Singapore Banks - CIMB Research 2017-11-22: Earnings Growth To Follow Multiple Expansion

Banks - CIMB Research 2017-11-22: Earnings Growth To Follow Multiple Expansion Singapore Banking Stocks 2018 Outlook DBS vs OCBC vs UOB DBS GROUP HOLDINGS LTD D05.SI OVERSEA-CHINESE BANKING CORP O39.SI UNITED OVERSEAS BANK LTD U11.SI

Banks - Earnings Growth To Follow Multiple Expansion

  • We believe FY18F NII would be driven by both asset volumes and yield spreads, with broad-based loan growth. A stronger US$ could lead to higher NIMs, in our view.
  • Positive performance of wealth management and cards is likely to sustain in FY18F for the three banks. Given the focus on digitalisation, we expect CIRs to trend down.
  • We think OCBC and UOB would follow in DBS’s footsteps and clean up their books in 4QFY17F. Hence, we expect credit costs and NPL ratios to peak in 4QFY17F.
  • Given RWA optimisation and clarity on Basel IV, we see upside risk to dividends.
  • Reiterate sector Overweight, with macroeconomic growth on a firmer path of recovery. DBS is our top pick in the sector.

3Q17 RESULTS WRAP-UP: DBS leads the way 

Focus on the road ahead; forget the rearview mirror 

  • Although DBS’s 3Q17 net profit of S$802m (-25% yoy/-29% qoq) missed expectations due to elevated credit costs, we consider the group to be the “true” outperformer among peers. We commend the bank as it was the first to take advantage of the upcoming FRS 109, cleaning up of its oil & gas book in the process. We believe that its peers would follow suit in 4Q17F. Additionally, other positives from DBS’s 3Q17 results include the 8% yoy/4% qoq increase in loan volumes, as well as sustained business momentum, which underpinned non-NII.
  • Meanwhile, both OCBC and UOB posted encouraging quarterly results. OCBC’s 3Q17 net profit of S$1,057m (+12% yoy/-2% qoq) demonstrated its holistic franchise encompassing banking, insurance and wealth management (WM) platforms. The bank achieved 11% yoy/2% qoq expansion in loan volumes, while Great Eastern Holdings (GEH, GE SP, Not Rated) and WM driving non-NII in 3Q17. GEH achieved good operational performance (3Q17 operating profit was up 18% yoy), with total weighted new sales (TWNS) up 16% yoy but new business embedded value (NBEV) down 10% yoy due to lower NBEV margin (9M17: 40.4% vs. FY16: 43.6%).
  • UOB’s 3Q17 net profit of S$883m (+12% yoy/+5% qoq) represented the bank’s strongest quarter YTD. Higher net interest margin (NIM) and loan volumes were slightly marred by higher non-performing asset (NPA) formation. We understand that one last chunky account could turn NPA in 4QFY17F, but believe that the worst of the effects from the oil & gas weakness is over and we will see improvement in NIM and loan volumes in FY18F.


Banks may utilise excess general provisions before “Day One” to clean up their books 

  • The Monetary Authority of Singapore (MAS) has clarified the IFRS 9 rules on loan loss provisioning. Domestic systematically-important banks (D-SIBs, including subsidiaries of foreign banks) must comply fully with IFRS 9 requirements, while maintaining general provisions (GP) of 1%, net of collaterals. However, instead of providing for general allowances on the P&L (which would cause conflict with IFRS 9), the banks are instructed adopt the regulatory loss allowance reserve (RLAR) approach. This means that come “Day One” of FRS 109 kicking in (1 Jan 2018), the banks must transfer any shortfall GP to RLAR in shareholders’ equity (to meet the 1% requirement). Going forward, in the event that Stage 1 and 2 provisions fall below the 1% minimum, banks must top up the shortfall through appropriation of retained earnings to RLAR.
  • Currently, all three Singapore banks have excess GP. On “Day One”, banks could either transfer the excess GP to retained earnings or to RLAR. By transferring to the former, the banks would boost Common Equity Tier 1 (CET 1) ratio. As for the latter, RLAR counts as Tier 2 capital and is non-distributable.
  • Prior to “Day One”, the banks are allowed to write back excess GP to P&L. (Note that GP charges through P&L are tax deductible, although there is uncertainty about whether transferring GP to shareholders’ equity would incur additional tax liabilities). 
  • As of 30 Jun 2017, DBS had GP of S$3.2bn, comprising 1.5% of gross loans. The bank took advantage of the upcoming FRS 109 and accelerated recognition of residual oil & gas exposures as NPAs. However, it softened the “blow” with the writeback of excess GP. With this move, DBS has cleaned up its books and will start 2018F on a clean slate. We believe that OCBC and UOB would follow suit in 4Q17F.

