Banks - CIMB Research 2016-10-18: Earnings decline could be manageable, for now

Banks - CIMB Research 2016-10-18: Earnings decline could be manageable, for now OCBC OVERSEA-CHINESE BANKING CORP O39.SI  DBS DBS GROUP HOLDINGS LTD D05.SI  UOB UNITED OVERSEAS BANK LTD U11.SI 

Banks - Earnings decline could be manageable, for now

  • Despite higher provisions as more oil & gas accounts turn into NPLs, we expect 3Q16 earnings decline to be manageable at 2-5% qoq.
  • NIMs could underperform as the SIBOR/SOR fell, cost of funds rose with new SEC rules and banks shored up liquidity ahead of a Fed hike.
  • Non-NII could be the only saving grace as client activity picked up and markets recovered post-Brexit. This could buffer the fund outflows from tax amnesty.
  • We remain Underweight on the Singapore banks, with worsening asset quality the key concern. Order of preference remains UOB, DBS, OCBC.

Trends we expect to see in 3Q16 

Customer loan yields to be squeezed by lower SIBOR/SOR 

  • For the period Jul-Sep, the 3-month Swap Offer Rate (SOR) fell 13.8bp to 0.672%, while the 3-month Singapore Interbank Offered Rate (SIBOR) fell 6.1bp to 0.872%. This continued the declining path of the SIBOR and SOR since Jan 2016, and is likely to put more pressure on customer loan yields as floating rate loans reprice to the lower benchmark rates. 
  • In 2Q16, DBS already saw a 7bp qoq fall in non-trade loan yields, OCBC saw 6bp decline and UOB had a 12bp decline. As loans typically take 3-6 months to reprice, the negative impact of the lower SIBOR and SOR on NIMs could stretch into 2017.

DBS could see more downside in NIMs 

  • Besides depressed asset yields, we think NIMs could also come under pressure from unforeseen higher funding costs and lower LDRs in 3Q. We saw two phenomena in 3Q: 
    1. global banks shored up liquidity in preparation of a Fed rate hike at year end, which drove up funding cost and could lead to lower LDRs. 
    2. The new US Securities and Exchange Commission (SEC) regulations on money market funds drove the LIBOR to new highs and also made commercial paper (CP) funding more expensive. 
  • We see these trends translating into lower NIMs especially for DBS as LDRs are the highest among the three banks and have more room to fall, while it is also more active in CP funding for its trade book. As a result, we think DBS’s NIM could come in below its initial guidance of 3-4bp contraction in 2H16. OCBC could also see some negative impact from these trends given that it is second behind DBS in trade finance, though its LDRs are already low and unlikely to fall much further.
  • On the other hand, we expect UOB to see relatively stable NIMs qoq, due to several factors: 
    1. it has consciously managed its cost of funds since Jun by running off expensive US$ deposits; 
    2. its non-loan yields have lagged behind peers, but it has worked to close the gap by deploying excess liquidity into higher yielding assets; 
    3. UOB has already taken a big hit on NIMs from the lower SIBOR/SOR in 2Q, so we see less downside to customer loan yields than peers in 3Q; and 
    4. UOB is less reliant on CP and interbank funding, thus we think the new SEC regulations are unlikely to have a meaningful impact.

Loan growth remains muted, largely driven by property 

  • Based on MAS data, total system loans were down 2% YTD as of Aug. Loan growth was dragged by a contraction in business loans, largely from the commerce, transport and manufacturing sectors. Property loans and mortgages continued to be the key growth drivers for domestic loans, and saw a steady increase in Jul-Aug. 
  • In China, tighter liquidity in the offshore market has led to widening of spreads between the SHIBOR and CNH HIBOR, which makes it more attractive for corporates to borrow onshore. We think this could result in further contraction in China trade loans, which will be more pronounced for OCBC given its lack of growth in other loans to buffer the downside, especially as it has turned more cautious in extending loans to unfamiliar customer segments. 
  • Our conversations with the banks suggest that loan demand returned in 3Q, driven by wholesale loans. We think they could be on track to meet their FY16 loan growth guidance of mid-single digit for DBS and UOB and very low-single digit for OCBC.

