Can Singapore banks achieve post-Asian financial crisis peak P/Bs again?

In May 2007, just before the credit crisis struck, Singapore banks traded at post-Asian-financial-crisis high P/B multiples (DBS 1.9x, UOB/OCBC 2.2x). In a detailed report, we analyse whether Singapore banks can reach those valuation multiples again.

To achieve those multiples again, DBS would need an ROE of 12.8% (CS 2011 forecast 10.2%), UOB 13.2% (CS 12.9%) and OCBC 12.2% (CS 11.0%) using Gordon Growth. So, even in 2011 (a “normalised” year), banks may not reach their recent peak P/B.

Although Singapore banks are enjoying some of the strongest consensus earnings upgrades among the Asian banks, 2011 profits are projected to be only marginally ahead of 1H07 (annualised).

We find bull-case ROEs in 2011 could be 1.5% higher than our base case. In that case, DBS would still fall short of the 12.8% needed to reach 1.9x P/B, while UOB/OCBC would be comfortably ahead.

UOB remains our top pick; while DBS should perform well when rates start rising. UOB is the highest ROE bank in Singapore and has built a sustainable 200-300 bp ROE lead over peers.

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Singapore Banking Sector: Turning the corner

Better set of results. Overall, 2Q09 results were better than expected. OCBC’s strong results were driven by higher non-interest income and lower specific provisions. UOB’s results were mildly better than expectations but still dragged by higher collective impairments. DBS’ results were also above street estimates. All banks declared interim dividends.

Sentiments improving. We gather that loan demand is back. Positive signs in the rejuvenation of housing loan demand were apparent in the Jun-09 banking stats where housing loans grew by 4.1% YTD. We also note that loan spreads for the corporate and SMEs have peaked while loan rates for consumer loans, especially housing loans, remain competitive. Specific provisions are starting to trend down although NPL ratios may still inch up. However, we believe the worst of spiking NPLs are over. We expect NPL ratio to peak at 3% for FY09. Capital ratios for banks remain robust.

Pegged to mid-cycle valuations; further upside depends on sustainability of capital markets and clear signs of macro recovery. Our target prices are still pegged to mid-cycle valuations based on FY10 book value. Further upside to our valuations would depend on the recovery in book values as credit market normalizes. Our preference lies with UOB as its valuation lies in the recovery of its book value. In the longer term, UOB’s ROE stacks up better than its peers. Maintain Buy for UOB with TP at S$18.60. Meanwhile, we have a Hold call for OCBC with TP at S$8.00 as we believe most good news have been priced in.

DBS - May He Be The Right Choice

DBS has appointed Piyush Gupta as its new CEO. (It is no surprise that none of the oft-touted local candidates was the chosen one.)

Gupta, a Singapore PR, is a 27-year veteran in the banking industry, of which 8 years were spent here, briefly as Citi’s Country Head. He was also country head for Malaysia (2002-2007) and Indonesia (1998-2000). He is currently CEO for Citigroup’s South East Asia Pacific, including Australia, New Zealand and Guam.

We do not expect the market to react materially one way or the other, to Gupta’s appointment. (DBS’ share price had recovered to around $12.90 yesterday before the announcement, from $12.64 the day before. It hit $13 but ended at $12.72.)

All his predecessors over the last 10 years - from John Olds, P Paillart, Jack Tai, to the late Richard Stanley were veteran bankers, from JP Morgan and Citibank, and with different expertise, eg Jack Tai, an investment banker, when the Bank had IB ambitions, and with a good grounding in optimal capital structure; Stanley for his intimate knowledge of Hong Kong / China, particularly important with the rising importance of China, and after the acquisition of Dao Heng Bank 8 years ago, and which has yet to produce the “desired” returns. (Gupta unfortunately lacks this exposure, even though he had spent some time in HK.)

After all the hustle and bustle, it will be down to execution, to maintain DBS as one of the strongest financial institutions in the region. We maintain BUY.

Singapore Banking Sector - Hold UOB, OCBC, Sell DBS

n the midst of the economic recession, Singapore system loans growth remained lackluster with total loans outstanding higher by 2.2% to S$271.8bn over the year. Business loans contracted 2.1%, as we believe lower economic activities caused many SMEs to reduce their short term financing. However, consumer loans managed to offset some of that contraction as it recorded resilient growth of 8.3%, boosted mainly from the housing loans.

We expect consumer loans segment to expand; especially the mortgage loans (70.3% of consumer loans, 31.0% of total loans) as the number of private properties transacted in Singapore remains elevated in 2009 despite the economic recession. Mortgage loans are usually disbursed over 3 years and thus provide a healthy loans pipeline for the Singapore banks.

However, we currently rate UOB and OCBC as HOLD and DBS as SELL. This is due to the recent run-up in the banks’ share prices and that the risk reward is not as attractive as before. UOB and OCBC are currently trading close to the 5 year average price to book ratio, whereas DBS is trading at a lower P/B valuation. The lower rating of DBS is due to the lower growth assumption, and lower ROE expectation relative to its listed competitors. Moreover, we believe that the increase in non-performing loans remains as a key risk shadowing the banking industry.

DBS - Buy: New Target S$15.50; Raising EPS Estimates 2%-18%

Target S$15.50 (1.46x '09E P/B): DBS has retraced 10% from recent highs on concerns of sharply rising NPLs. But DBS' provisions-hit 2Q09 ROAE of 9.3% belies record pre-provision operating profits, and a PPOP ROAA of 1.73%, back to the 2007 peak. The P&L provisions cycle should start to normalize over 2010E for a 2011E ROAE of 12%. Our 12-month target has been reset to DBS' mid-cycle P/B multiple of 1.46x.

2Q09 pre-provision profit a record S$1.16bn: DBS' 2Q09 PPOP is up 30% vs. 2Q07 (the last economic cycle peak). Loan growth +29% over 2 years drove 8% net interest income growth despite NIM pressure from low S$ SIBOR, while basic bank fees remained resilient. Markets-related income has been a key boost to 2Q09 revenues, but operating costs are 4% lower than in 2Q07 despite a much larger balance sheet, for a 2Q09 cost-income ratio of just 35%.

2Q09 NPLs, +36%qoq, the area of concern: NPLs rose to S$3.7bn on a S$1bn rise in "rest of world" (Middle East and shipping) NPLs, but as "substandard" NPLs, mgmt do not expect large losses, stressing that 38% of all NPLs are fully current. We expect NPLs to peak by end-2010E, and provisions to return to "normalized" levels by 2011E, markets pricing in normalization ahead of that.

Raising 2009-11E EPS estimates 2-18%: We now project profit growth of +25% in '10E and +22% in '11E on [1] 3-7% loan growth; [2] modest NIM improvement to 210bps; [3] PPOP ROAA of 1.7%, [2] provisions falling from 133bps in '09E to 50bps in'11E. Our 2009E profit forecast of S$2bn remains 12% above Bloomberg consensus estimates.

UOB - New Target S$18.60; Raising EPS Estimates 2%-20%

Target S$18.60 (1.76x '09E P/B): On the back of high 2Q09 provision charges, UOB has sold off 9% from recent highs. But despite annualized provisions of 188bps of net loans, UOB still reported a 2Q09 ROAE of 12.8% Our pro forma analysis suggests that UOB could achieve a 15% ROAE with provisions of 50bps. Two-thirds of 2Q09 charges were general provisions, which could fall rapidly if the economy improves. Our 12-month target has been reset to a P/B multiple of 1.76x vs. a 2009E ROAE of 13%.

2Q09 pre-provision profit a record S$937m: UOB's 2Q09 PPOP is up 18% vs. 2Q07 (the last economic cycle peak). Loan growth +23% over 2 years has driven net interest income growth of 19% on improving NIMs. Basic bank fees remained steady, other income has been lifted by investments gains. Operating costs are up just 3% vs. 2Q07, for a 2Q09 cost-income ratio of 36%.

2Q09 provisions 188bps, overly conservative? NPLs rose to S$2.5bn for a still reasonable 2.5% NPL ratio. Mgmt reiterated that there were a few lumpy NPLs, but no trend asset quality deterioration. We expect NPLs to peak by end- 2010E, and provisions to return to "normalized" levels by 2011E, but markets should price in normalization well ahead of that.

Raising 2009-11E EPS estimates 2-20%: We project EPS growth of +17% in '10E and +21% in '11E on [1] 2-7% loan growth; [2] NIMs easing to 233bps; [3] PPOP ROAA of 1.9%, [2] provisions falling from 130bps in '09E to 50bps in'11E. Our 2009E forecast of S$1.9bn is 9% above Bloomberg consensus.

Great Eastern - Raising Target to S$15.30 on Improving Outlook

set at 1.25x P/EV: Recovery of equity, and stabilization of debt markets should lift GEH's performance, and we now view 1Q09 was the cycle trough for premium sales and new business value. We treat the 3Q09E S$250m provision for "GreatLink Choice" redemption as a one-off, just like the S$213m Malaysia RBC gain in 1Q09. A possible 30% sale of GE Life Malaysia (GELM) may cost S$43m in FY08 profit (15% of group) but generate over S$0.5bn in proceeds.

2Q09 profit S$98m, in line: (1Q: S$237m; S$42m core) premiums +6%qoq to S$1.25bn. Core insurance profit S$128m (1Q: S$65m): par fund profit S$27m, non-par profit S$77m, ILP profit S$23m. 1Q had S$213m (S$195m net of tax) gain from change to risk-based capital in Malaysia. 1H09 DPS S$0.05/share.

GreatLink Choice redemption offer: GEH is making a one-time redemption offer to policyholders of this product, whose market value remains at a steep discount to par due to its underlying CDO investments. The 5 tranches of this product had invested premiums of S$594m, a Jun-09 NAV of S$217m and coupons paid of S$48m. Making some assumptions on redemption, GEH will make an estimated S$250m provision to be reflected in its 3Q09 results.

Possible GELM 30% divestment: With a FY2008 EV of S$1.64bn and FY2008 net profit of S$144.7m, 30% of GELM may generate over S$0.49bn (S$1.04 per GEH share) in sale proceeds, but at the loss of about S$43m in income contribution based on FY2008 profits (15% of GEH FY2008). In July 2009, GELM began a formal bancassurance partnership with OCBC Malaysia, distributing life products through its 29 bank branches.

Fortune REIT proposes acquisition and 1-for-1 rights issue; positive for ARA

ARA-managed REIT, Fortune REIT, has announced 1) the proposed acquisition of three suburban retail properties in Hong Kong for HK$2,039 mn (+23% to FRT’s AUM), 2) securing of debt facilities of HK$3.1 bn to refinance existing term loan facility due in June 2010, and 3) a 1-for-1 rights issue at HK$2.29/right to raise HK$1,889 mn (a 44% discount to the last trading price, a 28% discount to TERP of HK$3.2).

As the manager of the REIT, ARA stands to earn a one-off acquisition fee of HK$20.4 mn (S$3.8 mn, being 1% of the purchase consideration) and also HK$6.3 mn as Advisory Fee.

We leave our estimates unchanged for now as the deal is subject to EGM approval on 11 September and due to be completed around mid-October 2009. The acquisition could boost ARA’s AUM by 3% from S$12.6 bn, and its FY09E EPS by 10% (due to the one-off fees) and FY10-11E EPS by 3% (recurring AUM fees).

We continue to like ARA for its high cash generative and scaleable business model. With positive momentum at both REITs and private funds, it is on track to growing its AUM to S$20 bn from S$12.6 bn by 2012. Maintain OUTPERFORM.

United Overseas Bank - hold with the results

Results review UOB reported a 21.8% decrease in core net earnings to S$470 mil (- 21.8%yoy, +15.0%qoq, 1Q09: S$409 mil) due to higher impairment charges but largely buffered by a steep decline in taxes. Effective tax rate for the quarter was 4.58% versus 20.1% in 2Q08.

