UOB - DBS Research 2018-10-29: Respectable Quarter Amidst Volatility


UOB - Respectable Quarter Amidst Volatility

  • Respectable quarter amidst market volatility as strong loan growth continues to drive interest income. 
  • NIMs declined as UOB deliberately built deposits; remains hopeful of future NIM expansion. 
  • Continues to benefit from rising rate cycle. 
  • Maintain BUY, revised Target Price of S$29.50; at current prices, the stock provides 4.8% yield. 

Poised to benefit from strong capital position and rising rate cycle.

  • We believe UOB will continue to be a beneficiary of the rising rate cycle even as it currently sees pressures from higher deposit costs.
  • UOB’s strong capital position continues to provide opportunities to tap quality loan growth as broad-based loan growth outlook for the year continues to stand tall, with mid-to-high single-digit growth expected next year. UOB is also less exposed to volatility in wealth management fees as its customers invest mostly in non-leveraged products.
  • Capital levels remain strong with fully loaded CET1 ratio at 14.1% as at September 2018.
  • Higher dividends are possible on its higher capital levels with UOB’s new dividend policy as the bank continues to deliver sustained growth.

Where We Differ:

  • We continue to like current volatile market conditions. UOB has deliberately up SGD deposits curve as it increases cost of deposits. We view this as move.

Potential catalyst:

  • Sustained positive deliveries. Further improvement in NIM should support earnings. Lower credit cost is a new trend for UOB and should be viewed positively.

Key Risks to Our View:

  • Asset quality escalation of war may subject some companies turn malign, more might be required. In the event that trade trigger further loan and fee growth.

WHAT’S NEW - Respectable quarter amidst market volatility

3Q18 earnings driven by higher loan growth and lower credit costs.

  • UOB's 3Q18 earnings of S$1.04bn (-4% q-o-q, +17% y-o-y) were in line with expectations as quarterly earnings cross the S$1bn mark for the second time this year. Earnings were driven by higher net interest income on higher loan growth and lower credit costs.
  • Fee income improved y-o-y on higher loan-related, credit card and trade-related fees but declined 3% q-o-q due to lower loan-related and fund management fees, as well as structural foreign exchange positions in relation to its accounting asymmetry from its hedges.

Credit costs remain low.

  • Credit costs were lower as expected at 18bps vs historical 32bps (2Q18: 13bps) while absolute non-performing loans (NPLs) declined slightly against a larger loan book, NPL ratio improved to 1.6% (2Q18: 1.7%). New NPL formation stayed at normalised levels of S$475m compared to S$436m in 2Q18.

Strong loan growth supports net interest income.

  • Loan growth continued to be strong at 2% q-o-q, 10% y-o-y and was broad based with increases largely across sectors. However, net interest margin (NIM) dipped during the quarter from 1.83% in 2Q18 to 1.81% this quarter even as loan yields rise (3Q17: 1.79%), as UOB continued to build up deposits during the quarter. Group loan-to-deposit ratio (LDR) at 85.7% remained stable y-o-y.

Expenses grew ahead of revenue.

  • Expenses were down 1% q-o- q, 12% y-o-y largely due to staff variable costs and IT investments. On higher revenues, cost-to-income ratio improved q-o-q to 43.4% (3Q17: 41.6 %; 2Q18: 43.6%).

Mixed regional performance.

  • UOB saw broad-based y-o-y growth across most countries. In particular, Thailand saw strong q-o-q performance on higher incomes against lower provisions while Malaysia started to see cost of funds going up. China’s liquidity conditions have also driven up short-term funding significantly. As UOB continues to restructure its Indonesia operations, provisions increased q-o-q in a lower NIM environment.

Capital ratios remain strong, dividend policy reiterated.

  • Capital ratios stood strong with CET1, Tier-1 and Total CAR at 14.1%, 15.1% and 17.4% respectively. UOB reaffirmed its commitment to the new dividend payout ratio of c.50% (of net profit), subject to minimum CET1 ratio of 13.5% and sustainable business performance. No dividends were declared for the quarter.

Key takeaways from analyst briefing

NIM declines as UOB builds deposits in anticipation of higher interest rates and pipeline.

  • UOB had deliberately built up SGD deposits, particularly fixed deposits, and lowered the SGD LDR to 91.5% (2Q18: 94.8%) against the current macroeconomic backdrop, in anticipation that deposit costs is likely to trend up further as there is increasing competition for SGD deposits. UOB expects some drawdowns that did not happen in the quarter to occur next quarter, as it continues to deploy loans.
  • While UOB expects some uptick in cost of funds next quarter, the bank remains hopeful that there will be NIM recovery in the rising rate environment due to better loan pricing.

Current credit environment still benign, stress tests performed across portfolio.

  • Credit costs for the year might come in lower than UOB’s original guidance of 20bps in the current benign environment.
  • While UOB does not see any major deterioration in its loan portfolio and weakness coming up from trade war currently, UOB has proactively conducted stress tests based on trade war scenarios and is closely monitoring accounts that show some vulnerability and assessing the need to make provisions for some of these accounts.

UOB to capture opportunities from shift of manufacturing base to Southeast Asia.

  • According to UOB, firms in the region are planning to shift their manufacturing base to SEA even as trade activities slow down for the time being. UOB believes that it is able to capture loan opportunities in this space by helping companies in their move.

Launch of Digital Bank by early 2019.

  • UOB is planning to launch its Digital Bank, starting with one of the regional countries, by early 2019 as it seeks to target potential underserved customers outside of Singapore.

Updates on Evergrowing bank.

  • Evergrowing bank is still getting clearance for its financials and has future IPO plans. UOB had previously mentioned in its 2Q18 results briefing that it does not expect significant impact on UOB’s books as UOB took a significant discount to Evergrowing’s net tangible assets when valuing the investment on its books.

FY19 guidance.

  • UOB sees loan growth at mid-to-high single digit next year, following a higher base this year as it continues to drive cost-to-income ratio lower, on digitalisation and cost efficiencies.

Valuation and recommendation

Maintain BUY, revised Target Price of S$29.50.

  • We arrive at our revised Target Price of S$29.50 (previous: S$31.70) based on the Gordon Growth Model (12% ROE, 3% growth, 10% cost of equity), equivalent to c.1.3x FY19F P/BV, at its average 10-year forward P/BV multiple.
  • We believe UOB will continue to benefit from the rising rate cycle as it continues to leverage on its strong funding position to deliver loan growth.
  • We revised our earnings marginally by -3 to -5% through FY20F mainly on lower non-income expectations.

Sue Lin LIM DBS Group Research | https://www.dbsvickers.com/ 2018-10-29
SGX Stock Analyst Report BUY MAINTAIN BUY 29.50 DOWN 31.700