Hong Leong Finance - Domestic strength

Post its 1Q09 results, we have reduced our NPL assumptions for HLF – albeit to a still-conservative level, in our view – resulting in lower provisions and a higher net profit for this year. We maintain our view that HLF is likely to weather the downturn better than its larger banking peers given its domestic focus. We have raised our target price and reverted to Gordon growth valuations. We maintain our Outperform recommendation.

Better lending spreads are benefitting HLF through better margins despite a contraction in loans in 1Q09. Historically, HLF’s margins have been better than its banking peers’. At the same time, we believe the various governmentinitiatives to boost lending to the SME segment, one of two core lending areas for the group, will cushion its net interest income. Collectively, we believe its net interest income should be stronger YoY.

As at the end of FY08, provisions were 74bp of gross loans, higher than the banking sector average of 69bp. This was due almost entirely to provisions for the Lehman mini-bonds structured deposits, for which the company compensated its customers. However, for FY09, we anticipate lower provisions of 58bp of gross loans, despite our assumption of a 4% NPL ratio. These are still significantly higher than the annualised figures for 1Q09.

Post 1Q09 results, we have raised our net profit estimate for 2009 (albeit to a still-conservative level, in our view) by 23% due largely to lower loan loss provision assumptions. Consequently, we have raised our target price to S$3.10 from S$2.79 (+11%).

12-month price target: S$3.10 based on a Gordon growth methodology. Catalyst: Lower-than-expected NPLs and stronger net interest income. While its share price has rebounded off the lows seen in March, we believe this stems largely from the turn in market sentiment towards a less pessimistic view. However, this has merely returned HLF’s valuations closer to their historical mean. The stock is currently trading at an FY09E P/BV of 0.8x, still below its historical mean of 0.9x. Beyond this, we believe that with reduced risk aversion, the company’s more resilient earnings, given a pure domestic exposure, should bode well for its share price. We maintain our Outperform rating.

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DBS - Rebound in non-interest income from loans related and treasury activities

Net profit of S$433m was above our forecast of S$378m.

Loans expanded 3.4% qoq and 14.8% yoy, with growth from overseas markets. Net interest margin at 1.99%, slightly lower than 2.04% in 4Q08. DBS experienced a large inflow of funds with customers' deposits up 3.2% qoq to S$130.6b. It also raised S$4b from 1-for-2 rights issues in Jan 09. Loans / deposits ratio dropped from 74.5% in 4Q08 to 72.6% in 1Q09. Margins were affected by lower Singapore interbank interest rates as addtional funds has not been fully deployed in more profitable products.

Fees & commissions rebounded 21% qoq to S$317m with growth from loans related activities and guarantees.

Boost from net trading income of S$204m coming from interest and foreign exchange activities supported by customers' flow. Gained S$106m from sale of fixed income securities.

Group NPL ratio increased from 1.5% to 2.0%, with NPL ratio for Hong Kong increased from 1.7% to 2.6%. DBS made specific provision of S$225m and general provision of S$182m, totaling 124bp.

SGX: Recent strength in stockmarket turnover, but valuation is rich

There was a sharp pick-up in stockmarket turnover over the past 2-3 months. From Feb 09's ADT of S$831m, it has risen to Apr 09's S$1,299m. For the first 3 weeks of May 09, ADT has risen further to S$2,286m. The May 09 level is close to the S$2,357m achieved for CY2007, when the stockmarket was at its peak.

The futures trading volume has also shown resilience, with trading volume of 4.60m for Apr 09, close to Mar 09's 4.84m. This is sharply higher than the monthly average of 3.47m for the first two months of CY2009. Separately, SGX announced yesterday the launching of a Fuel Oil Futures contract in 2HCY09, which is a positive. However, we are assuming minimal impact in the initial quarters.

We have raised our assumptions of stockmarket turnover, given the recent strength. Our FY09 stockmarket ADT forecast has been raised from S$1.10b to S$1.26b ? this assumes 4QFY09 ADT of S$1.70b, versus 3QFY09's S$0.98b. Though we expect turnover to soften from the high May 09 levels, we believe FY10 ADT will be stronger than our earlier assumptions. Hence, we raise our FY10 stockmarket ADT from S$1.24b to S$1.36b.

Target price raised, but SELL call remains. Correspondingly, we raised our FY09 and FY10 net profit forecasts both by 7% to S$296m and S$332m respectively. As the likelihood of FY10 ADT being greater than FY09 is now much higher, we raise our P/E multiple to 20x, from our previous 13x assumption. This is close to the average 21x that SGX traded at over the past 3.5 years. Hence, based on 20x FY10 P/E, our revised SGX target price is S$6.20 (versus our previous S$3.95). SGX remains a SELL.