Net interest income grew 3.9% to S$908 mil (+3.9%yoy, -4.3%qoq, 1Q09: S$949 mil) over the year as funding costs fell faster than asset yields. Net interest margin was higher at 2.35% as compared to 2.23% last year.

Non-interest income was unchanged at S$551mil as profit from other operating income, i.e. change in fair value of financial instruments, compensated for the lower fee and commission income.

Operating expenses were capped at S$520mil (+0.4 yoy, +5.9% qoq) as lower staff costs offset higher revenue related expenses. Cost to income ratio declined to 35.7%. Total impairment charges rose 158% over the year to S$465mil as collective impairment of S$321mil was set aside for loans, investments and foreclosed assets. Individual impairments more than doubled to S$151mil as Singapore impairments shot up to S$88mil as compared to a write-back of S$9mil last year.

Loans expansion slowed as gross loans expanded 0.1% in 2Q09 to S$100.3bil (+0.1% yoy, -1.7% qoq), driven by housing loans (+10.1% yoy) and professionals and private individual loans (+8.7%). However, the growth from these industries was negated by loans contraction in financial institutions, manufacturing and general commerce industries. Asset quality deteriorates as the Group recorded higher NPL of S$2.48bil and higher NPL ratio of 2.4% as compared to the 1.5% last year. Total cumulative allowances amounted to 100.0% of NPLs as compared to 128% last year.

Total CAR ratio increased to 17.5% with Tier 1 also higher at 12.6% from the issuance of Class E preference shares, higher retained earnings and lower riskweighted assets. The Bank also declared an interim dividend of 20 cents per share.

Macro economy improves The Ministry of Trade and Industry expects the Singapore’s GDP to contract by 4.0% to 6.0% in 2009, up from the previous estimate of –6.0% to –9.0%. This was largely due to an upward revision of the output estimate in 1Q09. Unemployment rate was also capped at 3.3% in June 2009 as Government introduced many initiatives for the employers to keep and retrain the workers. The two integrated resorts that are slated to open in 2010 will also provide employment opportunities and keep unemployment rate in check. With the property market heating up again and YTD consumer loans in Singapore growing at 3.81%, we are also revising our Singapore system loans growth in 2009 from –4% to 1%.

Recommendation As the economy improves in this Island state, we are lowering the market risk premium in our valuation to 6% from 6.5% we used during the financial crisis. Accordingly we adjust our target price to $17.00, peg to 1.61x FY09 NAV. However, this matrix valuation is a discount to the 5-year average P/B valuation of 1.64x NAV. Maintain HOLD rating.

OCBC - 2Q09 beats expectations

Following a 1.5% q-q decline, OCBC’s loanbook has contracted 2.6% YTD (sector: -0.5%) on a mix of weak credit demand and continuing repayments. Net interest margin was lacklustre, falling 13bps q-q to 2.29% as management moderated gapping activities despite a steepening yield curve (controls are slowly easing now).

Buoyant non-interest income (NII) (+22% q-q) was underpinned by a 25% q-q recovery in fee income (primarily capital market-related) and a doubling in life assurance profit, driven by valuation gains on 87%-owned life insurer GE’s non-par funds. Credit costs sharply undershot, at 76bps on an annualised basis (FY09F: 100bps) and with the bulk being for non-loan assets; gross NPL ratio inched higher (+30bps to 2.1%; mostly from manufacturing and transport in Singapore), while loan loss cover slipped below 100%, to 97%.

Apart from better-than-expected earnings momentum, OCBC should see a pick-up in book value from a S$640mn mark-tomarket gain on AFS securities – this equates to S$0.20/share and could expand over 3Q09F should equity and debt prices continue to rally. With insurance demand likely to gain traction over 2H09, and management indicating the inflow of new NPLs has slowed from 1Q09, our fee and credit cost assumptions are under review.

Our existing Gordon Growth-based price target (methodology unchanged, assuming 11% sustainable ROE, 9.5% cost of capital and 5% longterm growth) is S$8.10, implying 1.6x FY10F adjusted book value (1.4x stated book) and 12.5x FY10F earnings. Worsening credit conditions and another knock-on drop in property prices and demand would be a key earnings risk, given some 50% of the loan book consists of exposures to mortgages and building & construction loans. While we are relatively comfortable with the Singapore loan book (59% of total book) given the relative strength of domestic corporates and the broad lack of leverage in the system, the Malaysian book (19% of total) looks more vulnerable and could surprise negatively if execution of the sizeable fiscal stimulus measures aimed at cushioning the economy from the downturn is poor, or if commodity prices collapse.

Ready to Sing- upgrading price targets, UOB to Buy

Despite recent share price strength, we see further upside from current levels. A more benign economic outlook suggests earnings upside in '10e and beyond, on improved revenues and falling loan losses. This is only partly captured by our 5-6% EPS upgrades. And given our analysis of historical trends suggests 20%+ upside to current valuation multiples, we think investors should be overweight the sector. DBS is our key Buy (23% TR upside) while we also upgrade UOB to Buy (18% TR upside) with price targets raised across the sector.

Our analysis of historical trends indicates Singapore banks tend to deliver strong absolute and relative share price performance in the year following a trough in GDP growth. The sector typically trades at a premium to average PB and PE multiples post recession, reaching an average 1.9x within one-year post downturns in 1998 and 2001, roughly 27% above current levels. In PE terms, while the premium to average is less pronounced (5% above 15.7x ave. post3Q98 and 3Q01 trough) this still represents 18% upside from the current sector PE of 13.9x.

With the fall in equity markets reducing total sector income by 5% in 2008 we see scope for revenues to rebound materially as a result of improving market conditions. And our analysis suggests loan losses should normalise rapidly as the economy recovers. Within 2-3 years of the 3Q98 and 3Q01 GDP troughs Singapore loan loss rates fell to 16bps and 19bps respectively, well below the 45bps sector’s 2000-08 average (69bps 2008) . Applying the 45bps average rate to 2010e loan forecasts implies earnings 16-22% above our previously published estimates. This upside is partly captured by our 5-6% upgrade to 2010e EPS across the board, but still implies a further 10-16% EPS upside should loan losses return to average levels. And given loan loss rates typically ‘overshoot’ average levels as the cycle matures, medium term EPS benefits could be even greater.

TP’s raised for DBS ($16.50 from $14.50), OCBC ($8.10 from $5.80) and UOB ($20.30 from $14.50). Valuation based on Gordon growth model with COE 7.5% and terminal growth 2% revised up from 0.8% to better reflect long term GDP growth prospects. We now base ROE assumptions on explicit three-year forecasts, compared to previous methodology which reflected estimated sustainable ROEs. Note book value estimates exclude the benefit of unrealised revaluation gains. Key sector downside risks are a downturn in investment markets adversely impacting market-sensitive income, and worsening asset quality as a result of a worse-than-expected global economic slowdown. Key upside risk for OCBC is if there is a further narrowing in CDS spreads, driving higher book values (details pp 14-16x).

Singapore Exchange - FY09: The future is more relevant

Singapore Exchange’s (SGX) FY09 net profit dropped 36% yoy to S$306m. The results were in line with our expectation. ADT dropped 42% to S$1.23b in FY09, leading to 34% yoy decline in revenue from the equity market. Nonetheless, SGX staged a major comeback in 4QFY09 with 65% qoq increase in net profit as ADT surged 84% qoq to S$1.68b.

While our assumed turnover velocity remains largely unchanged at 96.2% (vs 108.1% in May 09), total market capitalisation for shares listed on the SGX rose from S$533b at end-Jun 09 to S$605b at end-Jul 09. Hence, we lift our ADT assumptions for FY10 (from S$2.03b to S$2.24b) and FY11 (from S$2.13b to S$2.31b). As a result, we raise our FY10 and FY11 earnings forecasts by 13% and 12% respectively.

We raise our target price from S$9.50 to S$10.80 (23.6x FY10 PE). The 23.6x PE is the average between the historical average PE and the average of the highest PE for every fiscal year since SGX’s listing. While the A-share and H-share markets have stronger appeal to China enterprises than SGX (due to valuation gap and stronger market liquidity), SGX’s successful diversification strategy, as evident from its non-Singapore derivatives offerings, should ensure long-term growth. As our revised target price represents 27% upside from the current level, we upgrade the stock from HOLD to BUY.

SGX - 4Q09: marginally below

Average securities daily value traded (DVT) in 4Q jumped 85% q-q to S$1.7bn, taking FY09 DVT to S$1.2bn as per Nomura forecasts. Our FY10F securities revenue forecast imputes DVT improvement, to S$1.6bn — this is where FY10F YTD DVT currently stands, which, we believe, is relatively light given the strong rise in benchmark indices, ie, risk of DVT undershooting should the market pull back. We estimate every 10% change in DVT (assuming no change in effective clearing fee) moves forecast earnings by just over 5%.

Derivatives and stable revenues, together 50% of operating revenue, underperformed. Traded contracts saw broad rebound over 4Q but at shallower pace than expected, while stable revenue remains hobbled by weak corporate activity and IPOs, the latter standing at just 15 for the whole of FY09 compared to 60 in FY08.

New products (eg, OTC clearing, single stock futures) and the accompanying infrastructure (ie, new trading, clearing and data engines) are delivering positive, increasingly diversified revenue traction (eg, algo trading is now 21% of derivatives volumes vs 14% in Dec) but progress remains incremental. While opportunities in areas like CDS clearing and dark pools are being explored, SGX will remain hostage to DVT expectations well into the medium term.

We derive our price target using a P/E-based method derived from the Gordon Growth model. With market equity risk premium and stock beta pegged at 6% and 1.6x respectively, we estimate cost of equity of 11.5%. We derive a fair P/E of 19x, which when applied to FY10F (June year-end) adjusted net profit of S$415mn, gives a fair value of S$8.0bn. On the current share base of 1,072mn shares, this comes to a price target of S$7.40. Risks include another slump in market sentiment, which would depress trading interest and hence, clearing fees. A pick-up in regional competition for listings and derivatives contracts would stunt SGX’s growth appeal, given its drive to become the region’s primary pan-Asian listing and derivatives market. Finally, an SGX participant defaulting on its obligations could potentially threaten the entire system though this risk is mitigated by imposition of safeguards ranging from position limits and circuit breakers to margin requirements.

UOB: Signs of improvement; upgrade to $17

Net earnings of S$470m were ahead of consensus. UOB posted 2Q09 earnings of S$470m, down 22% YoY but up 15% QoQ, and better than S$426m based on a Bloomberg poll. Earnings for 1H09 fell 22% to S$880m due mainly to higher impairment charge, which rose sharply from S$180m in 2Q08 to S$378m in 1Q09 and S$465m in 2Q09. About S$321m was set aside for loans investments and foreclosed assets in the quarter. Net interest margin of 2.35% was better than 2Q08's level of 2.23%, but was down from 2.41% in 1Q09. Customer loans grew modestly, up 0.4% YoY (down 1.9% from the previous quarter) to S$97.8b by end-Jun 2009. Management has declared an interim tax-exempt dividend of 20 cents which will be paid on 2 Sep 2009.

NPL rose for another quarter. While most ratios were healthy, nonperforming loans (NPL) rose from S$1547m in 2Q08 to S$2185m in 1Q09 and hit S$2476m in 2Q09. NPL ratio also increased from 1.5% to 2.1% to 2.4% for the same periods. With uncertainty still a factor in the market, this ratio is likely to edge up slightly in the current quarter. Economic prospects are improving. The recent pick-up in equity markets should help to beef up fee income and associates contribution for 3Q09. In addition, improving key economic indicators from the US and China are signalling that the world economy is recovering. In Singapore, recent sharp appreciation in property prices is also indicating that loan demand is getting stronger. While we are cautious about impairment charges, we believe that 2Q09 should be the peak and it should start to taper off in the coming quarters.