Bank earnings going forward would be more pro-cyclical 

  • With the adoption of FRS 109, we believe that the banks’ earnings going forward would be more pro-cyclical. Ironically, one of the intentions of IFRS 9 was to create counter-cyclicality. Under the previous accounting standard, banks booked allowances on an incurred basis (specific provisions). Nonetheless, banks could also “smooth” earnings out by using general provisions.
  • IFRS 9, on the other hand, seeks to be forward looking. Rather than booking losses as they occur, banks must provide for expected credit losses (ECL). In addition, using a significant credit-deterioration approach, the banks would have to add an intermediate stage of asset quality between performing loans (stage 1) and non-performing loans (stage 3), called underperforming (stage 2). The accounting for stage 3 ECL involves the banks measuring and recognising lifetime ECL, which is more or less the same as the measurement and recognition of special provision (SP).
  • The accounting treatments differ in the treatment of GP, which is now replaced by stages 1 and 2 ECL. Under stage 1 (where the loan is performing), banks would have to provide for 12 months of ECL. Under stage 2 (where there is a significant increase in credit risk), banks would have to provide for lifetime ECL, which is similar to stage 3.
  • Essentially, this means that when times are good, the quantum that banks recognise as ECL would be lower than the current regime of GP and SP, since most of the loans would be classified under Stage 1. However, when the credit cycle turns, the shift of assets from stage 1 to 2 would mean a sharp spike in ECL (as banks would now have to recognise lifetime of ECL vs. 12 months of ECL).
  • On a final note, we observe that while the measurement and recognition of ECL is model-based, there is still an element of judgment involved (e.g. macro outlook may differ between banks and the respective managements’ sense of default risk may vary). Hence, it is possible for differing banks to classify the same loan under different stages.


  • We foresee the following trends in 2018F: 
    • A stronger US$ could aid the transmission of higher Fed Fund rates 
    • Banks are likely to take advantage of FRS 109 and clean up their books. This means that the worst of oil & gas is over. We expect lower credit costs under FRS 109.
    • Economic growth is expected to be broad-based, which could spur loan growth and fees. In addition, we expect costs to be well-contained.
    • Banks are well capitalised and there is scope for higher dividend payout, in our view.

Broad-based loan growth 

  • Based on our estimates, all three banks are on track for loan growth of 5-6% in 2017F (DBS YTD gross loan growth: +4.4%, OCBC: +5.6%, UOB: +3.7%). Both DBS and OCBC gave explicit guidance for loan growth of 7-8% for FY18F. Meanwhile, we expect loan growth for UOB to be 5% yoy in FY18F. 
  • We believe 2018F loan growth will be broad based, supported by housing (spurred by revival in Singapore’s residential sentiment and sales volume), trade and corporates expanding overseas.
  • In 2014-16, DBS’s housing loan growth (10% CAGR) has outpaced OCBC’s (5% CAGR) and UOB’s (5% CAGR). While the housing loan numbers encompass all geographies, we view the figures as representative of Singapore’s housing market because the country comprises the bulk of the banks’ housing loans. Here, DBS has been aggressive. The bank revealed that its mortgage market share rose above 30% in 3Q17 (2Q17: 28.7%) from the low of 24-25% in the past 2-3 years. In 3Q17, DBS received a 1% pt benefit from the ANZ consolidation and gained c.40bp through organic growth. Recall that DBS acquired Australia & New Zealand Banking Group Ltd’s (ANZ AU, Not Rated) wealth management and retail banking business in Singapore in Oct 2016.

