UOB - DBS Research 2016-10-28: Addressing asset quality issues

UNITED OVERSEAS BANK LTD U11.SI

UOB - Addressing asset quality issues

3Q16 earnings in line with ours, above consensus; net profit lower dented by provisions as expected.
Loan growth was strong; mid-single digit loan growth sustainable; tapping on regional opportunities.
Asset quality issues to be closely monitored.
Maintain HOLD, TP raised to S$18.10 as valuation base is shifted to 2017.

Near-term concerns still lie in exposure to the oil & gas sector.
Non-performing loans (NPL) classification had accelerated in 3Q16, with hopes of addressing most of the asset quality issues. UOB used its general provision reserve buffer to offset the specific provisions. The quantum of specific provisions should ease next year.
Separately, net interest margin (NIM) is expected to be flattish from here while loans growth is still targeted to be in the mid-single digit levels.
Non-interest income growth is expected to be muted.
Capital ratios have been strong but scrip dividends will continue to be a feature in view of the uncertain regulatory requirements.

UOB's 3Q16 earnings were dented by higher provisions, largely expected.
Specific provisions were higher and these were mostly related to the oil & gas sector as collateral values deteriorated. There was a transfer of general provisions to specific provisions this quarter, as such annualised credit cost stood at 32bps.
Loans grew strongly by 7% y-o-y; 2% q-o-q.
NIM rose by 1bps q-o-q albeit a steep decline of 8bps on a y-o-y basis as loan yields fell.
Non-interest income was lower due last year’s high base from a one-off gain from investment securities.
Expenses were well controlled with bulk of growth coming from IT-related costs.

Total credit costs are still guided at 32bps albeit a larger chunk skewed towards specific provisions. There is more than sufficient excess general allowances as a buffer to manage its credit costs with general allowance reserve-to-total loans at 1.4%, highest among peers, even after utilising part of it to offset specific provisions during the quarter.
Expect loan momentum to stay at mid-single digits and NIM to remain flattish from here.
Wildcard to NIM will depend on the US rate situation and SIBOR/SOR movements.

TP is raised to S$18.10 as we roll forward the valuation base to 2017.
Our TP is based on the Gordon Growth Model (11% ROE, 3% growth and 12% cost of equity), implying 0.9x FY17 BV, While UOB’s regional footprint in ASEAN is more complete vs peers, near-term headwinds faced in managing asset quality issues could hamper earnings growth and hence share price performance.

Further risk to asset quality. Prolonged weakness in oil prices could pose risks to 20% of its oil & gas exposure, potentially causing higher provisions and hence earnings risk.

LIM Sue Lin DBS Vickers | http://www.dbsvickers.com/ 2016-10-28

DBS Vickers SGX Stock Analyst Report HOLD Maintain HOLD 18.10 Up 17.700