Retain HOLD, raised fair value to S$17. With the more buoyant outlook, we have raised our earnings for FY09 and FY10 by 15.4% and 10.6%, respectively, to S$1978m and S$2274m. We continue to like UOB for its prudent management stance as seen from its low cost-to-income ratio of only 36%. While demand is showing signs of picking up, sustainability remains unclear. Against this backdrop, we are reluctant to revert back to peak valuation methodology (of more than 1.8x book). However, we do take note of the recent re-rating in the market, and we are raising our peg from 1.5x to 1.7x book, increasing our fair value estimates from S$14.70 to S$17. Maintain HOLD rating on the stock.

OCBC - profit beat from provisions and insurance; already priced in

Event: OCBC reported 2Q09 profit of S$466 mn, up 26% QoQ/22% YoY, ahead of our forecast of S$398 mn and consensus of S$357 mn. Beat came from lower provisions and higher insurance income (from investments), helped by better-than-expected fee income and good control on costs.

View: Key earnings drivers (loan growth, margins, NPLs) remain soft and the main factors behind earnings revision are lower provisions and higher trading income, both relatively inferior quality. 2Q09 performance was robust but boosted by capital markets (fee, insurance) and volatility (trading). In terms of key drivers, OCBC managed to maintain loan spreads but overall margins were down QoQ and are likely to remain at current levels. Loan book is not really growing while NPLs continue to creep up, albeit at a slower pace. Fee income and insurance should hold up in 2H09, but insurance would be hit by a S$218 mn liability in 3Q09 on early redemption of CDOrelated structures sold by insurance subsidiary to retail investors.

Catalyst: CDO-related loss in 87%-owned Great Eastern Holdings could create a drag. Other than that, we do not see any major catalyst near term, unless the economic recovery leads to strengthening of earnings drivers. An interesting angle would be whether OCBC takes this opportunity to make a general offer for the remaining 13% stake in Great Eastern Holdings.

Valuation: OCBC’S 1.6x P/B 2009E and 17.4x P/E 2010E correspond to a range of 10.5-11.0% ROEs, which is what we are forecasting for 2011E and using for our new target price of S$8.0 (from S$6.5), hence the upside is relatively limited, in our view. OCBC has doubled from the March lows but has underperformed peers.

UOB: Stillbuilding up reserves

Mild upside surprise. 2Q09 net profit of S$470m (+15% q-o-q) was driven by non-interest income and one-off recognition of deferred tax assets. Collective impairment continued to rise while specific provisions edged down. Provision charge-off rate up to 1H09 was 87bps (63bps from collective impairment). NPL ratio inched up to 2.4% led by manufacturing, general commerce and financial institution sectors. NIM compressed by 6bps due to lower asset yields and interbank rates, coupled with 2% loan contraction q-o-q. Deposits shrank 2% q-o-q with lower fixed deposits, and loan-to-deposit ratio was flat at 84%. Capital ratios were higher due to lower risk weighted assets. An interim 20 cents DPS was declared.

Lower FY09F earnings, but raised FY10F/FY11F. We raised our collective impairment assumption, which raised over-provision charge-off rate for FY09F to 108bps, from 85bps. We raised NIM by 10bps, but reduced loan growth to 3% for FY09F. Non-interest income is raised to reflect improved capital market activities. All in, we cut FY09F earnings by 4%, but FY10F/FY11F earnings are raised by 13%/27% mainly due to lower provisions. We also revised estimated book value to reflect the adjustments to its AFS portfolio.

Maintain Buy, TP raised to S$18.60. UOB’s result is less impressive than OCBC’s, but we believe the key catalyst to UOB’s valuation lies in the normalization of its book value. In the longer term, UOB’s ROE of 13% stacks up better than its peers, hence our preference for UOB over OCBC. Our revised target price of S$18.60, based on the Gordon Growth Model, implies 1.6x FY10F P/BV (mid-cycle valuation).

ARA Asset Management: Revving its growth engines

Results showed resilience. ARA Asset Management (ARA) reported a stable set of 2Q09 results. Gross revenues climbed 23% yoy to S$20.6m as a result of (i) a stable AUM base and growing performance fees from higher NPIs from its listed REIT vehicles, (ii) 3rd closing of Dragon fund back in June 2008, (iii) one-off S$2m gain from selling of certain units in its managed reits for working capital purposes. Net profit grew by 35% to S$11.9m due to a lower than expected increase in operating expenses. For 1H09, the board declared an interim dividend of 2.3 Scts (higher than 1H08 of 2.17 Scts), translating to a payout ratio of c60%.

In view of the higher than expected operating margins, we have revised up our FY09 EPS by 14% to 7.6 Scts.

Re-rating catalysts - further possible avenues for AUM growth. ARA is set to resume its AUM growth trajectory. A new PE fund targeted at the healthcare sector may be launched in the near term. We estimate total AUM size for this fund to be US$500m, to close by 1H10. In the REIT space, we could potentially see new developments given the more buoyant and improving liquidity in current capital markets.

Contribution from the new PE fund could add 1 Scts EPS assuming full year contribution. This would increase our EPS estimates to 8.1 Scts in FY10 and 8.5 Scts in FY11.

Maintain BUY, TP adjusted to S$1.02 based on SOTP. Our TP is adjusted higher mainly as a result of new fund contribution in 2010. Further upside potential will derive from ARA (i) launching new REITs & PE funds, (ii) larger than projected AUM for its new PE fund.

OCBC - 2Q09 Profit S$466m Ahead of Forecast on Lower Provisions

2Q profit ahead of Citi 2QE S$400m: Near flat qoq pre-provision profit lifted by sharply lower provisions charges drove a 26%qoq rise in net profit (1Q: S$370m excluding one-time items, reported S$545m). Pre-provision profits saw lower net interest income on a 13bps qoq fall in margins but stronger markets-driven fee income. Provisions charges at an annualized 53bps (1Q: 99bps) of net loans reflecting the bank's view that inflows of new NPLs have slowed. OCBC estimates that it will suffer a negative impact of about S$218m in its 3Q09 result from Great Eastern's decision to redeem S$594m of its "GreatLink Choice" product.

2Q09 profit S$466m, +26%qoq: (1Q recurring: S$370m, less one-time life profit of S$175m net of tax). 2Q09 NII S$710m -4%qoq: Loans -1.5%qoq, NIM 229bps (1Q: 242bps). Loan-to-deposit spread 2.81% (1Q: 2.79%), LDR 82%. Non-II 2Q S$494m (1Q: S$432m excluding one-time profit S$175m) +14%qoq, fees S$194m (+25%qoq), insurance earnings S$157m, other income S$143m (1Q: S$155m) on lower FX/dealing income. Costs S$450m, +9%qoq, on higher insurance-related costs. Provisions S$104m (1Q: S$197m). NPL ratio 2.1%, coverage c97%. Tier-1 ratio 15.4%. 2Q09 annualized EPS S$0.56 (1Q recurring cash EPS S$0.48), BPS S$4.94 (1Q: S$4.75).

2Q09 provisions S$104m: annualized 53bps of loans (1Q: S$197m, 99bps): S$44m specific loan provisions, S$55m other assets impairment, S$5m general. 1Q included S$94m allowances for corporate CDOs.

Total CDO portfolio S$255m (1Q S$305m): ABS CDO portfolio S$95m is 100% provided. The S$160m corporate CDO portfolio has cumulative allowances of S$95m, and including S$65m of cumulative mark-to-market losses previously recognized to the income statement, in effect full provision has been made. Credit rating of total CDO portfolio as of Jun-09: BB: 23%, CCC: 57%, CC:20%.

GreatLink Choice redemption: Great Eastern is making a one-time redemption offer to policyholders of this product. The 5 tranches of this product had invested premiums of S$594m, a Jun-09 NAV of S$217m, and coupons paid of S$48m. Making some assumptions on redemption, GEH will make an estimated S$250m provision (OCBC's share S$218m) to be reflected in 3Q09 results.

Singapore Exchange: Raised fair value to S$8.35

FY09 results came in slightly better than expected. Singapore Exchange Ltd's (SGX) posted FY09 earnings of S$305.7m (-36% YoY) which came in slightly above market expectation of S$297m (from Bloomberg). This meant 4Q earnings of S$91m, flat YoY but +65% QoQ. This was evidenced from the strong trading activities in May. FY09 revenue fell 23% YoY to S$594.8m, with declines in all three key segments; Securities Market Revenue -34%, Derivatives Revenue +0.2% and Stable Revenue -14%.

While IPOs and the average trading value fell in FY09, higher secondary capital raising activities helped to prop up the Securities Market. Total group operating expenses fell 5.6% YoY to S$227.6m, giving FY09 operating profit of S$367.3m. Management has declared a final dividend of 15.5 cents (quarterly base of 3.5 cents and a variable dividend of 12 cents), giving full year dividend of 26 cents (FY08: 38 cents), or a payout ratio of 90%. Based on yesterday's closing price, dividend yield is 3.0%.

Outlook is uncertain, but showing more positive signs. Although average daily trading volume has tapered off from May's peak, the recent rally has boosted interest and is a reflection of the growing confidence in the economy and the equity/derivatives market. IPOs are also slowly tickling back into the Singapore market. With the recent infusion of liquidity into the market, we expect this to translate into more capital market activities which will in turn buoy SGX's revenue. Taking into account improving economic outlook and better sentiment, we have raised our FY10 earnings by 6% to S$333m. In addition, we are also introducing our FY11 forecast and are projecting earnings of S$381m, up 14.5%.

Raised fair value to S$8.35. We do not expect the transition to the new CEO at the end of this year to bring about dramatic changes at SGX. We expect SGX's key drivers and objectives to remain on developing new products and growing its existing businesses (including working on more strategic working relationships). With the recent rally in the market, SGX and its regional peers have similarly been re-rated, and are trading at an average PER of 29x (range from 17-50x). We are raising our peg from 20x to 25x (but still below peak valuation of more than 30x), giving a fair value estimate of S$8.35 (previous: S$5.60). At current price, we are maintaining our HOLD rating on the stock.

Singapore Banks - The start of a new credit cycle

Accelerated growth in total deposits. Total deposits in Domestic Banking Unit (DBU) grew at an accelerating pace of 7.9% in Apr 09, 9.1% in May 09 and a double-digit rate of 11.7% yoy in Jun 09. Growth in deposits has been driven by demand deposits (current accounts) and savings deposits, which expanded 17.0% and 23.8% yoy respectively in Jun 09.

Deposit growth leads credit expansion. We surveyed economic cycles in the past 20 years and concluded that expansion in deposits typically leads expansion in loans, normally by 3-12 months. This happened in previous economic recoveries in the mid-80s, post-Asian financial crisis and post- SARS. As such, we expect current strong growth in deposits, a harbinger of a new credit cycle, to lead to stronger loans growth in 2010.

Loans growth a lagging indicator. Overall loans growth remains anaemic at 3.7% yoy. Growth is driven by loans to consumers. Housing loans expanded 1.5% mom and 7.5% yoy due to accelerated drawdown as more private residential projects received temporary occupation permit (TOP). Credit cards loans grew 4.2% mom and 7.1% yoy due to buoyant domestic spending during the Great Singapore Sale (GSS) in May and June. Loans to businesses lag economic recovery and increased only 1.8% yoy in Jun 09.

