Banking – Singapore - UOB Kay Hian 2018-01-05: Fintech – Enabler Or Disruptor?

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DBS vs OCBC vs UOB DBS GROUP HOLDINGS LTD D05.SI UNITED OVERSEAS BANK LTD U11.SI OVERSEA-CHINESE BANKING CORP O39.SI

Banking – Singapore - Fintech – Enabler Or Disruptor?

• Fintech introduced many foundational innovations that enable banks to reach and serve a wider audience with a leaner cost structure. Distributed ledger technology (DLT) may cause some disruption but we see the impact as manageable. 
• BUY DBS and OCBC. 
  1. DBS is recognised as the world’s best digital bank and has the most productive workforce. 
  2. OCBC leads in cost efficiency, and its income and PPoP per employee have grown at a faster CAGR of 4.6% and 4.3% respectively for 2013-17. 
• Maintain OVERWEIGHT.

WHAT’S NEW

Fintech is not a hype. 

• Fintech introduced many foundational innovations that transform the way financial services are delivered to the new generation of millennials. It comprises four key domains, namely:
  1. artificial intelligence (AI)/big data,
  2. distributed ledger,
  3. cryptography, and
  4. mobile access. 
• We see AI/big data, cryptography and mobile access as enablers, allowing the banks to reach and serve a wider audience with a leaner cost structure. 
• On the other hand, distributed ledger could be disruptive due to its ability to simplify the transaction chain, which may reduce the number of financial intermediaries.

The virtual reality of cryptocurrencies. 

• Cryptocurrencies, such as bitcoin and ethereum, are virtual currencies and their exchange rates are extremely volatile. However, cryptocurrencies are built on distributed ledger technology (DLT), which is a genuine foundational innovation. At this stage, cryptocurrencies do not affect central banks’ ability to conduct monetary policy. 
• Central banks could fight back by issuing their own central bank cryptocurrencies (CBCC) if the usage of cryptocurrencies becomes more prevalent.

MAS conducting trials on DLT. 

• It is premature for central banks to introduce retail CBCC as complex issues on financial stability are inadequately addressed. Central banks could introduce wholesale CBCCs, especially if existing wholesale payment systems are near-obsolescent. 
• The Monetary Authority of Singapore (MAS) is conducting trials on wholesale CBCCs, securities settlement and cross-border payments, which are practical areas where DLT could be applied.

Manageable impact from disruption by DLT. 

• We see the potential negative impact on earnings from disruption by DLT to be minimal. PayNow and potential new payment options using cryptocurrencies could affect fees from credit cards. However, the negative impact is not significant as PayNow facilitates low-value payments, which are currently made primarily through cash. 
• DLT could be applied to clearing & settlement for foreign exchange and derivatives traded between banks but the MAS has not conducted any trials in this direction.

Cashless payments have become easy and fuss-free. 

• Singaporeans are able to use PayNow, an instantaneous fund transfer service that requires just the recipients’ mobile number, NRIC number or Singapore Quick Response (SG QR) code. SG QR is Singapore’s common QR code, and would cover 100,000 acceptance points by mid-18. 
• PayNow and SG QR facilitate cashless payments, including low-value payments at food courts, coffee shops and hawker centres, paving the way for Singapore to become a cashless society.

ACTION

Maintain OVERWEIGHT. 

• We postulate that normalisation of the size of central banks’ balance sheets downward could lead to normalisation of valuations for banks upward. Banks will also benefit from NIM expansion due to higher interest rates. BUY DBS and OCBC. We prefer OCBC on valuation grounds.
• We are witnessing a broad-based cyclical upswing in economic activities around the globe. As such, we have raised the growth rate used in our Gordon Growth Model from the previous 1.5%, which we deemed to be too conservative under the current circumstances, to 3.0%. Our new target prices are S$29.50 for DBS (previously: S$26.10) and S$14.88 for OCBC (previously: S$13.56).

DBS (Rating: BUY/ Target Price: S$29.50). 

• DBS is recognised as the world’s best digital bank and has launched mobile-only Digibank in India and Indonesia. 
• DBS leads in productivity with the highest income per employee at S$538,805 and pre-provision operating profit (PPoP) per employee at S$313,701 due to its focus on developed markets in Singapore and Hong Kong. It generated income of S$4.20 and PPoP of S$2.39 for every S$1.00 invested in staff costs. 
• DBS had a lean cost-to-income ratio of 42.5% as of 9M17.
• See report: DBS Group Holdings (DBS SP) - The Digital Warrior

OCBC (Rating: BUY/ Target Price: S$14.88). 

• OCBC has experimented with using AI to handle home loan enquiries, wealth management advisory and regulatory compliance. 
• OCBC leads in cost efficiency with the lowest staff cost per employee at S$83,333. Its other non-wage expenses are also very lean. It has grown income per employee and PPoP per employee at a faster pace with CAGR at 4.6% and 4.3% respectively for 2013- 17. 
• OCBC had a lean cost-to-income ratio of 42.3% as of 9M17.
• See report: Oversea-Chinese Banking Corporation (OCBC SP) - Focusing On AI To Enhance Productivity

SECTOR CATALYSTS

• Rising interest rates and bond yields.
• Easing of pressure on asset quality from the O&G sector.

ASSUMPTION CHANGES

• We maintain our current earnings forecasts.

RISKS

• Rapid increase in the federal funds target rate (steep rate hikes) that may trigger capital outflows from countries in Southeast Asia.

Jonathan Koh CFA UOB Kay Hian | http://research.uobkayhian.com/ 2018-01-05

UOB Kay Hian SGX Stock Analyst Report BUY Maintain BUY 29.500 Up 26.10

NOT RATED Maintain NOT RATED 99998.000 Same 99998.000

BUY Maintain BUY 14.880 Up 13.56