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. If one feels that these are more reasonable assumptions, then they can trade on SGX. However, we are not so optimistic.

Singapore Banking: 1Q09 loan spreads widened but provisions surged

Stripping out trading gains and non-recurring items, banks’ 1Q09 net profits are generally in line with expectations. Both DBS and OCBC reported 1Q09 net profits that were above ours and market expectations, whilst UOB’s was in line. DBS recorded a jump in trading income, due to interest rate and foreign exchange rate activities, whilst OCBC had non-recurring gains from the implementation of the new Risk Based Capital framework in Malaysia effective 1 Jan 09. Stripping out these, DBS and OCBC earnings were close to our expectations.

Expect OCBC and UOB 1Q09 outperformance in NIM to persist, whilst DBS NIM to remain squeezed due to soft SIBOR. OCBC and UOB recorded 1Q09 YoY NIM widening to 2.42% and 2.41% respectively, due to better lending spreads, the consequence of reduced competition from foreign banks. On the other hand, DBS’ 1Q09 NIM of 1.99% is sharply lower than peers, due to its low Singapore loan deposit ratio of 57% amidst the soft SIBOR environment. We expect this variance in NIM between DBS and its peers to remain for the remaining quarters of 2009.

DBS and OCBC non-interest income boost not sustainable. We do not expect the surge in 1Q09 DBS’ trading income and OCBC’s non-recurring life assurance gains to be repeated in the subsequent quarters. Although the recent pick-up on stockmarket activity offers hope, we do not believe this can be sustained for long and hence expect fee and commission income to be relatively subdued. Hence, we do not expect much excitement from non-interest income going ahead.

Asset quality to deteriorate further, with DBS at higher risk. All three banks recorded higher NPL ratios, and also significantly higher provisions in 1Q09. NPLs typically lag the deterioration in economic growth, and we are forecasting Dec 09 NPL ratios of between 3.7% and 4.2%. As DBS was the most aggressive in lending over the past 3 years, with a 18.3% CAGR loan growth, versus OCBC’s 12.4% and UOB’s 13.3%, it faces the risk of a higher NPL ratio. We are assuming 2009 provisions to loans of between 114 and 126 bps, sharply higher than 2008’s 59 to 84 bps range.

UOB is our preferred pick within the sector. With the share price surge of the banks over the past 2 months, valuation has become stretched. We are NEUTRAL weight the sector. For investors interested in the Singapore banking sector, UOB (NEUTRAL call) is our preferred pick on the back of its higher-quality loan asset.

UOB - Capital raising concerns diminish

UOB reported a significant improvement in its Tier 1 ratio, from Q4’s 10.9% to 12.3%. We believe this will erase concerns about the bank wanting to raise any capital. Equally important, in our view, the book value did not deteriorate as it had in the last four quarters because of lower write downs of AFS securities and a recovery in equity securities.

Q1 earnings were 9% below our estimate but 6% above consensus. Margins were impressive at 2.41%, an indication of the on-going repricing of its loan book. We were also encouraged by its low cost-to-income ratio of 35.5%. Provisioning was high, but expected. 46% of it was general provisioning.

We intend reviewing our estimates and price target once all three local banks have reported their results.

The stock trades at 11.7x earnings and 1.5x book 09E. Our price target is derived by using the Gordon growth model with the key assumption being an ROE of 11% and COE of 8.6%.

SGX - Rising futures volume adds to the momentum

The ADT has rebounded sharply from below a billion in mid-March to the current $2bn levels. Since May, the ADT has sustained at around $2bn and even hitting bull market levels of above $3bn on certain days. So far into SGX’s final quarter (Apr-June), its ADT has shown a sharp resurgence of 93% qoq and 10% yoy. The significant bounce in ADT, which is a key performance indicator of its mainstream securities market revenue, bodes well for a strong earnings recovery ahead.

Besides the turnaround of the securities market revenue, the derivatives market revenue has been strengthening as well. Futures volumes rose 6% yoy in April after 3 consecutive months of decline. Further, the group’s new product launches such as the Extended Settlement contracts and various initiatives to grow the options market will continue to sustain its fast-growing derivates market segment.

Despite turbulent times, the group stays committed to technology upgrade. On-going improvements in trading, clearing, data and web capabilities provide a good infrastructure for SGX to capture opportunities in algorithmic trading, commodities clearing and information services business. It has recently launched an enhanced web site and will be introducing a new derivatives clearing system by year-end.