Stronger US$ could lead to higher pass-through 

  • While YTD NIM expansion has been sluggish, we expect NIMs to climb faster in FY18F. We expect the pass-through rate from expected Fed Funds rate hikes in 2018F to be stronger, given the likely stronger US$. YTD, we believe the passthrough rate to be 30-40%, lower than the long-term average rate of 60-70%.
  • We note that it was only towards end-Jul 2017 that the 3-month Singapore Interbank Offered Rate/Swap Offer Rate (3M-SIBOR/SOR) saw a slight uplift of c.10bp. Even so, floating-rate loans are generally repriced between 30 to 90 days. Along these lines, we are positioning for a 1-3bp increase per quarter in FY18F. 
  • Overall, we forecast 6-7bp improvement in NIM for the three banks in FY18F vs. the -9bp to +4bp experienced in 9M17. Given compressed loan yields, DBS’s average 9M17 NIM was 1.74bp (-9bp yoy), while OCBC’s was 1.64bp (-4bp yoy). UOB’s was 1.76bp (+4bp yoy) due to gapping and active liquidity management. The bank has slightly lengthened its duration in Singapore government bonds from < 3 years to 3-5 years.

Healthy business momentum to drive fees 

  • We expect the healthy business momentum for fees to continue. We focus on fee income as it is more sustainable than trading income, which is volatile. Fees accounted for 19-24% of the banks’ FY16 total income, while non-NII made up 36-40% of banks’ FY16 total income. Partly due to GEH, OCBC has the highest contribution from non-NII.
  • Sustained positive performance from wealth management (WM) and cards is expected to feature for the three banks in 2018F. Both DBS and OCBC are benefiting from the inorganic and synergistic contributions from ANZ and Barclays WM, respectively. As at 3Q17, DBS WM had AUM of S$195bn, and based on Private Banker International, it has the sixth-largest AUM in Asia. Meanwhile, OCBC’s WM arm, Bank of Singapore, had AUM of c.S$129bn and is ranked seventh in Asia.
  • As for other non-NII, we expect DBS’s traction in transaction and cash management services to continue. Additionally, we expect OCBC’s insurance earnings to sustain, given that GEH’s performance has been underpinned by healthy operational performance. GEH’s 9M17 total weighted new sales (TWNS) and new business embedded value (NBEV) grew 16% yoy and 8% yoy respectively, offering an element of reiteration to future earnings.
  • With focus on digitalisation and increased productivity, we expect banks’ cost-to-income ratios (CIR) to inch downwards in FY18F. In particular, we were particularly impressed by DBS granular narration of its digitalisation transformation, and see scope for further reduction in CIR. Putting the above together, we forecast that Singapore banks will achieve 6-7% pre-provision operating profit (PPOP) growth for FY18F.

