Singapore Banks - Maybank Kim Eng 2017-08-22: A Clearer Path

Singapore Banks Comparison OVERSEA-CHINESE BANKING CORP O39.SI DBS GROUP HOLDINGS LTD D05.SI UNITED OVERSEAS BANK LTD U11.SI

Singapore Banks - A Clearer Path

More visibility ahead

For 2Q17/1H17, OCBC and UOB’s performance improved but DBS posted weaker results.
We revised our profit estimates for the banks by -2%- 5%/1%-10%/1%-11% for FY17-19E and also our Target Prices. (See report: DBS Group - Patience Is A Virtue; OCBC Bank - Risks On; United Overseas Bank - A Solid Franchise; Upgrade To BUY ).
For FY17-18E, we think loan growth momentum is likely to be sustained at 6-9% YoY and higher interest rates should improve NIMs slightly. Banks could also benefit from a risk-on environment to drive higher non-interest income.
UOB is now our preferred pick (previously DBS).

UOB upgraded to BUY on pricing discipline and sensitivity to re-pricing intervals

Although banks guided for mid-single digit loan growth in FY17, we are more optimistic and raised our FY17-19E loan growth assumption to 5-9% given:
1. sanguine economic prospects as the Singapore economy started to see benefits from trade-led growth recovery; and
2. improved buying sentiment in the Singapore property market (see Singapore Property and Housing Loans).
Customer spreads are now slightly higher at 1.96-2.14% across the banks, with UOB having the highest spread. We attribute this partly to UOB’s pricing strategy discipline in protecting against margin erosion from high-quality customers that tend to have lower-yielding margins.
We expect FY17-19E NIM to improve slightly from current levels of 1.68-1.77%/1.69-1.79%/1.70-1.82% on the back of higher rates.

O&G remains a drag

We kept our provision estimates at elevated levels given tail risks from exposure to the O&G sector (see report: Singapore Bank - Tail Risks from O&G). Our credit-cost assumptions are an average 29-34bps across the banks for FY17-19E. UOB is relatively better shielded than peers from further deterioration in the O&G sector as it has:
1. the lowest O&G exposure but higher specific provisions; and
2. highest provision coverage and general provision buffer.
Aside from O&G, we expect asset quality for the broader sectors to remain stable for the banks.

Our pecking order: UOB, DBS and OCBC

Post 2Q17 results season, we revised our valuation assumptions and rolled forward valuations to FY18 resulting in a 12-27% change in target prices. Our order of preference is as follows: UOB, DBS and OCBC.
We U/G UOB to BUY for its disciplined approach to its pricing strategy, sensitivity to re-pricing intervals, and lowest O&G exposure.
With limited upside to current share prices, retain HOLD for DBS and OCBC.
Upside risks are:
1. higher non-interest income; and
2. lower provisions;
downside risks are:
1. lower net interest income and
2. higher provisions.

1. More visibility ahead

Post-2Q17, we forecast ROEs to remain at current levels or trend higher into FY18-19E. Our assumptions are centered on the following:
- Lending opportunities: momentum likely to sustain into 2H17 and our loan growth expectations of 8-9% YoY are ahead of management’s guidance of mid-single digit growth for the year;
- Non-interest income (non-II): Could lift banks’ revenues as we expect buoyant market conditions into 2H17. Key drivers of non-II could come from wealth management (WM) fees and trading income. We think Singapore banks’ wealth franchise could benefit as Asia Pacific will be one of the fastest-growing regions for wealth. In addition, OCBC could stand to benefit from subsidiary Great Eastern’s (GE) higher contributions in favourable market conditions. GE’s non-operating profits surged 262% YoY in 1H17 to SGD118m (1H16: -SGD73m);
- Provisions: provisions from the O&G sector will remain elevated into FY17-18E, especially as industry dynamics deteriorate. However, we think UOB is ahead of peers in terms of provisioning. Despite having the lowest level of O&G exposure, UOB’s specific provisions of average gross loans loans remained high at 30bps, vs peers’ 19-39bps.
As such, we see earnings visibility ahead for Singapore banks, but more so for UOB. We upgraded UOB from HOLD to BUY at TP SGD26.40. We believe UOB has:
1. better pricing discipline and sensitivity to re-pricing intervals;
2. bigger scope to increase its trading book, if it is more willing to take on more risks as it repositions its trading capabilities;
3. ahead in its provisioning through pre-emptive classifications.

