth Model (ROE: 9.5%, COE: 8.3% (Beta: 1.1x) and Growth: 0.0%).

Oversea-Chinese Banking Corp (BUY/S$8.72/Target: S$10.68).

  • We expect overall NPL ratio to increase from the current 0.9% to peak at 1.6% in 2Q17 (previously 2.6%), assuming:
    1. For exposure to the O&G sector, 20% of loans to offshore support services defaulted while 5% of loans to downstream customers defaulted.
    2. NPL ratio for loans to China increases from 0.5% to 2%.
    3. NPL ratio for loans to Malaysia increases from 2.5% to 4%.
  • We raise our net profit forecasts for OCBC by 18% for 2016 and 10% for 2017.
  • Management is conservative and proactive in managing its exposure to the O&G sector. It has restructured S$822m of loans extended to the O&G sector and recognised them as NPLs. We estimate its current 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%.
  • Our target price of S$10.68 is based on 1.26x P/B, derived from the Gordon GrowthModel (ROE: 9.8%, COE: 7.8% (Beta: 1.0x) and Growth: 0.0%).

United Overseas Bank (NOT RATED/S$18.71).

  • UOB has the least exposure to the O&G sector. Loans extended to the O&G sector amounted to S$7.7b, compared with DBS’ S$17b and OCBC’s $12.4b.
  • 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.
  • Banks’ share prices have experienced a massive correction. But downside is limited as valuations are near the trough levels of the global financial crisis (GFC). DBS is trading at 0.89x 2016F P/B (GFC: 0.67x) and OCBC at 1.03x 2016F P/B (GFC: 0.83x).


ASSUMPTION CHANGES

  • Key changes to our earnings are as stated above.


RISKS

  • Further economic slowdown and political risks in regional countries.


PEER COMPARISON





Jonathan Koh CFA UOB Kay Hian | http://research.uobkayhian.com/ 2016-04-07
UOB Kay Hian SGX Stock Analyst Report BUY Maintain BUY 10.68 Up 9.98
BUY Maintain BUY 19.25 Up 17.48



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