Credit costs, NPA formation to ease 

  • We believe that OCBC and UOB would follow in DBS’s footsteps and utilise their excess GP to clean up their books in 4QFY17F. Hence, we expect their credit costs and NPL ratios to peak in 4Q17F. This also implies that credit costs in FY18F could be lower than through-the-cycle averages. 
  • Under FRS 109, we estimate that credit costs from stages 1 and 2 under a benign credit environment would be lower than the combined GP and SP under the previous accounting standard. 
  • To recap, DBS provided for S$815m net allowances in 3Q17 (SP of S$1.67bn was offset by GP writeback of S$850m), translating into 109bp of average loans. New NPAs of S$2.06bn (including S$123m from the ANZ consolidation) were recognised during the quarter as the bank accelerated recognition of residual oil & gas exposures as NPAs. NPL ratio rose to 1.7% in 3Q17 from 1.5% in 2Q17. Around S$1.7bn of the new NPAs were due to oil & gas. About half of the new NPAs came from five chunky names, of which, we understand only one account has not turned NPA as it enjoys strong support from its parent company. The other half of the new NPAs were attributable to 100-odd names. With this move, we view that DBS loan book is largely clear of oil & gas woes. For FY18F, we project that DBS would recognise around c.S$200m of ECL per quarter, which we attribute to business-as-usual (BAU) provisions.
  • OCBC booked S$156m net allowances in 3Q17 (lower 6% yoy/8% qoq), translating into 27bp of average loans. However, SP was 40% yoy/31% qoq higher at S$138m (24bp of loans) due to declining collateral values (oil & gas) and restructuring of credit for a Chinese state-owned enterprise in the steel industry. New NPA formation eased 8% qoq/18% yoy to S$409m, with c.40% of new NPAs due to oil & gas. NPL ratio was unchanged at 1.3%.
  • UOB booked S$214m SP on loans in 3Q17 (+24% qoq/-26% yoy). The qoq increase was due to a large account in the oil & gas sector. As a result, new NPAs increased 49% qoq/2% yoy to S$799m. NPL ratio rose to 1.6% in the quarter from 1.5% in 2Q17. UOB guided that one last chunky account could turn NPA in 4QFY17F. However, we believe this is somewhat irrelevant now as we expect the bank to accelerate recognition of oil & gas exposures as NPAs in the quarter. Overall, with a release in GP (S$26m), total credit costs were kept at 38bp (net allowances of S$221m).
  • DBS currently has the lowest allowance coverage among the three banks (83%). However, we view this coverage level as adequate. The bank emphasised that it was conservative in recognition of NPAs. In terms of period overdue, c.26% of oil & gas NPA of S$3bn were current; 37% were within 90 days overdue. This means that in the normal course, DBS would not have had to recognise these exposures as NPAs, and would have let these credits continue deteriorating over the next few quarters.
  • By collateral, half the oil & gas NPAs are secured (S$1.5bn), and the other half are unsecured (S$1.5bn). The unsecured portion represents the difference between the outstanding loan amount and the marked-down collateral values.
  • More importantly, we note that DBS had marked down its oil & gas collateral to c.25% of 2014 values. Judging from recent transactions, we believe the markdown is adequate. Anecdotally, we have observed evidence of oil & gas vessels being transacted at this level. Hence, oil & gas SP of S$1.5bn covers 100% of unsecured NPAs and 50% of secured NPAs.
  • Outside oil & gas – where the three banks have generally described the portfolio as very stable – DBS’s other NPAs of S$3.2bn are 115% covered.

Upside risk to dividends 

  • With further optimisation in risk weighted assets (RWA) and better clarity on Basel IV, we see upside risk to dividends. Singapore banks are well capitalised, with fully-loaded CET 1 ratios at 12.0-13.8% at end-3Q17. The banks have recognised this and are starting to indirectly shed some of the excess capital. 
    1. To illustrate, even though OCBC has the lowest fully-loaded CET 1 ratio among the three banks (12%, but still comfortable in the absolute sense), it has removed its scrip dividend. The bank is cognisant that there could be some capital uplift when OCBC Wing Hang and OCBC NSIP adopt the Internal Ratings-based (IRB) approach for its capital computation at the end of the year. 
    2. Meanwhile, UOB has lowered the discount offered for its scrip, in recognition of its capital base (fully-loaded CET 1 of 13.8%). 
    3. Lastly, DBS has increased its 1H17 dividends by 10% yoy. The release of its excess GP to P&L also underlines its confidence in its capital base.
  • For FY18F, we are forecasting dividend payout of c.35% for the three banks, and believe that there is room for payout to reach 40%. Currently, we estimate the banks are trading at FY18F dividends yields of 2.9-3.2%.