2. Loan growth: More optimistic for 2H

2.1 Lending momentum to sustain

In 2Q17, loans grew 6-11% YoY for Singapore banks, with OCBC posting a stronger growth than peers. Loan growth was generally broad-based across countries and industries. Loan growth from “Others” region (Australia, UK and US etc) rose 16-34% YoY, as companies continue to invest and expand their businesses in these countries. By sector, lending to Financial Institutions (FI) grew 22-39% YoY for OCBC and UOB.
We are now more optimistic on banks’ lending opportunities given the improved economic outlook. Singapore’s property market has seen some recovery due to improved buyer sentiment, and the domestic economy has also started to benefit from trade-led growth recovery.
We expect loan growth momentum to be sustained in 2H17. Our FY17-19E net loan growth is currently around 8-9% / 6%/ 5-6% YoY for Singapore banks. Banks continue to guide mid-single digit loan growth in FY17.

2.2 Loan growth in Singapore and around the region

Our economist forecasts Singapore’s 2017 GDP to grow 3%. Based on data stretching back to 2Q09, the multiplier between system loans growth and Singapore GDP growth was 2.0x on average, while the multiplier between banks’ loan growth in Singapore and GDP growth was 2.2x on average.
Banks’ loan growth in Singapore was 4-8% vs system loan growth of 6% YoY, with UOB and DBS’s growth trending slightly lower in 2Q17. This could be partly attributed to a slight decline in their housing loan growth, but Singapore banks’ growth was still faster at 4-7% YoY vs system’s 4%.
Recovery in Singapore’s property market will drive loan volumes. Margins, however, will stay tight in order to defend/gain market share. (See report: Singapore Banks - Singapore Property and Housing Loans.)
Close to 40-50% of Singapore banks’ loans are extended to both the housing and building and construction (B&C) sectors. As at 2Q17, banks’ B&C loan growth was faster than system, at 8-9% YoY vs system’s 4%.
According to our property analyst, the office supply pipeline in Singapore is likely to come down for FY18-20E. This implies that B&C loan growth coming from the Singapore office space is likely to be capped.
However, future loan growth for B&C lending could come from large infrastructure projects both in Singapore and around the region, such as the Tuas Terminal, the Kuala Lumpur-Singapore High Speed Rail, and China’s One Belt, One Road Initiative.

3. Interest rates: Modest NIM upside potential

In 2Q17, customer spreads improved or was maintained QoQ across the banks at 1.96-2.14% in 2Q17 (1Q17: 1.95-2.14%; 2Q16: 2.10-2.23%). UOB’s customer spreads were maintained at 2.14%, higher than peers’ 1.96- 2.03%. We believe this is attributed to its pricing discipline as it is now being selective on its customers ‘selective lending’ strategy to ensure no significant margin compression from high-quality customers, as these customers tend to have lower-yielding margins as they have lower credit risks.
MKE’s Singapore economist expects 3M SIBOR to be 1.20% in FY17E and 1.55% in FY18E. Based on our linear regression analysis, we tested the Fed Funds rate (independent variable) against the 3M SIBOR (dependent variable) from 1Q00-2Q17. For every 100bps increase in the Fed fund rate, 3M SIBOR and 3M SOR will increase by 44bps and 48bps respectively. This translates to a pass-through effect of 40-50%.
In our quantitative tests of Singapore banks’ NIM sensitivity through repricing interval, risk premium and yield curve, we ran two models on our customer NIM’s multi-step regression. In Model A, we regressed customer NIMs against SIBOR first, followed by credit risk and yield curve. In Model B, we regressed customer NIMs against credit risk first, followed by SIBOR and yield curve (see report: Singapore Banks - The NIM Enigma).
Assuming 30bps increase in SIBOR, credit spreads and interest differentials, our quantitative analysis show that UOB stands to benefit most in these scenarios.
On the back of a mild increase in interest rates for our base-case scenario of 20-25bps increase in SIBOR, we expect stable or slight improvement in NIM from current levels for FY17-18E across the banks, at 1.68-1.77% / 1.69-1.79% respectively. Both DBS and UOB’s are sensitive to re-pricing intervals, providing upside to NIM. However, competitive pressures will offset some of the re-pricing benefits.

4. Non-interest income: All have headroom

We expect non-interest income to increase by 4-15% / 3-6% / 4-6% for FY17-19E across the banks. We think the increases could come from wealth management (WM) fees and net trading income. We expect UOB to have bigger headroom to drive net trading income, if it is willing to take on more risks as it repositions its trading capabilities. For WM fees, we expect decent growth as Singapore banks built up their AUM quite substantially, with 5-years CAGRs of 11-23%, through organic and inorganic growth.
Non-interest income formed c.38-44% and c.35-44% of total income across the banks in 1H17 and 2Q17 respectively. In 1H17, non-interest income rose by 10-32% YoY, helped mainly by higher net fee and commission income (for DBS, OCBC and UOB), and net trading income (for OCBC and UOB).
Comparing 2Q17, non-interest income rose by 2-34% YoY for OCBC and UOB, but declined by 5% YoY for DBS. DBS’s underperformance in 2Q17 was mainly attributed to lower fee and commission income (+1% YoY) from lower investment banking fees, and lower net trading income (- 4% YoY).