Impact of tax amnesty could be abated by client activity 

  • According to press reports, total assets declared by Indonesians in Singapore under the tax amnesty programme amounted to Rp760.8tr (US$58bn). Of this, only 12% or Rp87.9tr (US$7bn) was repatriated back to Indonesia. Based on the three banks’ combined wealth management AUM (DBS: US$75bn, OCBC: US$55bn, UOB: US$13bn), the repatriated funds form only 5% of AUM, while the actual figure should be smaller if the foreign private banks’ AUM are included. 
  • Furthermore, as the Indonesian subsidiaries of the three Singapore banks have been designated as “gateway banks” approved to receive incoming funds under the tax amnesty programme, we think it could help to buffer some of the wealth management fund outflows from the Singapore branches.
  • Outside of the tax amnesty programme, our channel checks suggest that client activity picked up in 3Q after Brexit, which should lead to a pickup in wealth management fees. Loan-related fees should also return for DBS and UOB with stronger loan demand in 2H16. Trading remains the wild card, as markets recovered in 3Q.

Further deterioration in asset quality, still from oil & gas 

  • We expect asset quality to worsen in 3Q16, still driven by new non-performing asset (NPA) formation in the oil & gas sector. As of 2Q16, we estimate that OCBC led the banks in NPL recognition for the upstream oil & gas book at c.15% NPL ratio, followed by UOB at c.12% and DBS at c.5%. We expect a pickup in NPLs and provisions in 2H16 as more corporates requested to restructure their debt and faced difficulty in meeting coupon payments on their bonds. These include Perisai, Ausgroup, Swissco and Marco Polo Marine.
  • Together with Swiber, the total debt of these companies represent c.14% of the three banks’ total exposure to the upstream oil & gas sector. We expect DBS to catch up with peers on NPL recognition for oil & gas in 2H16.

Earnings expectations 

DBS (Hold, TP: S$15.31) 

  • We expect DBS to report 3Q16 net profit of S$1,000m (-4.9% qoq, -6.2% yoy).
  • We think NII could be hurt by a sharp fall in NIM as it has yet to take a hit from lower customer loan yields with the lower SIBOR/SOR, while funding costs are likely to rise in 3Q with the spike in LIBOR and cost of CP funding. While the bank’s guidance was that the loan pipeline remains decent, loan growth is unlikely to be able to offset the impact of lower NIMs on NII. 
  • Management also guided that it was seeing weakness in c.S$1.4bn of exposure to the upstream oil & gas sector (includes one chunky exposure and other smaller exposures that could see contagion effects from Swiber); we think some of these could turn into NPLs in 2H16 as DBS catches up with OCBC and UOB on NPL recognition for the sector.

OCBC (Reduce, TP: S$8.11) 

  • We expect OCBC to report 3Q16 net profit of S$842m (-4.8% qoq, -6.6% yoy).
  • We think loan growth could remain challenging, as OCBC pulled back on lending to new customer segments. LDRs are also unlikely to improve as OCBC planned to hold on to excess liquidity. 
  • Together with NIM downside as floating rate loans repriced to the lower SIBOR/SOR, we expect some softness in NII qoq. We think provisions could more than double qoq to boost its coverage ratio, which now stands at 100%, the lowest among the three banks.
  • The key wild card for OCBC is its trading book and GEH’s non-par fund, which could see qoq improvement as markets recovered post-Brexit.

UOB (Hold, TP: S$18.52) 

  • We expect UOB’s 3Q16 net profit to come in at S$786m (-1.5% qoq, -8.3% yoy). 
  • We think it could see the most resilient NIM among peers, backed by efforts to run off expensive US$ deposits, deploy excess funds into higher yielding assets and steady loan growth from property and wholesale loans.
  • Coupled with steady loan growth, we think its NII could outperform peers in 3Q.
  • We expect fees to remain relatively robust, with a pickup in loan-related fees, while its wealth management arm continues to see encouraging AUM growth.
  • Our estimates have factored in higher provisions for oil & gas and some legacy loans, though still manageable and in line with management’s guidance of 32bp total provisions for the full year.

Valuation and recommendation 

Maintain Underweight 

  • We keep our Underweight call on the Singapore banks in view of worsening asset quality and challenged topline growth, which will result in a drag on ROEs over the medium term. 
  • While we expect 3Q earnings decline to be manageable at 2-5% qoq, we think the impact will be more pronounced in 4Q as provisions mount in a seasonally weak quarter. 
  • UOB remains our top pick for its lowest NIM downside, smallest exposure to a shrinking China trade book and smallest exposure to the problem oil & gas sector. 
  • OCBC remains our least preferred for its excess liquidity and lowest provision coverage ratio.

Jessalynn CHEN CIMB Research | http://research.itradecimb.com/ 2016-10-18
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