UOB - DBS Research 2017-07-28: Lacking The Extra Mile

UOB - DBS Vickers 2017-07-28: Lacking The Extra Mile UNITED OVERSEAS BANK LTD U11.SI

UOB - Lacking The Extra Mile

  • NIM moved up a little but loan growth traction was muted in 2Q17; hopeful for a pick-up in 2H17.
  • New NPLs ticked up; issues spread to SMEs.
  • Still in need of a stronger non-interest income franchise; 2Q17 earnings trend proved the point.
  • Downgrade to HOLD despite a higher TP of S$24.80 as we roll forward our valuation base to 2018.

Pricing in positives, downgrade to HOLD. 

  • YTD, UOB’s share price has lagged peers despite delivering a 21% return (peer average: 28%). However, we believe the lag could be due to the lack of its non-interest income franchise. This was proven when the bank failed to surprise on the upside in its non-interest income line compared to OCBC in 2Q17. 
  • While NIM is chugging along well, loan growth has been muted up to 2Q17. Loan growth could pick up in 2H17 but NIM will likely stay flat from here. New NPLs, which came from the SME segment, surprised on the downside.
  • Credit cost will stay sticky at 32bps. Even if specific provisions were to decline, UOB will build up its general provision reserves which have dropped to 1.2% from a high of 1.4% as it managed its asset quality situation in 2016.


  • UOB's 2Q17 earnings were a moderate set. 

Highlights: 2Q17 earnings were driven by loan growth and wealth management. 

  • UOB’s 2Q17 earnings were largely in line with expectations. Y-o-y top-line growth was supported by a better NIM (+7bps) and loan growth (7%). On a q-o-q basis, top-line growth was less inspiring as NIM only rose by 2bps (largely from its Singapore book) while loans contracted marginally. 
  • Deposits were flat q-o-q, +5% y-o-y. Fee income was well supported by its wealth management business but this was largely offset by lower trading and investment gains.
  • Expenses were higher owing mainly to IT-related costs; cost-to-income ratio rose to a high of 46%. Provisions were flat.
  • While specific provisions were lower, general provisions were pumped to continue building its general provisions reserves.

New NPLs rose contrary to expectations. 

  • While credit costs stayed at an annualised 32bps as expected, new NPL formation saw a slight uptick – we had expected this to stabilise or even decline since the peak in 3Q16. 
  • Although the new NPLs of S$537m is lower than the peak we saw in 2Q16 and 3Q16 at S$802m and S$780m respectively, we are a little discouraged by the rising trend noted since 4Q16. We understand that the new NPLs arose from the general commerce and manufacturing sector; these are largely SME-related accounts. 
  • The new NPLs in the general commerce sector were related to oil & gas. UOB’s oil & gas exposure now stands at 4% of total loans (1Q17: 5%). Overall NPL ratio stayed flat at 1.5% while loan loss coverage dipped a little to 114% (but still the highest vs peers).

Decent regional operations except Indonesia. 

  • UOB Malaysia’s pre-tax profit was flat q-o-q but higher when compared on a half-year basis, thanks to stronger fee income. Provisions were largely stable. 
  • UOB Thailand did exceptionally well, although on a low base. We saw revenues picking up but provisions offset most of this. 
  • UOB Indonesia remains in “repair-mode”. We continue to see provisions staying high and NIM slipping. 
  • UOB takes pride in its ASEAN-centric strategy, and similar to Maybank and CIMB Group in Malaysia, UOB has an extensive ASEAN presence, including Myanmar and Vietnam. Management believes that there is huge potential in the Mekong region and UOB could use its operations in Thailand as an anchor to expand its business in this region.

Stable DPS (with scrip dividend); strong capital levels. 

  • UOB declared a 35-Sct interim dividend, similar to that declared last year; the scrip dividend option applies. 
  • Capital ratios were strong with fully loaded CET1 at 13.3%. It appears that UOB intends to continue to buffer capital levels to meet regulatory requirements including that of Basel 4. 
  • It will however consider managing the discount attributed to the scrip dividend should the need arise rather than to turn off the scrip dividend completely.

Outlook: NIM guided to be flat by year-end; hopeful for a slight increase. 

  • UOB’s Singapore operations saw a strong NIM uplift in 2Q17 mainly from active balance sheet management and effective deployment of its excess funds. While this may continue to persist, NIM pressure from its regional operations could offset the uplift. 
  • UOB expects one more US Fed rate hike for the year and a possible sequential spillover to the Singapore interest rates. That said, however, management is guiding for NIM to be flat from here by year-end, but hopeful for a slight increase. 
  • We are toning down our NIM forecast by 3bps (from 1.78% to 1.75%). But we expect NIM to gradually rise in FY18-19F by 2-3bps per year with a view that SIBOR would rise on a sustainable trend and loans repriced accordingly.

Loan growth guided at mid-single digits. 

  • Loan growth has been anaemic 2Q17 YTD at less than 1%. While we expect a pick-up in loans in 2H17, we have nevertheless tweaked our loan growth assumption lower to 5% (from 6% previously). We expect loans to hover around 5% per year in FY18-19F.
  • Loan growth is expected to be driven from its customer franchise proposition and cross-border investments.

Minimal earnings tweak. 

  • Following the adjustments above, our FY17/18/19F are lowered by 5%/4%/2%. 
  • Loan growth YTD has been anaemic at less than 1% while we are expecting loan growth for FY17F to be at 5%; this could potentially disappoint. A relapse in SIBOR movement could also pose risks to our NIM forecast. 
  • Finally, if NPL issues start to spread further from here, more specific provisions might be required.

Valuation and recommendation 

Downgrade to HOLD, TP raised as valuation base is shifted to 2018. 

  • Despite a slight trim made to our earnings forecasts, our TP is raised to S$24.80 (11% ROE, 3% growth, 9.7% cost of equity) as we roll forward our valuation base to 2018; equivalent to 1.2x FY18 BV, closer to its 10-year mean P/BV multiple.

Where we differ. 

  • Despite our slight earnings cut, our FY17-19F earnings forecast remain above consensus levels. The key difference lies in our NIM expectation for UOB where we impute a 4-bp increase from FY16 and a sustained uplift of 3bps in FY18- 19F. 
  • We have toned down our loan growth assumption marginally to 5% from 6% following a weak YTD loan growth.

Potential catalyst: Asset quality and non-interest income boost.

  • A visible improvement in asset quality, contrary to blips seen in new NPL formation, could mark an added re-rating catalyst apart from better NIM and loan growth. 
  • A significant pick-up in UOB’s non-interest rate franchise could also add to its revenue traction in the future.

Key Risks to Our View

  • Slower-than-expected top-line growth and an NPL creep-up. Loan growth YTD has been anaemic at less than 1% while we are expecting loan growth for FY17F to be at 5%; this could potentially disappoint. A relapse in SIBOR movement could also pose risks to our NIM forecast. 
  • Finally, if NPL issues start to spread further from here, more specific provisions might be required.

Sue Lin LIM DBS Vickers | http://www.dbsvickers.com/ 2017-07-28
DBS Vickers SGX Stock Analyst Report HOLD Downgrade BUY 24.80 Up 22.700