4.1 Net trading income: a boost to profits

Over the years, DBS’s net trading income pulled ahead of peers. In 2016, its net trading income were almost 1.7x-2.5x higher than UOB and OCBC, thanks to its larger trading position, which contributed to larger gains.
Despite stronger capital markets in 1H17, DBS’s net trading income declined 9% YoY, in contrast to peers’ 12-22% increase. Notably, UOB’s value-at-risk (VAR) of its trading book had been trending higher since 2014. While the higher VAR seen in 2016 could partly reflect the uncertainties in the macro environment, UOB’s higher VAR contributed to higher trading gains.
Trading income CAGRs were 15–33% between 2011-2016 for the three banks, with UOB the strongest. We believe UOB has a bigger scope to increase its trading income as:
1. it is more conservative and has a lower risk appetite; and
2. it looks to reposition its trading capabilities.

4.2 WM fees: a key driver

Between 2016 to 2Q17, banks’ AUM grew decently by between 5-7%, thanks to their wealth franchise. Wealth management (WM) fees continued to drive revenue contribution, which grew by 24-43% YoY and 32-55% YoY across the banks in 2Q17 and 1H17 respectively.
In 1H17, WM fees formed 26-44% of total net fee and commission income across the banks. This was partly attributed to positive market sentiment as compared to a year ago.
DBS and OCBC are more aggressive in the WM space, partly through inorganic acquisitions.
- For DBS, if we remove the amortized quarterly contributions of SGD26.5m/quarter from the Manulife bancassurance partnership, WM fees grew by 37% YoY and 43% YoY in 1H17 and 2Q17 respectively.
- OCBC’s growth is more pronounced, as WM fees rose 56% YoY and 43% YoY in 1H17 and 2Q17 respectively, partly due to the acquisition of Barclays’ wealth and investment management business in Nov 2016.
WM is a prominent growth avenue for the banks, as Asia Pacific will be one of the fastest-growing regions for the WM space. We expect Singapore banks’ WM fees to be in double digit growth over FY17-18E.

5. Asset quality: O&G remains a drag

Singapore banks have ~1-3% of loan exposure to the O&G support services sector. Lending to this sector is on a downtrend, reflecting banks’ reduced risk appetite. The NPL ratio for support services was around 15-23% as at 2Q17.
Further deterioration in O&G industry dynamics would require higher specific provisions (SP). We maintain the view that provisions for O&G will remain elevated. We estimate credit costs of 29-34bps on average for Singapore banks between FY17-19E. For every 10bps increase in FY17E credit cost estimate, net profits will be reduced by 6-7%, ceteris paribus.
See Tail Risks from O&G.
Although UOB has the lowest exposure to O&G, its SP on loans were higher than peers between 3Q16-1Q17, thanks to its prudent provisioning approach to factor in the decline in collateral values. UOB’s provision coverage remained the highest at 113% vs peers’ 100-101% as at 2Q17.
UOB’s general provision (GP) buffer was also higher at 1.2%, vs peers’ 1.0- 1.1%. We are comforted that UOB will look to rebuild its GP buffer should SP on loans fall below 32bps. UOB is relatively more shielded than peers from any further deterioration in this space. We believe UOB is ahead of the curve in provisioning.

6. Maintain NEUTRAL; Top Pick UOB

We remain NEUTRAL on the Singapore banks sector. We value the banks at ~1.1-1.2x FY18E P/BV, as we roll forward our valuations to FY18E. This is slightly lower than their 10-year mean so as to reflect our lower forecast ROEs compared to prior periods.
We previously revised our estimates and target price for DBS in our 2Q17 results note (link: DBS). We also revised our estimates and target prices for UOB and OCBC. We upgrade UOB to BUY. With limited upside to current share prices, we retain our HOLD recommendations for DBS and OCBC.
We now prefer UOB (BUY, TP SGD26.40) for its disciplined approach to its pricing strategy, it’s sensitivity to re-pricing intervals and as it’s more shielded than peers from any further deterioration in the O&G sector.

Ng Li Hiang Maybank Kim Eng | http://www.maybank-ke.com.sg/ 2017-08-22

Maybank Kim Eng SGX Stock Analyst Report HOLD Maintain HOLD 11.05 Up 9.850

HOLD Maintain HOLD 21.500 Same 21.500

BUY Upgrade HOLD 20.80 Up 26.400

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