Strong growth in deposits reinforces our positive view on Singapore banks, indicating the start of a new credit cycle. Singapore banks face less competition as foreign banks retreat while an easing of the credit crunch provides positive industry dynamics. Systemic risk has reduced, paving the way for valuations to recover to pre-crisis levels.

We tentatively keep our earnings forecast unchanged because all three local banks will be announcing their 2Q09 results this week.

OCBC : 2Q09 Results Management Briefing Highlights

OCBC now at 1.6x P/B — A relatively muted price response to a better than consensus 2Q result suggests that the recent price rally had largely discounted a good result, with valuations already close to mid-cycle levels. Revenues were largely capital markets driven, while net interest income dipped on limited loan opportunities and softer margins. Management explained that the qoq rise in NPLs was due to some lumpy accounts, but that generally the new NPL trend is slowing. Rising equity markets lifted AFS reserves by S$580m (S$0.18/share)

Commentary — New NPL inflows have slowed across all key markets. The rise in 2Q NPLs, especially in Singapore, were due to some lumpy loans that were classified as substandard for early recognition but management do not anticipate losses from them. Loan growth is coming from mortgages and SMEs. Loan spreads may have peaked, but the near-term margin squeeze is from lower gapping profits. Management believes that the S$250m provision against the "GreatLink Choice" redemption will prove to be adequate.

2Q09 profit S$466m, +26% qoq — (1Q09 recurring: S$370m, less one-time life profit of S$175m net of tax). 2Q09 NII S$710m -4% qoq: Loans -1.5% qoq, NIM 229bps (1Q: 242bps). Loan-to-deposit spread 2.81% (1Q: 2.79%), LDR 82% (1Q: 87%). Non-II 2Q S$494m (1Q: S$432m excluding one-time profit S$175m) +14% qoq, fees S$194m (+25% qoq), insurance earnings S$157m (1Q: S$122m), other income S$143m (1Q: S$155m) on lower FX/dealing income. Costs S$450m, +9% qoq, on higher insurance-related costs. Provisions S$104m, 53bps of loans (1Q: S$197m, 99bps). NPL ratio 2.1%, coverage 97%. Tier-1 ratio 15.4%. 2Q09 annualized EPS S$0.57 (1Q recurring c ash EPS S$0.46), BPS S$4.94 (1Q: S$4.75).

OCBC - Gesture of goodwill from Great Eastern

OCBC’s insurance subsidiary, Great Eastern, will make a one-time redemption offer to policyholders for investment in GreatLink Choice (GLC), a series of investment-linked products with underlying investments in collateralised debt obligations (CDOs). The product has a built-in loss protection and is diversified across multiple industries and geographical regions. Unfortunately, market values for GLC products are at steep discounts to par (38.9-80.8% discount) due to credit events triggered by the global financial crisis.

Great Eastern will redeem 594m GLC units at $1.00 each. GLC policyholders taking up the offer will receive a refund based on their original investment amounts less total payouts received to-date, and the insurance coverage will cease. Great Eastern will take delivery of the underlying CDOs and will account for the fair value of these instruments at the close of the offer period.

This is a one-off gesture of goodwill to pacify Great Eastern’s loyal policyholders.

We expect investors to focus on the positive outlook for the banking industry. Local banks face less competition as foreign banks retreat while an easing in the credit crunch provides positive industry dynamics. Systemic risk has reduced and this paves the way for valuations to recover to pre-crisis levels.

Latest MAS statistics showed accelerated growth in total deposits of 11.7% yoy in Jun 09, indicating the start of a new credit cycle.

The financial hit will be incorporated in Great Eastern’s 3Q09 results and is estimated at S$250m. The negative impact on OCBC 3Q09 results is expected at around S$218m.

Maintain BUY. Our target price of S$8.12 is based on a P/B of 1.58x derived from the Gordon Growth Model (ROE: 11%, payout ratio: 48%, required return: 8% and constant growth: 4.5%).

Singapore Banks - June Loans Rise on Mortgage Growth

Singapore mortgage growth rose 4% YTD — Domestic system loans rose by 0.5% MoM (+4.2% YoY, flat YTD) to S$272bn as consumer/mortgage growth offset continued weakness in business lending (down 3% YTD). The completion in 2009 of an estimated 4,560 units under the DPS scheme and another 2,540 units in 2010 is likely driving mortgage drawdowns, with this year's pick-up in property transactions also likely to assist mortgage momentum in 2010. Loan-to-deposit ratio fell to 73.1% (May: 74.3%) as system deposits rose by 2.1% MoM to S$372bn (+11.7% YoY, +7% YTD), suggesting liquidity remains flush.

Sharp rebound in 2Q09 GDP — The 20.4% QoQ SAAR jump in 2Q09 GDP marks the first QoQ increase since 1Q08, and together with the upward revision to 1Q09 numbers will provide a statistical uplift to GDP numbers for rest of ‘09. Economist Kit expects GDP to contract 2.7% for ‘09 (vs. govt. forecast of -4 to -6%).

Banks, STI closing in on mid-cycle P/B levels — Our investment case for the banks is that Singapore will return to positive YoY GDP growth by 4Q09, so banks (and the STI) should normalize towards mid-cycle P/B levels. A rally of c.20% in 3 weeks has brought the banks (and STI) close to those mid-cycle P/B values. While we expect 2Q09 results (out first week of August) to surprise a bearish consensus on the upside, prices already may be factoring in strong 2Q results. If Singapore can pull out of recession in 3Q09, and the banks deliver 2Q numbers ahead of our above-consensus forecasts, then the recent rally might be sustained.

ARA Asset Management: Bagging a trophy asset

Growing its AUM. ARA Asset Management Ltd (ARA) announced its appointment as asset manager and convention and exhibition services provider for “Harmony Fund” post the fund’s purchase of Suntec Singapore International Convention & Exhibition Centre for S$235m. One of ARA’s managed reit – Suntec REIT, is a 20% stakeholder in this fund.

A strategic acquisition. We view this transaction as a strategic move for ARA as it will control both the convention centre and as manger of Suntec REIT - the adjacent office and retail mall. This will give ARA the free role in realizing the full potential of one of Singapore’s iconic asset amidst the re-making of downtown Marina Bay area with the upcoming Marina Bay Sands Resort.

Growing EPS by 10% in FY10. ARA is expected to earn management fees as asset manager & service provider for the fund, we project these fees to increase EPS in FY09 and FY10 to 6.6 Scts and 6.9 Scts respectively.

Maintain BUY, TP S$0.89. We have revised our valuation metrics to sum of the parts (SOTP) valuation, which is likely to reflect fully its strategic equity stakes in Suntec REIT and AmFirst REIT. Our SOTP valuation of S$0.89 offers 31% upside.

Singapore Banks - Firm loan recovery in June on mortgages, back to end-08 levels

While Singapore system S$ loan growth in June continued to slow on a yoy basis, +4.2% vs May’s 5.5% and December-08’s 16.6%, it was positive to see Singapore system S$ loans recover to end-2008 levels for June loans’ sequential growth of +0.5% mom. Growth was largely driven by mortgages, +1.5% mom, on an improved property market with property transactions reaching record highs in June, as well as new loans for completed properties under the Deferred Payment Scheme. Broadly, corporate loans were flattish, -0.1% mom, despite a 2.6%/2.5% mom fall in manufacturing loans/non-bank financial institution loans. For the first time since early 2008 on yoy basis, manufacturing loans fell, -5.2%. Building & construction loans continued to contract at -0.3% mom, down since last April. SME loans fell 0.9% mom, despite continued take-up of new loans under Singapore government’s risk-sharing lending scheme - April: S$1.1bn, May: S$0.8bn, June: S$0.8 bn. Consumer loans remained the most resilient, continuing a positive sequential momentum throughout the downturn, June +1.5% mom. As with the previous 4 months, every consumer sub-segment saw growth except for car loans. Asian Currency Unit (ACU) loans also grew 0.6% mom, but are down 6.6% yoy.

System deposits grew 2.1% mom on broad growth across both CASA (+1.6% mom) and fixed deposits (+2.7% mom). Fixed deposit growth in June was surprisingly strong, for the first time since end-2008 it saw growth on a yoy basis (up 2.6%). We note 3M SIBOR has stayed at 0.69% since February. Loan-to-deposit fell to 73.1% vs. May’s 74.3% on stronger deposit growth. Upside risk to our loan growth forecast; staying positive With the loan recovery in June, system loans are back to end-2008 levels.

While our forecast is for loans to stay flat this year, the recent improved property market, which has been supportive of this year’s mortgage loans, could pose upside risk to our loan forecast. We are maintaining our forecast, pending further evidence of stronger mortgage loan growth momentum. We forecast mortgage loans to grow 5% in 2009E vs ytd 4.1%. We retain our positive stance on Singapore banks, key catalyst to watch is 2Q results, which we expect credit losses to positively surprise in an NPL-light cycle. Our top pick is DBS (DBSM.SI, Buy, Conv List). Key sector downside risks: prolonged global recession; larger-than-expected NPL/credit costs.

OCBC: Most goodies priced in

Better than expected 2Q09. Net profit was S$466m (+26% q-o-q vs 1Q09 core earnings), ahead of street and our expectations due to lower provisions and higher non-interest income. Note that 2Q09 specific provisions fell 50% q-o-q. NPL ratio rose to 2.1% led by the manufacturing and general commerce segments. Loans contracted 2% q-o-q due to corporate loan repayments. The provisions set aside for Great Eastern¨s redemption of its GLC products would have offset the one-off item OCBC booked in 1Q09. Our FY09F net profit of S$1.4bn reflects core earnings. Interim 14.0 cents DPS was within expectation (scrip dividends is an option).

Tweaked assumptions. We raised our NIM assumptions by 4bps for FY09F and 5-7bps for FY10-11F, to reflect normalized SIBOR rates by end 2010. We lowered loan growth to 3% for FY09F (from 6%), but left FY10-11F loan growth at 6%. We also lowered our provision estimates by 3-10% for FY09-11F, leading to provision charge-off rates of 47-55bps for the same period. All in, earnings are revised by 4-23% for FY09-11F. We also revised our estimated book value to reflect the adjustments made to its AFS portfolio.

Goodies priced in. We believe the good news for 2009 has been priced in and to some extent 2010, too. We are downgrading OCBC to Hold, despite raising target price to S$8.00 after incorporating our revised earnings and book value. Our target price, based on the Gordon Growth Model, implies 1.6x FY10F P/BV (mid-cycle valuation).

DBS - Competitive advantage from strong deposit franchise

With huge base of savings deposits and largest exposure to the interbank market, DBS is prime beneficiary of recovery to positive GDP growth and higher SIBOR. Well positioned to expand in home base Singapore. Maintain BUY.

DBS Group Holdings (DBS) is a high-beta play on the eventual economic recovery, which is usually accompanied by higher interest rates. High-beta play on eventual economic recovery. DBS derives the bulk of its funding from savings accounts (DBS: 42.5% of customers’ deposits, OCBC: 19.2% and UOB: 22.0%), a stable and low-cost source of funding. It was the largest lender with S$28.3b parked in the interbank market as at Mar 09 (OCBC: S$14.5b and UOB: S$12.3b), equivalent to 10.5% of total assets. Current earnings have already factored in a depressed SIBOR. Net interest margin (NIM) will rebound when Singapore recovers to positive GDP growth, bringing about a higher SIBOR.

Streamlining for greater efficiency. DBS has cut headcount, streamlined its organisational structure and “de-risked” its treasury operations. There is latent growth potential in Singapore as the bank’s Singapore-dollar loan/deposit ratio (LDR) was only 57.4% as at Mar 09. It is a leader in providing financial services to large corporate and institutional clients and could expand market share in SME and consumer lending. DBS has instilled discipline in cost management and its cost/income ratio fell from 44.3% in 2006 to 38.4% in 1Q09.

