Singapore Banking - UOB Kay Hian 2016-05-19: Anaemic Growth But Balance Sheet Not At Risk

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OCBC OVERSEA-CHINESE BANKING CORP O39.SI  DBS GROUP HOLDINGS LTD D05.SI 

Singapore Banks - Anaemic Growth But Balance Sheet Not At Risk

• 1Q16 GDP growth moderated to 2% yoy with the slowdown extending into domestic-oriented sectors. 
• Loan growth is anaemic but NIM is stable. 
• Pressure on asset quality from the O&G sector is manageable. Our scenario analysis provides assurance that banks’ balance sheets would not be unduly impacted. 
• The recent pullback brought valuations to attractive levels at 0.89x 2016F P/B for DBS (1SD below long-term mean) and 0.98x for OCBC (almost 2SD below long-term mean).
• Maintain OVERWEIGHT.

WHAT'S NEW

Slow grind extends to domestic-oriented sectors. 

• Singapore’s GDP growth in 2015 was weighed down by contraction in the manufacturing sector (-5.2%) and non-oil domestic exports (-0.1%). 
• Investment spending from developed economies has been weak since the global financial crisis (GFC). 
• Locally, multinational companies have also scaled down their domestic operations. 
• Slower growth in manufacturing in China has affected demand for intermediate goods produced in Singapore. The slowdown in trade flows has also reduced sea cargo handled by 3.5% qoq in 4Q15.

The slowdown has broadened to the domestic economy. 

• Firms have started to consolidate their operations due to softening of business expectations in 1H16. There has been an up-tick in redundancies to 4,850 in 4Q15 and 4,000 in 1Q16 although unemployment rate remains stable at 1.9% on a seasonally adjusted basis. 
• Weak consumer confidence and cutback in discretionary spending has started to affect consumer-facing retail services. Advance estimates indicate that the economy expanded by 2% yoy but stagnated on a qoq basis in 1Q16.

Anaemic loan growth likely to persist. 

• Loans to businesses have contracted 4.2% yoy in Mar 16. A 15.1% loan growth to the building & construction sector could not offset the drastic 22.8% decline from general commerce. This was cushioned by a mild 1.9% yoy growth in loans to consumers, driven mainly by a 3.5% expansion in housing loans.
• Banks are affected by lower US$ lending, which contracted 11.3% yoy for DBS and 13.8% yoy for OCBC. We estimate trade loans to have declined by a further 11% and 22% qoq for DBS and OCBC respectively in 1Q16. 
• Demand for trade loans has fallen due to the narrowing of interest rate differential between onshore and offshore renminbi. The spread was negative in 4Q15 and 1Q16 but has normalised back to positive since mid-March, which augurs well for a recovery in trade loans in 2Q16.

Firmer NIM a positive. 

• The 3-month SIBOR and SOR have stabilised at 1% and 0.9% respectively post a change in the MAS’ exchange rate policy to zero appreciation. UOB Global Economics & Markets Research forecasts the 3-month SIBOR and SOR would reach 1.5% and 1.7% respectively by end-16. 
• Further upward moves in interest rates would be triggered by two rate hikes by US Fed anticipated in 2H16. 
• We are reluctant to build in expectations of further NIM expansion as realisation of upcoming rate hikes in the US is highly uncertain. Nevertheless, NIM would still be higher than in 2015.

Single-digit growth in fee income. 

• Wealth management fees have fallen 15-25% yoy due to heightened risk aversion in 1Q16. DBS was the exception with wealth management fees growing 5.4% yoy, boosted by its bancassurance partnership with ManuLife. 
• Contributions from market-sensitive sources, such as brokerage and investment banking, have been subdued. Fees have become more diversified with increased contributions from credit cards, service charges and loan-related fees.

Headwinds on asset quality. 

• NPLs have shown more significant up-tick since 2H15, although the deterioration in NPL ratio is small at 0.2ppt for both DBS and UOB. The up- tick is more sizeable at 0.4ppt for OCBC but its NPL ratio at 1.0% is similar to DBS’ but lower than UOB’s 1.4%. The hit on asset quality arose mainly from the oil & gas (O&G) sector. DBS and OCBC have larger exposure to the sector at 6.2% and 6% of total loans respectively. OCBC approaches customers to re-negotiate lending terms to ensure that vessels continue to be chartered and deployed. It was more affected with a NPL ratio of 16% for the offshore support services segment.
• Overseas, both OCBC and UOB experienced pressure on asset quality in Indonesia. OCBC saw a slight pick-up in NPLs from Malaysia.
• While there are many headline concerns over sustainability of economic expansion, asset quality for loans extended to companies in China remains resilient. Singapore banks focus on trade finance and cross-border investment loans, targeting mainly state- owned enterprises and large corporations. DBS’ and OCBC’s NPL ratios for China are very low at 0.6% and 0.4% respectively.

Scenario analysis. 

• We have worked out our best and worst case scenarios for asset quality. Our base case scenario assumes:
  1. NPL ratio of 20% for loans to offshore support services (best: 10%, worst: 40%).
  2. NPL ratio for loans to Malaysia increases to 4% (best: 3%, worst: 6%).
  3. NPL ratio for loans to Indonesia increases to 4.5% (best: 3%, worst: 7.5%).
  4. NPL ratio for loans to Mainland China increases to 2% (best: 1%, worst: 4%).

ACTION

• Cautiously optimistic. Banks’ share prices have receded post announcement of their 1Q16 results. Valuations are appealing at 0.89x 2016F P/B for DBS (more than 1SD below long-term mean) and 0.98x 2016F P/B for OCBC (almost 2SD below long-term mean). 
• Downside is limited to 25% for DBS and 15% for OCBC as they trade near trough levels seen during the GFC at 0.67x and 0.83x. DBS and OCBC also provide attractive dividend yields of 4.0% and 4.3% 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.

DBS Group Holdings (BUY/S$15.07/Target: S$19.30).

• DBS is less susceptible to withdrawal of liquidity after US Fed hikes interest rates as the developed markets in Singapore and Hong Kong account for 84% of total income.
• Our target price of S$19.30 is based on 1.14x P/B, derived from the Gordon Growth Model (ROE: 9.4%, COE: 8.3%, beta: 1.1x, growth: 0.5%).

Oversea-Chinese Banking Corp (BUY/S$8.45/Target: S$10.88).

• Management is conservative and proactive in managing its exposure to the O&G sector. It has restructured S$895m of loans extended to the sector and recognised them as NPLs. We estimate current NPL ratio for the O&G sector at 7.2%.
• Our target price of S$10.86 is based on 1.26x P/B, derived from the Gordon Growth Model (ROE: 9.7%, COE: 7.8%, beta: 1.0x, growth: 0.5%).

United Overseas Bank (NOT RATED/S$17.97).

• UOB has the least exposure to the O&G sector. Loans extended to the sector amounted to S$8.9b, compared with DBS’ S$17b and OCBC’s 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 massive correction. DBS is trading at 0.89x 2016F P/B (GFC: 0.67x) and OCBC at 0.98x 2016F P/B (GFC: 0.83x). Thus, downside is limited as valuations are near the GFC trough levels.

ASSUMPTION CHANGES

• We maintain our earnings forecasts.

RISKS

• Further economic slowdown and political risks in regional countries.

PEER COMPARISON

Jonathan Koh CFA UOB Kay Hian | http://research.uobkayhian.com/ 2016-05-19

UOB Kay Hian SGX Stock Analyst Report BUY Maintain BUY 10.88 Down 10.98

BUY Maintain BUY 19.30 Up 19.22