UOB - DBS Research 2018-01-04: Stronger For Longer

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UNITED OVERSEAS BANK LTD U11.SI

UOB - Stronger For Longer

• Three critical factors to watch:
  1. property market recovery,
  2. NIM improvement,
  3. end to its asset quality woes and lower credit costs. 
• Better traction in loan growth with NIM uplift to drive top-line growth. 
• Raising loan growth to 8% and lower credit costs to 27-28bps for FY18-19; FY18-19 earnings lifted by 4% each year. 
• Maintain BUY, TP raised to S$29.50.   

Reiterating positive signals; maintain BUY. 

• UOB’s 3Q17 earnings reaffirms our positive stance on the bank with NIM and loan growth picking up strongly, better than what we had expected. With probably the last leg in classifying NPLs from the oil & gas stress, we believe UOB should enter FY18 on a cleaner state. 
• We reiterate our three catalysts for the stock:
  1. The property market recovery bodes well for UOB as it is perceived to be a proxy - UOB has the largest proportion of property-related loans vs peers; this saw loan growth improve from as early as 3Q17.
  2. Imminent NIM improvement albeit backloaded; SIBOR/SOR finally edged up more visibly over the quarter with some repricing as early as 3Q17. The repricing effect typically takes approximately up to 90 days and as such, firmer NIM levels could be expected in 4Q17, spilling over to FY18.
  3. While asset quality concerns may still linger, the quantum of new NPLs (9M17 vs 9M16) has eased; the end to asset quality woes should warrant a re-rating, which we believe would be the case in FY18. 
• Separately, with the implementation of IFRS9, banks may no longer be able to continuously build up general provisions which will result in lower credit costs from its sticky 32-bp guidance.

Where we differ - Staying above consensus. 

• Our earnings remain above consensus with a further boost from loan growth and lower provisions resulting in +4% earnings uplift for FY18-19. Our TP is also at the higher end of consensus.

Potential catalyst: A better year ahead. 

• With asset quality issues largely dealt with by end-FY17, we should expect a better year ahead. There would likely be another large NPL classification in 4Q17, this should mark the end of massive asset quality upsets.
• Further improvement in NIM and more importantly, a pickup in loan growth due to the recovery of the property market should support earnings strongly.

Key Risks to Our View

• Relapse in NIM and asset quality trends. A relapse in SIBOR movement could also pose risks to our NIM forecast. If NPL issues start to spread further from here, more specific provisions might be required.

Riding The Wave 

A better year ahead. 

• With asset quality issues largely to be dealt with by end-FY17, we should expect a better year ahead. There would likely be another large NPL classification in 4Q17, but this should mark the end of massive asset quality upsets. Further improvement in NIM and more importantly, a pickup in loan growth due to the recovery of the property market should support earnings strongly.
• Separately, with the implementation of IFRS9, banks may no longer be able to continuously build up general provisions; we have lowered UOB’s FY18-19F credit costs to 27-28bps, away from its current sticky 32-bp credit cost guidance.

Improved loan growth outlook but still cautious on NIM. 

• Our FY17 loan growth forecast is 6.2%. Judging from the loan momentum, there is even a chance UOB could outpace this.
• Our FY18-19F loan growth forecasts are now tuned up to 7% per year from 6% in light of a better operating environment.
• UOB operates almost purely like a commercial bank (less reliant on capital markets), and it would need to compete in the loan space more aggressively vs peers. Similarly for its wealth management business, which unlike peers, UOB targets the mass affluent space. 
• Although its private banking business is small, we believe UOB will still be able to grow comfortably in the wealth management space. With competition a key consideration, NIM uplift, although should be expected, may be dampened. Even then, 9M17 YTD NIM has done well. 
• We expect the bank to end FY17 NIM at 1.77% (+6bps y-o-y). We expect NIM to rise by 4bps each in FY18 and FY19.

Considerations post IFRS9/SFRS109. 

• Although the Monetary Authority of Singapore (MAS) has released the proposed amendment to regulatory requirements pertaining to credit loss under the IFRS9/SFRS109, UOB is still assessing considerations in dealing with its excess general provisions reserves. The considerations include how much the bank will need going forward post IFRS9/SFRS109, whether it should take advantage of its excess reserves and bump up specific provisions and whether it should transfer the excess into P/L or keep it in retained earnings. 
• There are also tax implications it will need to consider. We gauge that the impact would be neutral to mildly positive to capital but positive to its P/L.
• There will be more clarity in the next 4Q/FY17 briefing on 14 Feb 2018.

Last leg of oil & gas stress; aggressive provisions made. 

• UOB had previously identified up to S$3.7bn vulnerable accounts within the oil & gas space. Of which, the bank is comfortable with > S$1bn of its portfolio as these are from the national oil majors. Another > S$1bn lies with 6-7 obligors which are all familiar names; of this, there is one more big name which needs to be classified and provided for in 4Q17. After this, the coast should be largely cleared. 
• A look at UOB’s special-mention loans (SML) which are only disclosed once a year in the annual report. As at end-2016, the SMLs had risen mainly from the oil & gas exposures. As most, if not all, of these have been classified as NPLs, the SML by end-2017 should be much lower. 
• Management reiterated that they are comfortable with the level of provisions they have made and taking into account the coverage/collateral (which the bank has marked down by 70-80%), the question now lies in how much more it would want to set aside (aggressively) ahead before the implementation of IFRS9/SFRS109 which will take effect from 1 January 2018.

Current high capital levels; what can be done. 

• UOB’s capital ratios are by far the highest vs peers now. It will have to be sustainable core earnings that will be the key consideration to pay higher dividends. UOB’s strong capital position enables it to compete aggressively to grow its top line. 
• At this juncture, management has not finalised plans to deploy excess capital.

Hengfeng Bank disposal. 

• UOB announced on 26 October that it will be disposing its 12% stake in Hengfeng Bank (Evergrowing Bank). It is in exclusive talks with Shangdong Lucion Investment Holdings (Lucion). 
• Lucion is wholly-owned by Shandong Provincial State-owned Assets Supervision and Administration Commission and Shandong Provincial Council for Social Security. Talks are still at preliminary stages and it is too early to speculate on the potential pricing. It is however safe to say that if and when this transaction is completed, it will be mildly positive to capital given that this investment carries a high risk-weight in its assets.

Valuation & Recommendation 

Maintain BUY, TP raised further to S$29.50. 

• Our revised TP of S$29.50 is based on the Gordon Growth Model (12% ROE, 4% growth and 9.5% cost of equity), equivalent to 1.3x FY18 P/BV, which is its 10-year average P/BV multiple.

Sue Lin LIM DBS Vickers | http://www.dbsvickers.com/ 2018-01-04

DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 29.50 Up 27.500