Conservative classification of NPLs. DBS adopts a conservative approach in recognising non-performing loans (NPL) and taking provisions early. About 34.2% of its NPLs are not overdue (still current in interest and principal) compared with 16.7% for OCBC and 17.1% for UOB. This indicates that DBS is more stringent and conservative in the classification of NPLs.

We have raised our assumptions for loans growth to 7.8% for 2009 (previous: 6.4%) and 8.2% for 2010 (previous: 4.9%) to factor in increased demand from property developers and housing loans. Demand from general commerce should also improve as confidence returns, particularly in Asia. We have assumed the bank’s NPL ratio will hit 4.0% by end-10. Our earnings model has imputed allowance for credit losses of 120bp in 2009 (unchanged) and 80bp in 2010 (unchanged). We raise our 2010 net profit forecast by 3.1% to S$1,934m.
Valuation is attractive with P/B at 1.18x, the lowest among Singapore banks (OCBC: 1.47x, UOB: 1.67x). Our target price of S$14.43 is based on a P/B of 1.36x, derived from the Gordon Growth Model (ROE: 9.5%, payout ratio: 55%, required return: 8% and constant growth: 4.0%).

OCBC 2Q09 Results Flash

OCBC reported net profit of S$466m for 2Q09. The results were higher than our forecast of S$398m due mainly to lower provisions for NPLs and higher trading income.

Loans contracted 1.5% qoq to S$79.2b due to repayment of short-term loans and term loans by corporate customers. Net interest margin contracted from 2.42% in 1Q09 to 2.29% in 2Q09 due to lower gapping income.

Fees & commissions grew 25.1% qoq to S$194m with growth from brokerage, wealth management, investment banking and loans-related activities. It also recorded positive net trading income of S$61m.

NPLs increased by 14.3% qoq to S$1,628m due to manufacturing, general commerce and transport & communications sectors. By geographical regions, the new NPLs came from core Singapore and Malaysia markets. It is important to note that the increases in NPLs came from loans that are not overdue. We take this as a sign of conservative management and prudence.

OCBC made specific provision of S$44m and general provision of S$5m in 2Q09, represeting total provision of 25bp on an annualised basis. This is lower that provision of 45bp in 1Q09. OCBC also made provision of S$57m for investment in debt and equity securities. Preserved healthy NPL coverage of 97.1%.

Management commented that the inflow of NPLs has slowed across key markets.

OCBC remains strongly capitalised with tier-1 CAR at 15.4%. Core equity tier-1 is 11.3% after stripping out preference shares.

OCBC declared interim tax-exempt dividend of 14 cents/share, representing payout of 44% on core net profit for 1H09.

UOB 3Q09 Results Flash

Net profit of S$470m in 2Q09 (+14.9% qoq) was above consensus estimate of S$421m.

Performance was boosted by net gain of S$34m from trading activities and investment income of S$141m from financial instruments and S$63m from available-for-sale assets.

NPL ratio has increased from 2.1% in 1Q09 to 2.4% in 2Q09. General provision of S$151m was similar to last quarter but UOB made a large general provision of S$321m for loans, investments and foreclosed assets.

Tax was only S$23m (1Q09: S$112m) due to deferred tax assets.

Available-for-sale reserve recovered by another S$1.2b. Thus, NAV/share increased from S$9.37 to S$10.14. Tier-1 CAR has also improved marginally from 12.3% to 12.6%.

Singapore Exchange - Strong recovery in the final quarter

Singapore Exchange (SGX) will announce its FY09 full-year results on 5 August. We expect net profit to drop 33% yoy to S$319m mainly due to a contraction in average daily turnover (ADT) from S$2.12b in FY08 to S$1.26b in FY09. Derivatives revenue was largely stable as the number of derivatives contracts traded on SGX was largely unchanged at 55.5m in FY09 vs 53.5m in FY08. Nonetheless, SGX staged a major comeback in 4QFY09 with an estimated 76% qoq increase in net profit as ADT surged 90% qoq to S$1.73b.

While our assumed turnover velocity in FY10 remains largely unchanged at 96.2% (vs 76.8% in Jun 09), total market capitalisation for shares listed on SGX went up from S$377b as at end-Mar 09 to S$533b as at end-Jun 09. Hence, we have to raise our forecast market turnover. We raise our ADT assumptions for FY10 (from S$1.43b to S$2.03b) and FY11 (from S.1.46b to S$2.13b). As a result, we raise our FY10 and FY11 earnings forecasts by 35% and 39% respectively.

We raise our fair price from S$7.00 to S$9.50 (23.5x FY10 PE). 23.5x PE was the average between the historical average PE and the average of the highest PE for every fiscal year since listing. As the current price represents only 10% upside, we recommend investors buy at a lower price. Entry price is S$8.20. Maintain HOLD.

SGX - more upside

We initiate coverage of Singapore Exchange Limited (SGX) with a BUY call. Our fair value of S$10.42/share implies an upside of 22.3% based on DCF - assuming a discount rate of 10% and terminal growth rate of 2%.

SGX’s sizeable derivatives business (35% of operating revenue for 9MFY09) differentiates it from other exchanges and gives it a more diversified and stable earnings stream. SGX’s futures & options business has been remarkably resilient even in the current slowdown.

Quarterly securities turnover bottomed in 3QFY09 and we expect a recovery in volumes in FY10. Turnover velocity rose to 88.2% for 4QFY09, higher than averages of 76.5% and 70.9% for FY08 and FY09 respectively. Increased algorithmic trading and higher retail participation are expected to drive future growth.

SGX now has a stable revenue stream (from membership fees, terminal & connection fees, price information fees and others) that is less susceptible to market trading volumes. This is expected to account for 22.4% of total operating revenue in FY10.

The appointment of a new CEO Magnus Bocker may accelerate SGX’s push into forming strategic partnerships and alliances with other exchanges. Currently, SGX has a 5% stake in Bombay Stock Exchange and Tokyo Stock Exchange has a 4.99% stake in SGX.

SGX’s advanced trading engines for securities & derivatives are a key competitive advantage. Its clear technology roadmap will ensure that it can support the increased needs of algorithmic and high velocity traders.

SGX has a strong balance sheet with substantial cash hoard (estimated at S$739mil as at June 2009). Given its strong operating cashflows and rising cash reserves, we will not be surprised if SGX pays a special dividend to shareholders in the near future.

SGX’s valuation is attractive on a regional basis. SGX’s prospective PEs of 23.8x and 20.3x for FY10 and FY11 respectively are below the averages of 28.1x and 24.5x for its regional peers even though its two-year EPS CAGR of 21.2% is higher (versus regional peer average of 9.6%).

Key risks include a possible decline in securities turnover. We estimate that an every 10% fall in securities volume will impact FY10 net profit by 7.7%. The threat of ECNs (including dark pools) should not be discounted but its impact is expected to be limited.

Singapore Financials Strategy - How Much 2Q09 Results Upside Is in the Price?

Banks, STI closing in on mid-cycle P/B levels: Our investment case for the banks is that Singapore will return to positive yoy GDP growth by 4Q09, so banks (and the STI) should normalize toward mid-cycle P/B levels. A rally of c.20% in 3 weeks has brought the banks (and STI) close to those mid-cycle P/B values. While we expect 2Q09 results (out first week of August) to surprise a bearish consensus on the upside, prices already may be factoring in strong 2Q results. If Singapore can pull out of recession in 3Q09, and the banks deliver 2Q numbers ahead of our above-consensus forecasts, then the recent rally might be sustained.

2Q09 results—consensus too bearish: Bloomberg consensus estimates for 2009E remain bearish on the earnings prospects for the 3 Singapore banks, implying a quarterly profit trend that is flat or lower than what was reported by the 1Q09 results. We see upside surprise for 2Q in two main areas: lower provisions as the NPL cycle appears to be far more benign than first thought, and a lift to book value/share from positive revaluation of AFS investments. We predict 2Q profits of DBS S$470m (+8%qoq), OCBC S$400m (+8%qoq vs. 1Q recurring profits) and UOB S$460m (+12%qoq). UOB should see the most AFS gain and BV/S lift.

Bank price rally may have factored in stronger 2Q expectations: With the banks closing in on our price targets (UOB surpassing), we believe the market is already factoring a strong 2Q earnings performance, particularly for UOB and to a lesser extent DBS. Our analysis suggests that if our 2Q forecasts are achieved, they are being priced in PER terms at the +1SD level for UOB and DBS, and at the +1SD P/B level for UOB. Only OCBC would be trading closer to mean PER and P/B levels based on Citi's 2Q09 profit estimates.

Singapore Exchange (SGX)—4Q09 (June) forecast profit S$89m (+61%qoq): From a cycle-low Mar 2009 qtr net profit of S$55.3m on ADT of S$900m/day, we expect 4Q09 (June) results to reach S$89.3m (annualized EPS: S$0.34) driven by the recent surge in May ADT to S$2.1bn. We expect the ADT for the June quarter to reach S$1.7bn/day, or near double that of the previous quarter.

OCBC Malaysia to sell Great Eastern products

OCBC Bank has launched a partnership with insurer Great Eastern in Malaysia to sell life insurance products through the bank's branches there. The deal will expand the reach of Great Eastern - a subsidiary of OCBC - in Malaysia. Under the partnership, OCBC's Malaysian subsidiary will distribute insurance products developed by Great Eastern Life Assurance (Malaysia) through its 29 conventional banking branches. Initially, OCBC Malaysia will distribute two insurance products from Great Eastern Life Assurance (Malaysia) - MaxMoney Plus and MaxMoney Back. 'Bancassurance is an important segment of our consumer banking business,' said Andrew Lee, OCBC Bank's head of global consumer financial services. He hopes to duplicate the success the bank has had in Singapore, through its cross-selling of insurance products from Great Eastern. Until recently, OCBC Malaysia was not allowed to sell Great Eastern's products - regulations there did not permit a foreign bank and a foreign insurance company to work together.

In late April, however, Malaysian Prime Minister Najib Razak announced several broad changes aimed at liberalising the country's financial services sector, including greater flexibility for foreign financial institutions to operate within the country. In particular, the government removed a restriction that prevented locally incorporated foreign insurance firms such as Great Eastern from working with banks there to sell insurance. 'Following the implementation of the new liberalisation rules, we can now work with our subsidiary, Great Eastern, in Malaysia to grow our bancassurance business there,' Mr Lee said. 'We look forward to transferring successful business models and product solutions from Singapore to Malaysia.' At OCBC's first-quarter results briefing in May, chief executive David Conner told reporters that Malaysia's plan to open up its financial services sector further to foreign players would open up new opportunities for the bank and its subsidiaries. He said then that Great Eastern would apply for a takaful or Islamic insurance licence in Malaysia, while OCBC would be keen to add to the 29 bank branches it has there.

SGX - Volumes uncorked

We upgrade SGX to OW from UW and add the stock to our Asia Analysts’ Focus List with a Jun-10 PT of S$10, raised from S$5.60 previously. The revision is driven by a 40% increase in FY10e (June end) EPS to S$0.38, as we revise volume assumptions to S$2bn for the year. We expect earnings momentum and re-rating to drive the stock due to sustained revival in trading volumes. Our PT is based on fair PE of 26x, which is single stage DDM derived. We use 30% normalized RoE, 9% Ke and 6% terminal growth rate.

We recommend buying every dip on the stock price as we expect trading velocity to increase, albeit in the midst of continued volatility. The stock has underperformed the STI by 8.4% since our downgrade on 14 May, and we believe the seasonality and consolidation of volumes have played out and that the risk-return has turned positive. In addition to securities trading volumes, we expect increased derivative volumes (23% of revenues) and IPO pipeline to support earnings and re-rating.