Maintain Overweight with DBS as our top pick 

  • With macroeconomic growth on a firmer path, we maintain our Overweight posture on Singapore banks. The banks have done well YTD, re-rating from an average of 9.4x forward P/E in 2016 to the current 11.7x. DBS has been the best outperformer, with share price gaining 41% YTD. OCBC’s share price and UOB’s share prices have gained 33% and 26%, respectively, YTD.
  • While the sector is no longer cheap, we believe that the later phase of the investment cycle would be underpinned by actualisation of earnings expectations, noting that the early leg is being led by multiple expansion. All in all, we expect Singapore banks to post 9-24% yoy core EPS growth for FY18F.
  • Our order of preference for Singapore banks is DBS, OCBC and UOB. Sector risks could include continued regulatory changes, recession, weaker regional and domestic loan growth and disorderly rise in interest rates.

Maintain Add on DBS with unchanged TP of S$25.0 

  • DBS is our top pick in the sector. Our GGM-based TP is based on FY19F ROE of 11.5%, 3.25% LTG and 9.6% COE, which is equivalent to 1.3x FY18F P/BV. This compares to its historical 10-year average P/BV of 1.17x vs. forward ROE of 11%. Among the three banks, we project DBS to achieve the highest ROE in FY18F (11.6%) vs. OCBC (11.0%) and UOB (9.9%). 
  • Given its industry-leading S$-CASA funding base (3Q17: 89%), we believe that DBS would be the biggest beneficiary of US rate normalisation. Meanwhile, continued healthy business momentum is likely to spur loan growth and fees (particularly WM and cash management). 
  • We also believe that the bank will gain traction in its digitalisation efforts in India and Indonesia (the two countries are currently loss making). The result of which is that CIR could trend down further. A downside risk is weaker-than-expected NIM expansion.

Maintain Add on OCBC with unchanged TP of S$12.6 

  • Our GGM-based TP is based on FY19F ROE of 11.2%, 3% LTG and 9.4% COE, which is equivalent to 1.29x FY18F P/BV. This compares to its historical 5-year mean of 1.26x vs. 11.4% ROE. 
  • What differentiates OCBC from the other Singapore banks is its holistic franchise comprising banking, insurance and wealth management platforms. Given the underlying positive business operations, we believe that performance from Great Eastern Holdings (GEH) would be sustained in FY18F.
  • Furthermore, we think there could be a dividend surprise from potential divestment of a 30% stake in GE Malaysia (OCBC has to comply with Bank Negara Malaysia’s stricter enforcement for foreign-owned insurers to have a minimum local shareholding of 30% by Jun 2018F). For 9M17, profit from life assurance made up c.9% of OCBC’s total income. We estimate that GE Malaysia contributes around 40% of GEH’s earnings. 
  • A downside risk is weaker-than-expected non-NII.

Maintain Hold on UOB with unchanged TP of S$25.4 

  • UOB is our least preferred due to a perceived lack of edge in a higher growth environment. Compared to its local peers, the bank lacks a strong non-NII franchise. Our GGM-based TP is based on FY19F ROE of 10.3%, 2.5% LTG and 9.1% COE, which is equivalent to 1.18x FY18F P/BV. This compares to its historical 5-year mean of 1.19x P/BV vs. 10.9% ROE. 
  • Moreover, we think there is a ceiling to UOB’s NIM expansion, which has rebounded from 1.68% in 2Q16 to 1.79% in 3Q17. UOB’s NIM expansion has been led by higher interbank and securities yields as the bank placed excess liquidity in longer-dated bonds. However, we believe this is on its last legs and the excess funds that could be re-deployed have reached a ceiling. 
  • Upside/downside risks hinge on improvement/worsening of the property market, higher/lower loan growth (which has trailed peers) and stronger/weaker-than-expected NIM.

YEO Zhi Bin CIMB Research | http://research.itradecimb.com/ 2017-11-22
CIMB Research SGX Stock Analyst Report ADD Maintain ADD 25.000 Same 25.000
ADD Maintain ADD 12.600 Same 12.600
HOLD Maintain HOLD 25.400 Same 25.400