SGX remains a fundamentally strong franchise in the medium term. The exchange continues to deliver product innovation and solid balance sheet and enjoys a monopoly in cash securities clearing. SGX stock price tends to be volatile as both PE and EPS expectations get revised simultaneously. We believe the stock is entering a phase of earnings momentum, and hence will be driven by earnings upgrade and PE re-rating. Please refer to page 4 for detailed view on valuation parameters for exchanges in various phases of investment cycle.

Key risks to our call include negative momentum as the stock acts as a high beta proxy to broader markets in the short term. Also, alternative trading platforms pose risks to SGX revenues, and hence also to our price target and recommendation. Please click on this link for our note dated 8 September 2008 for details on dark pools/alternatives.

UOB has the largest network of 41 branches among foreign banks in Malaysia

UOB benefits from the recovery in domestic consumption in Singapore. It is ranked number 1 in credit and debit cards with a total card base of above 1.5m. Professionals and private individuals accounted for 12.6% of total loans in 1Q09 (DBS: 7.8% and OCBC: 9.5%). UOB is the largest player for housing loans (24.2% of total loans) and financed one in three property transactions in 2008.

UOB has the largest network of 41 branches among foreign banks in Malaysia. Prime Minister Najib Razak’s plan to liberalise the financial sector has provided operational flexibilities. Locally incorporated foreign banks will be allowed to establish 10 micro finance branches with immediate effect and four new fullfledged branches in 2010.

Tier-1 CAR improved from 10.9% in 4Q08 to 12.3% in 1Q09 through the reduction of risk-weighted assets, higher retained earnings and a S$218m increase in available-for-sale reserves. The timely boost to tier-1 CAR has averted the risk of equity fund raising.

Singapore Banking - No major surprises seen

Interim results from 3 August. The 2Q09 results season will kick off with OCBC’s report on 3 August, to be followed by United Overseas Bank (UOB) on 5 August and then DBS Group Holdings on 7 August. We do not expect major surprises. Provisions will be the key swing factor. Overall, net profit (excluding one-off items) should show positive QoQ improvements in 2Q09.
Improvement in QoQ profit expected. Except for OCBC, we expect all three local banks to report a QoQ net profit rise in 2Q09. OCBC is expected to show a lower QoQ 2Q09 net profit because of its one-off S$175mil gain (net of tax and minorities) from the group’s 87%-owned Great Eastern Holdings recorded in 1Q09. Excluding this gain, OCBC should also see higher net profit in 2Q09 compared to the previous quarter. But 1H09 results of the three banks are still expected to show a YoY decline compared to 1H 2008 given much higher provisions made in 1H09.

Flat QoQ net interest income expected. Local banks are expected to report flat QoQ net interest incomes on the back of stable net interest margins and flat YTD loan growth. While interest spreads have widened on repricing of some loans, net interest margins may be weighed down by low S$ interbank rates in 2Q09. However, given a steepening in the positive yield curve (following the sharp rise in long-dated Government bond yields), there could have been opportunities for gapping profits in 2Q09.

Muted loan growth. We note that while industry housing loan growth has been very encouraging (+2.6% YTD as of May 2009), overall loan growth for the industry up to May 09 is still negative (-0.5% YTD). Lending to the commerce sector is still very weak, with YTD loan growth of negative 10.1% as of May 2009. But we think that with the downsizing in some foreign banks, local banks may have gained market share, particularly DBS. Hence, we think DBS would be likely to show highest loan growth among local banks.

Positive surprise may come from other income. Fees and commissions are expected to show marginal QoQ improvement as a result of higher brokerage income from more buoyant stock markets. One potential positive surprise could come from the banks’ other income or treasury income. We have been more conservative in our assumptions of local banks’ other income, which includes income from customer flows in interest rate and foreign exchange instruments - and the banks’ own proprietary book. Given the improvement in equity prices, these banks could have booked in higher gains from their trading portfolios in 2Q09.

Provisions could be lower-than-expected. Non-performing loans are expected to have risen in 2Q09 although we do not expect a sharp deterioration in the quality of the banks’ loan book. Local banks are expected to continue setting aside substantial provisions in 2Q09. But we think loan provisions for 2009 by DBS and UOB might be slightly lower - QoQ - given hefty amounts set aside in 1Q09. OCBC may report higher a QoQ rise in provisions given its low base in 1Q09.

Positive marked-to-market (MTM) adjustments. With the recovery in capital market prices since the lows in March 2009, we would expect to see positive marked-to-market adjustments for the banks’ available-for-sale portfolios in 2Q09. Note that any positive MTM adjustments to the banks’ AFS portfolios - in the case of UOB, which will be marked-to-model - would be made as a direct adjustment to equity and will help to boost BVs. UOB could possibly be the biggest beneficiary as it has the largest proportion of its AFS portfolio in equities and bonds (UOB: 60.2% as at December 2008 versus slightly more than 40% for the other two local banks).

Loan growth to pick up in 2H 2009. We expect loan growth in Singapore to improve in the second half of the year. One reason is that the buoyant sales in recent primary residential market launches (with 7,367 units sold in 1H 2009) will translate to loan drawdowns from 2H 2009 onwards. We would also expect loans to the manufacturing sector to pick up with the success of the Government’s sponsored SME loans under the SPRING scheme.

Reiterate our OVERWEIGHT call. We maintain our BUY calls on DBS, OCBC and UOB. Share prices of local banks are still below our fair values as derived from the Gordon Growth model. We think that there could be room for an earnings upgrade especially if the banks’ 2Q09 results were to turn out to be better-than-expected - and also if Singapore’s domestic economy continues to recover. We will soon be raising our GDP forecast to between -4% and -5% from an earlier forecast of -6% after Singapore’s positive 20% QoQ GDP growth in 2Q09.

UOB - Resilient operating earnings justifies premium

UOB outshines against its peers in terms of cost efficiency, earnings stability and high ROE. In 1Q09, it achieved the largest qoq cost savings and most stable net interest income (-0.8% vs peers’ -5%). Besides growing at 16% yoy in 1Q09 against the financial meltdown, UOB has been achieving better earnings stability in past years, recording 15-year core earnings CAGR of 11.6%, above the average of 10.5% for its peers.

Since the improvement in fair value of its AFS portfolio in 1Q09, UOB’s book value has reversed upwards from $8.90 to $9.37. Having the highest equity composition in its AFS investment portfolio (~10%) compared to its peers, UOB will be the prime beneficiary of the sharp rebound in equity values. The increase in equity prices globally (e.g. the MSCI world equity index was +19% since Apr and +39% since the low in March) points to further marked-to-market upside for UOB’s book value.

UOB’s well-managed asset quality is evident in the slight 6% qoq increase in its non-performing assets relative to a >20% jump at peers level in 1Q09. While specific provisions eased in 1Q09, the group has doubled up on its general provisions to buffer against the downturn. With coverage of 105% on its non-performing assets and a CAR ratio of 17.3% (highest in Singapore) that way exceeds regulatory requirement, UOB will be in good shape to emerge the crisis as a stronger player.

There are great opportunities for the group to expand its market share in the local SME segment where it has already carved a niche. SME lending in Singapore will stay buoyant backed by the government’s initiatives to undertake majority of the lending risks up to 80%. The government-backed loans in May have surged more than 400% from Jan. Besides, the recent resurgence in demand on private residential properties bodes well for UOB, which focuses on the private residential segment.

UOB’s share price underperformance (year-to-date) presents a good buying opportunity. Our target price is revised up to $17.10 pegged to 1.6x FY10 PBV (1.47x FY09 PBV previously) in line with its recovery PBV cycle. We are upgrading UOB to BUY.

DBS is a high-beta play

DBS is a high-beta play on the eventual economic recovery. It derives the bulk of funding from savings accounts (DBS: 42.5%, OCBC: 19.2% and UOB: 22.0%), where cost of funds is relatively stable. It is the largest lender with S$28.3b parked in the interbank market. DBS will experience the most significant improvement in NIM when the economy recovers, which is usually accompanied by higher interest rates.

DBS focuses on organic growth in its core Singapore and Hong Kong markets. There is latent growth potential in Singapore as its Singapore-dollar loan-deposit ratio was only 57.4% as at Mar 09. DBS is a leader in providing financial services to large corporate and institutional clients and intends to expand market share in SME and consumer lending.

Valuation is attractive with a P/B ratio at 1.13x, the lowest among Singapore banks (OCBC: 1.42x and UOB: 1.52x).

OCBC is the most well capitalised bank in Singapore

OCBC is a prime beneficiary of the rebound in sales of private residential properties. It has the largest exposure to property developers, with building & construction accounting for 20.8% of total loans in 1Q09 (DBS: 14.1%, UOB: 12.5%).

We expect low probability of negative surprises from marked-to-market losses for non-participating funds at Great Eastern given an improvement in sentiment in the equity market. In Malaysia, Great Eastern will be able to distribute insurance products through OCBC’s extensive branch network due to the liberalisation of the financial sector.

OCBC is the most well capitalised bank in Singapore with tier-1 capital adequacy ratio (CAR) at 15.1%. Given that the worst is likely behind us in terms of a Gross Domestic Product (GDP) contraction, OCBC could utilise surplus capital for reactivation of its share buyback programme.

Singapore Banks - 2Q09 results preview

Singapore banks report 2Q09 between 3-7 August. NIMs will improve YoY from better loan pricing and benign funding costs even though gapping profits will be absent from a flat yield curve. Non-interest income should see upside from the revival of capital markets. Yet our checks indicate still rising NPLs, which means credit charges will continue expanding QoQ. Here we expect OCBC to surprise on the negative. Wide Prime-HIBOR spreads should underpin a positive operational surprise for DBS.

Focus on asset quality and provisions
􀂉 Our checks with the Singapore banks point to rising NPLs, both domestically as well as in their overseas operations
􀂉 Recall NPLs increased 56% YoY in 1Q09 alone; with macro conditions remaining stressed we expect this pace to pick up going in to 2Q09
􀂉 The banks believe this NPL cycle will be drawn-out compared to the Asian Crisis given government backstops. Negative, as this means provisions will also be long
􀂉 Our key concern is OCBC, who saw aggressive SME loan growth in the bull-cycle Also, DBS whose North Asia exposure has been particularly vulnerable.
􀂉 Hence, expect credit charges to expand going in to 2Q. We expect FY09 to see 143bps vs. 65bps in FY08. Recall DBS saw 124bps and UOB 148bps in 1Q09 alone

Resilient NIMs
􀂉 Funding costs remained low in 2Q09, while banks have priced up their corporate/SME books especially in Singapore; positive for NIMs YoY
􀂉 The weak spot is Malaysia for both UOB and OCBC where Bank Negara has aggressively cut benchmark rates. Wide Prime-HIBOR should be a key DBS positive
􀂉 A relatively flat short end in the yield curve means limited gapping opportunities
􀂉 Hence, while we expect NIM growth to remain positive YoY, expect a slower pace
􀂉 Loan volumes should continue to retreat QoQ, with UOB the key laggard given Management’s conservative attitude

Positive on non-interest income
􀂉 With equity volumes up 83% QoQ expect brokerage to post a strong QoQ result
􀂉 Better valuations should also provide upside for fund management fees
􀂉 Rising equity valuations should provide upside in mark-to-market gains at Great Eastern. Recall 42% of the Life fund AUM is equities
􀂉 Volatility in FX, government and corporate securities will support trading income QoQ much like banks globally
􀂉 Yet domestic demand fees, especially wealth management, loan fees and trade fees should remain under pressure
􀂉 High QoQ government securities yields will see mark-to-market pressure on DBS’ and OCBC’s AFS books, although lower corporate yields should somewhat offset this

UOB top pick, SELL OCBC
􀂉 UOB remains our top pick given a better quality loan book. Hence a candidate for an early write-back cycle given the Group’s early provisioning strategy
􀂉 OCBC saw a jump in substandard NPLs in 1Q09 pointing to rising cautiousness. We expect this trend to strengthen driving higher credit charges QoQ. The only positive we see is Great Eastern, but this will not be enough to offset higher provisions. Hence we expect earnings risk to be on the negative for 2Q09. SELL
􀂉 Wide Prime HIBOR spreads and Management’s efforts to price up Singapore loans should see DBS surprise operationally. Provisioning though will be a wildcard

SGX - Recent strength in equities market may not be sustained

We maintain our SELL call on SGX. There was a clear pick-up on equities trading value in May 09, with a ADT of S$2.27b, almost 3x Dec 08’s S$0.79b, which led to the rally in SGX’s share price. However, Jun 09’s ADT has since fallen to S$1.75b and we expect the weakening trend to persist. Our S$6.20 target price is pegged to 20x FY10 P/E, which is close to the 21x that SGX traded over the past 3.5 years.

Equities market turnover value seen to weaken. Signs of “green shoots” have led to a rally in the equities market over the past 3-4 months. May 09 recorded a ADT of S$2.27b, which is only 25% lower than the peak of S$3.03b in Oct 07 during the bull run. However, we are of the view that global economic concerns will keep the equities market subdued over the next few months. Hence, we are forecasting FY10 ADT of S$1.36b.

Futures trading volume has also been lacklustre. May 09 futures trading volume of 4.28m is weaker than the 4.60m in Apr 09 and 4.84m in Mar 09. This will also lead to subdued earnings.

Our sensitivity analysis shows that SGX target price would be S$7.10 if FY10 ADT hits S$1.71b, or S$7.90 if ADT is S$2.05b. For investors who are more optimistic on the market trading volumes, they can trade on SGX. However, we are not so optimistic.

The listing of XingQuan Sports International, a Chinese shoemaker, on Bursa Malaysia, may mark the listing of more Chinese companies on the Malaysian bourse. This could lead to slower listings of S-chips on SGX and impact on its long term ADT growth.

OCBC - as solid as gold

Benefitting from surge in home sales. Sales of private residential properties have surged 240.7% yoy to 2,596 units in 1Q09 with buyers taking advantage of low interest rates and interest absorption scheme (IAS). Buying momentum continued unabated in 2Q09 and has reduced the risk of default by property developers. OCBC has the largest exposure to property developers with Building & Construction accounting for 20.8% of total loans in 1Q09 (DBS: 14.1%, UOB: 12.5%).

Steady contribution from life insurance business. We expect low probability of negative surprises from marked-to-market losses at Great Eastern for nonparticipating funds given improvement in sentiment in the equity market. In Singapore, domestic consumption has normalised and we expect sales of life insurance products to improve going forward. In Malaysia, Great Eastern will be able to distribute insurance products through OCBC’s branch network due to liberalisation of the financial sector.

Solid as a rock. OCBC is the most well capitalised bank in Singapore with tier-1 CAR at 15.1%. Given that the worst is likely behind us in terms of GDP contraction, OCBC could utilise surplus capital for reactivation of its share buyback programme or exercise option to redeem 5.1% non-cumulative class B preference shares of S$1b in July 2013. Management focuses primarily on organic growth and will expand regionally in Indonesia and China.

OCBC’s P/B of 1.42x is one standard deviation below its long-term average of 1.82x. BUY with target price of S$8.12 based on a P/B of 1.58x derived from the Gordon Growth Model (ROE: 11%, payout ratio: 48%, required return: 8% and constant growth: 4.5%).

DBS and POSB slash savings rates

According to media sources, DBS has slashed its deposit rates. Interest rates on the savings accounts at both DBS Bank and POSB will be trimmed by some 2.5- 12.5 bps depending on the different accounts and amount. For instance, POSB savings and passbook account holders will now be paid 0.125% (from 0.25%) for the first S$50k while DBS Savings Plus account holders will receive 0.1% for the first S$50k (vs 0.125% for the first S$3k and 0.175% for the remaining S$47k previously).

The move to slash rates to near zero is in tandem with similar cuts made by their local and foreign counterparts over the past few months. We believe the reduction will be accretive to earnings, given the Group’s large low cost deposit base. Note that CASA deposits make up around 55% of total deposits. In addition, the reduction in the deposit rates will give DBS more room to continue competing via pricing, in our opinion. Recall DBS trimmed yield on loans by close to 130 bps in FY08 compared to its peers average of 96 bps while deposit rate eased by a smaller 63 bps vs. 72 bps on average for UOB and OCBC.

We adjust our FY09/10/11 earnings forecast by 4.8/8.3/7.5% to S$1.6/2.1/2.6bn (from S$1.5/1.9/2.5bn) on the back of the increase in our NIM assumptions. Note that despite the larger decline in deposit rates, we are only imputing a 5-8bps increase in FY09-11 NIMs because we believe the impact would be muted by room for DBS to further reduce the yield on loans (although growing loans is not the Group’s primary goal amid the weak economic backdrop) and higher borrowing costs.

With that, we revise our TP from S$13.20 to S$13.80 (based on the Gordon Growth Model, assuming cost of equity of 7.5%, average ROE of 9.4% and sustainable long-term growth of 3.0% or implied PBV of 1.42x) after imputing our adjusted FY09-11 numbers. Our valuation includes the remainder of S$458mn corporate CDOs which have not been hedged or provided for.

Excluding the CDOs, we believe that DBS is valued at S$14.00. With that, we are upgrading our recommendation on DBS to Buy - premised on the potential capital gain of 20.2% from the stock’s last closing price of S$11.98. Key upside/downside risks to our fair value include: (1) better-than-expected 2Q and 3Q results, (2) potential write back on allowance for the CDOs, (3) the impact of the global recession to Singapore and Hong Kong’s trade, which will to a great extent impact GDP, (4) the impact from the downturn on both the countries’ unemployment rate, and (5) resilience of the property market as well as sustainability of property prices.

Singapore Banks May loans – still on a downhill

DBU loan growth (Exhibit 1) continued to contract to 5.5% y-y in May (April: 7.6%; March: 8.6%). The decline was attributed to the broad-based drop in business loan growth (Exhibit 10-13) which in the month of May suffered its seventh monthly contraction. Business loans contracted 0.1% m-m but grew 3.7% y-y (April: -0.9%; +7.3%). On the brighter side, consumer loan growth (Exhibit 4) remained resilient at 0.8% m-m or 7.9% y-y (April: +0.6%; +7.9%), largely thanks to solid housing loans following the recent revival of the local property market and more home completions.

ACU loans (Exhibit 2) recorded a 3.1% y-y contraction (March: -1.3%; February: +2.3%), primarily dragged by a continuation of the severe slowdown in consumer loans (May: -21.8%; April: -16.9%). ACU business loan growth also dipped into its first y-y contraction (May: -0.7%; April: +0.6%).

Massive liquidity remains a big plus – the loan-deposit ratio continued to hover around the 74% mark and there was excess deposits of SGD93.7b available in the system. Industry customer deposits have expanded by 4.9% YTD. Continued improvement in the deposit mix is another positive: the fixed deposit (FD) mix has now fallen to an all-time low of 46.8% (Exhibit 15). We expect the trend to persist as depressed FD rates and a buoyant equity market will encourage deposit migration to more flexible and liquid deposits such as current and savings deposits.

Trading close to its historical P/E mean, we think share prices have priced in an earnings recovery scenario and potential reversal of paper losses from investment books. Trading at mid-cycle valuation, banks do not look attractive and the initial re-rating may have run its course, in our view. We would await a pullback to regain entry. UOB remains our top sector pick for its more exciting ROE profile.

Singapore Exchange - Oslo Bors MoU - step in the right direction but no P&L impact near term

SGX announced today that it would enter into a MoU with Oslo Bors on co-operation related to dual listings of companies listed on each other’s exchanges. The MoU will be signed on 8 July. Shipping, O&M and Petroleum related companies appear to be the primary target of this MoU.

While positive from a strategic point of view, we foresee limited P&L impact from this measure. We believe the MoU would make it procedurally easier for companies on both exchanges to mutually dual-list, if they wish to. We do not expect any fundamental changes in SGX revenues in the medium term as a result of this arrangement.

We continue to maintain UW on SGX as we expect trading volumes and turnover velocity to remain low for the next couple of months.

Singapore Banks Big Picture - Thoughts on Interest Rates and Margins Outlook

Tightening unlikely until 2010: The recent bond sell-off saw SGD 10-year prices fall 18% into mid-June, 10-year yields rising to 2.8% (end-June 2.6%), while short-term SGD rates remain near record lows. Our economists view this sell-off as overdone with limited inflation fears and the US Fed unlikely to tighten until well into 2010E. Low short-term rates hurt margins for DBS (less so for OCBC, UOB), but rising lending spreads and higher loan growth should add to DBS' margins as we progress through the year. Top pick remains DBS on relative valuation.

DBS most sensitive to rates changes: While a positive sloping yield curve implies gapping opportunities for all 3 banks, historic trends show persistently low short-term rates hurt margins for DBS (see Figure 1), due to a low LDR and higher holdings of low-cost CASA funds. We think the recent 18% fall in bond prices implies AFS (book value) adjustments rather than any direct earnings impact.

GDP recovery swifter than expected. With IP rising 1.2%yoy in the Apr-May period, Citi Economist Kit suspects 2Q09 advance GDP estimates could come in close to minus 4%, with a qoq saar jump in the high teens, reversing the 14.8% qoq saar plunge in GDP in 1Q09. Continued positive momentum in May NODX may suggest upside risk to our base case of Singapore coming out of recession by 4Q09.

May-09 monetary data. Domestic lending rose marginally (+0.3%mom, +5.5%yoy) to S$271bn. Weaker business lending (-0.1%mom) was offset by stronger consumer lending (+0.5%mom) on steady mortgage growth. Loan-to-deposit ratio fell to 74.3% as total deposits rose by 0.5%mom to S$365bn (+9%yoy).

UOB: Outlook is looking better

Equity market gains and buying frenzy in the local property market. Earlier, we were concerned that higher impairment charges could drag down the performance of the local banking sector. While it was indeed a drag on 1Q09 earnings, other aspects of its operations were less affected than expected. In addition, with the recent pick-up in global equity prices and the still active transactions on the local property front, the outlook is definitely better than a quarter ago. The higher property transaction volumes in the 2Q09 should augur well for loans growth. Latest Urban Redevelopment Authority (URA) numbers showed that private resale deals jumped to 1464 units so far in 2Q, up an encouraging 71% from the 856 units in 1Q. Responses to new recent new property launches have also been good. In addition, sharp gains in the equity market since March has also led to more capital market exercises to raise funds as well as the possibility of a revival in the IPO market later on in the year.

Leading the pack with highest P/B ratio. Together with the market rally, UOB's share price hit a recent high of S$15.70, but has since eased with the current market correction. However, it has proven to be the most resilient among the three banks, as seen from its only 8% decline from recent high versus 10-12% for the other two banks. In addition, UOB has also moved ahead of the pack with its consistently higher P/B ratio (see Exhibit 1). Since 2002, it has constantly led the pack with a higher premium in terms of price to book. As an indication, its average from 2002-2009 was 1.58x versus 1.51x for OCBC and 1.34x for DBS (source: Bloomberg). This premium has remained even during the recent peak (in 2007) as well as the recent trough (1Q 2009).

Raised fair value to $14.70. Overall, we are retaining our FY09 earnings estimates for now, including our assumptions of stable margin for Singapore but expecting still challenging overseas markets. However, we are heartened by the re-rating for the Singapore equity market. In line with the more optimistic outlook, we have also raised our peg to 1.5x book, bringing our fair value estimate to S$14.70. As such, we are upgrading the stock to a HOLD. Yield is decent at 4.2% based on Friday's closing price of S$14.40. Accumulate at S$14.00 or lower.

Singapore Banks - Mortgages holding the fort, business lending declines in May

May-09 loan growth came in at 5.5% y/y for the industry, with personal loans clocking 7.9%. Business loans grew at a slower 3.7% y/y pace, while these loans contracted 0.1% m/m and 1.2% q/q. Details of loan growth are on page 2. Total loans, however, grew 0.3% m/m and 0.1% q/q.

Mortgages grew 8.8% y/y, 1.5% q/q and 0.8% m/m. In $ terms, loans grew by S$810mn m/m, with mortgages contributing S$627mn or 77% of the total growth. This is due to an increase in property transactions and completion of construction of apartments that were sold on a deferred payment basis in last few years.

Business loans have become a drag on overall loan growth this year, as against driving growth till late last year, per chart below. This change is due to continued risk reduction by banks as operating leverage becomes a concern for business credit.

Financials leverage related risks on business loans have diminished due to increased liquidity and revival of risk appetite. But we expect banks to remain in the risk reduction mode and closely ration business loan growth as operating cash-flows may remain sub-trend for an extended period of time.

We continue to expect DBS to lead industry loan growth, while OCBC may scale back mortgage loans due to low spreads. We expect UOB may reduce loans with higher capital charge (Asean, SME), while increasing mortgage loans (lower risk weight).

UOB - Lagging its peers

Expect NIM to hold up, even as bank remains selective in lending. We expect NIM to hold up as loans get re-priced at higher yields. We sense that UOB remains selective in lending. It aims to grow its Singapore loan book to take advantage of rising loan yields, but remains cautious in expanding regionally. Meanwhile, its loan portfolio margins remain competitive and interbank rates remain low. As such, there will be little upside to NIM. We are retaining our loan growth assumption of 6%.

Stabilising indicators. We note that NPLs have stabilised, but the extent of the recovery remains uncertain. There are still risks from smaller SMEs, which mean NPLs could still rise but not spike up sharply. UOB has increased its general provision reserves to provide buffer for uncertain times since the previous financial year. While prudent, it did dent its ROE for FY08 and would, to some extent, limit its ROE expansion for FY09.

Nevertheless, we expect a normalisation of ROEs for FY10. Laggard among Singapore banks. UOB had underperformed its peers and the market, due to the impairment to its book value back in 4Q08. It, however, should be able to steer away from this setback now, given that credit markets have stabilised. Our TP of S$16.50 is based on the Gordon Growth Model implying a 1.6x FY10F P/BV, which is the normalised mid-cycle multiple.

Singapore Banks - Differentiating Returns

Retain Cautious Industry View: While fundamentals are less bad, we see no reason to expect a sharp snap back in global growth. This makes Singapore vulnerable given its small, open economy and lack of domestic story. Our concerns over asset quality remain – credit cycles usually last at least two years and Singapore is still optimistically pursuing its over-build. We also have the inflation debate and US debt concerns. We missed this strong bounce, but from the risk reward on offer today, we see no reason to be more constructive on the sector. Moreover, with limited meaningful growth/ return options outside of Singapore, the sector looks to be headed back to the low return/ low growth phase.

Re-visiting return/ earnings power: Since 2001, the sector RoE has averaged 11.5% and peaked in FY07 at 13.3% with buoyant investment market related fees, wide margins and very low loan loss charges – the zenith of the global debt super cycle. Looking forward we see two years of elevated credit charges, as the recovery in growth is weak and troubled, and lower normalized RoEs with a less buoyant global economy. RoEs look set to trough at around 6% in FY10e.

Upgrade UOB to Equal-weight: Our analysis showed a structurally higher and more stable return profile – mean RoE of 12% with a standard deviation of 1%. We assess normalized RoE at 12%, 2% pts better than peers. UOB deserves a premium rating. Rudimentary investment arithmetic suggests 1.7x book vs 1.3x for DBS/ OCBC. We see UOB as a structurally higher return franchise less reliant on low quality investment markets.

DBS and OCBC remain Underweight: Our analysis showed structurally lower and more volatile return profiles. We assess normalized RoE at 10% for both banks. Lower core return power means a higher reliance on lumpy investment gains and very low loan loss charges … low quality and higher risk best suited to the halcyon days of the global debt super cycle.

Target prices increased for a reduction in the recession/ credit cycle discount: However, no change to earnings estimates. Asset quality remains critical.

DBS: TP - from S$8.00 to S$9.50
OCBC: TP - from S$4.10 to S$4.60
UOB: TP - from S$9.50 to S$12.50

DBS: Getting a boost from better fee income

DBS has staged remarkably >100% gains. In tandem with global equity markets, the Singapore market also staged a good rally in 2Q 2009, with the STI appreciating 67% from the 2009 low in March to the recent high of 2424.52. Together with renewed wave of buying, this also benefited the banking stocks. DBS, which hit a low of S$6.42 in Mar 2009, has since recovered to a high of S$12.90, more than doubling from the low. Over the past few days, a much-need breather has entered the market and we view this correction positively. There are also some signs of market fatigue, as reflected by the decline in daily trading volume and value on the local exchange as well as the drop in market breadth (with more declining issues than advancing issues on a daily basis).

Present weakness presents trading opportunity. This has thrown up an opportunity to buy into the banking sector again. There is also a gradual shift recently to defensive stocks and DBS offers a good dividend yield of 4.1% (based on our reduced DPS estimate of 46 S cents for FY09 versus 65 S cents in FY08).

Flood of rights issues should boost its fee income. In 1Q09, we saw some capital market raising exercises locally, but the momentum gathered pace in 2Q 2009, led by several government-linked entities. We note that DBS was one of the key underwriters/managers of these issues (see exhibit 1) and we expect fee income to get a significant boost this quarter even if impairments remain high. In addition, the improvement in the equity market should also boost other fee-related income.

Upgrade to BUY. Since hitting a recent high of S$12.90, the stock has corrected and closed at S$11.20 yesterday, down 13.2%. We are maintaining our FY09 earnings estimates for now, noting that impairment charges could remain high in 2Q and 3Q, albeit lower than the 1Q level of S$437m. We are also maintaining our peg at 1.2x book and our fair value estimate of S$12.40 for now, until we see further re-rating for the sector and the market. As there is a potential upside of more than 10% from current level coupled with the estimated yield of 4.1%, we are upgrading the stock to BUY. Accumulate at current level and lower.

Singapore Banks - Wait to pull the trigger

Banks performed in line with the market in June with stock prices falling by 5% vs a 4% decline in the FSSTI. We think there could soon be opportunistic entry points into the sector. At this stage, our top pick in the sector remains UOB. We see better entry points into DBS at 1x Dec 10E BV (S$10.65) and OCBC at 1.2x Dec 10E BV (S$6.15).

Recent checks suggest that the sector has held up well in the past 2-3 months. Specifically, revenues are still robust while overall asset quality has remained fairly stable. As a result, we raise our earnings forecasts by 6%-20% to adjust for higher non-interest income to reflect stronger fee income and capital market activity. Consequently, we adjust our price targets up by 1%-5%.

Recent financial market stability relative to the last two quarters should result in positive BV adjustments as banks mark-to-market their securities portfolios. While difficult to quantify, we think that a 30% write-back from what was written down last year is highly plausible, which could lead to a 2%-6% increase in BV.

Asset quality was stable QoQ in 2Q09 (1Q09 gross NPL: 1.8%-2.1%). At this rate, our gross NPL forecast (Dec 09: 4%) would seem too conservative. Nevertheless, provisioning charges will remain elevated as banks are likely to provide more for the sake of prudence. We still expect net provision charge of 1.5% of avg net loans in 2009E and 1.3% in 2010E. We think this is the key reason why our forecasts are 4%-11% below 2009-2010 consensus for OCBC and DBS.

With a stable SIBOR since Dec 08 (3-mth SGD SIBOR: 0.68%), we think NIMs have troughed. NIMs should remain stable to positive as loans are repriced on higher credit spreads. However, we believe this phenomenon is already largely expected by market watchers. Meanwhile, we continue to expect anemic growth in 2009 with low single digit loans growth at best.

DBS Group
Our S$12.50 PO (ADR PO: US$34.33) is derived using a modified Gordon Growth dividend discount model (DDM) that assumes an 10.5% sustainable ROE, 9.8% cost of equity and 4% long-term growth rate. At our PO, DBS would trade at 1.1x 2010E BV. Risks: (1) a slowdown in the Singapore and/or Hong Kong economies, which would depress loan growth, and (2) a sustained low SIBOR, which would compress its net interest margins. Upside risk would be a faster than expected upturn in Asian economies and markets.

OCBC BANK
We have set our PO at S$7.25 using a modified Gordon Growth dividend discount model (DDM). Our PO equates to 1.4x 2010E P/BV, wherein we have assumed a 11% sustainable ROE, 4% long-term growth rate and 9.1% cost of equity. The key risk is volatility from exposure to the emerging markets of Malaysia and Indonesia. Also, OCBC has greater mass market consumer exposure compared with its Singapore peers for which it may suffer comparatively higher credit losses during economic downturns.

United Overseas Bank
Our PO of S$15.55 (ADR PO: US$21.36) for UOB is based on 1.5x Dec 10E BV using a Gordon Growth dividend discount model. The fair-value PBV multiple reflects an 11.5% sustainable ROE, 4% long-term growth rate and 9.1% cost of equity assumption. Risks: (1) Regional macroeconomic and specific credit quality risks from its banking operations in Thailand, Indonesia and Malaysia, (2) banking franchise in Thailand could take impairment charges if the political and economic environment were to deteriorate, and (3) expansion into SE Asia represents a move out of its traditional core markets of Singapore and Malaysia.

SGX - Renewed market confidence to fuel growth

The ADT remains resilient in June, hovering at $1.7b levels. Rising confidence in equities has drove the ADT in 4Q09 (Apr – June) up by a notch, increasing by more than 88% from 3Q09. The sharp ADT rebound signals a strong earnings turnaround in SGX’s upcoming 4Q09 full year results, which will be released on 5 August. On an improved market outlook, we have estimated ADT to advance to $2bn in FY10.

More positive developments include the resilient futures volume (+13% qoq in the quarter) and record traded value and volume of SGX-listed ETFs. Total trading value of ETFs from Jan-May 09 continues to break new highs, rising 62% yoy to $1.95b. Furthermore, the IPO market has begun to rebound in the recent months with a handful of successful deals. Industry players are expecting IPO activities to pick up by 2H09. This will be a positive catalyst for SGX.

We estimate that the market is pricing in an ADT of around $1.5bn at the current price. With the current quarter’s ADT at $1.7b and an expected improvement in trading turnover to $2bn by 2010, our sensitivity analysis shows a price upside potential of up to $8.30 for the stock. Besides, SGX possesses good earnings quality and is able to achieve a superior operating leverage of above 100% even at worst times.

SGX has been sharpening its competitive edge as an Asian gateway through new product launches, cross border collaborations, constant technology renewals and tighter corporate governance. SICOM, a company of SGX has recently inked an agreement with NCDEX (the largest agricultural commodity exchange in India) that will make SICOM the first exchange outside India to trade NCDEX’s products. Other new product launches in the pipeline include the fuel oil futures contract.

In addition to a generous dividend payout out of at least 85% according to past trends and a committed annual base dividend of 14 cents per share, SGX offers a good proxy to the market recovery. The group’s strengthening monopoly status, first mover in new product launches and earnings quality deserves the valuation premium. Maintain BUY.