As ADT has risen to levels that more doubled of our ADT assumption of $1.2bn for FY10, we are increasing our FY10 ADT assumptions to $2bn in line with the market recovery. As such, we have raised our earnings estimates accordingly for FY10 by 21%. Our FY09 earnings estimates remain unchanged as ADT YTD was still within our estimates of $1.2bn.

We have raised our target price to $8.30, based on 21x FY10 PER (from 19x FY09 PER previously) in line with SGX’s recovery stage PER cycle. With renewed market confidence, we reckon SGX will be a fantastic recovery play given its monopoly status and appeal being the Asian gateway to a diversified range of securities and derivatives products. Upgrade to BUY.

OCBC - Strong pre-provision profit growth

Management remains cautious on the outlook and is still selective on lending activity. OCBC will focus on government-sponsored SME loans and high grade corporates in its lending business. Meanwhile, it has de-risked its securities portfolio by trimming exposure to corporate bonds and equities in favor of government bonds. We raise our price target to S$6.90 after rolling over our valuation base to 2010E. Our price target implies 1.4x Dec 10E BV and reflects 11% sustainable RoE, 9.1% cost of equity and a 4% long term growth rate.

1Q09 core pre-provision profit rose 24% YoY on robust net interest income and trading profits. But core net profit fell 26% YoY to S$ 325mn as provisions rose dramatically. Still, core recurring earnings were ahead of expectations, accounting for 25% of Reuters consensus estimates and 29% of BAS-ML forecasts.

Gross NPL rose to 1.8% (Dec 08: 1.5%) on weakness from manufacturing and building & construction loans. Most of the weakness came from abroad, especially from Indonesia and China. Management revealed that the spike in NPLs came mainly from two loans in the building & construction segment. Although the borrowers are still meeting their debt servicing obligations, they were reclassified as NPLs as one of them breached a loan to value covenant while the other missed a repayment, which has already been recovered. Loan loss coverage remains strong at 112% (Dec 08: 129%).

We have set our PO at S$6.90 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.

UOB - Key risk is loans growth

Results review UOB reported a 23.3% increase in core net earnings to S$409 mil (- 22.7%yoy, +23.3%qoq, 4Q08: S$332 mil), which were inline with our estimates. Net interest income fell 0.8% to S$949 mil with net interest margins slightly lower at 2.41% as compared to 2.45% last quarter due to lower loan spread.

Non-interest income improved 11.1% to S$434 mil, mainly due to higher other operating income from non-trading activities. Operating expenses fell 7.7% over the quarter to S$491 mil due to lower staff expenses and a grant received under the Jobs Credit Scheme, lower revenue related and IT related expenses. Expense to income ratio improved 3.9% to 35.5%. The Group took a total of S$378 mil impairment charges due to higher collective impairment provisions of S$174 mil but lower individual charges of S$169 mil. NPLs increased to S$2.19 bil while the NPL ratio is higher at 2.1% over the quarter. Cumulative impairment as a percentage of NPL moderated to 104.9%.

Net loans remained flat at S$99.7 bil (+5.6%yoy, -0.2%qoq), with growth in the overall portfolio negated by strong contraction in the manufacturing sector. Tier 1 and total capital adequacy ratio improved to 12.3% and 17.3% respectively due mainly to lower risk-weighted assets and higher retained earnings.

Key risk is loans growth Singapore total loans contracted 0.54% in the first quarter of 2009 and UOB’s loan book remained flat following a contraction in the previous quarter. And as we think that since loans growth is closely tied to the economy and MTI projects that Singapore may contract from –6% to –9%, we fear that it is probable that system loans will contract in 2009 and will impede UOB’s loans growth. Borrowers draw down credit lines to tide over liquidity crisis rather than capital expansion and growth.

Moody’s revises UOB’s outlook from stable to negative for the bank financial strength ratings. Moody’s has also revised the Aa1 long-term deposit and debt ratings from stable to negative. Reasons cited include deterioration of asset quality and earnings due to the global economic downturn, weak demand of loans and other banking-service products.

Recommendation Given this unprecedented economic crisis and the factors stated above, we are cutting our 2009 earnings by 13.6% from S$1.92bil to S$1.66bil. Accordingly, we adjust our target price to S$14.60; peg to 1.52x FY09 NAV. Given the strong advancement of the share price within last week, we think upside maybe limited. We maintain our HOLD rating.

DBS Group - Treasury rebounded; cost discipline

DBS's 1Q09 core net profit of S$456m was above our expectation (S$406m) and Street estimate (S$342m). Key positives were: 1) resilient fee income; 2) a strong rebound in treasury (even if deemed low-quality earnings); and 3) commendable cost-control. Key negative was a sharper-than-expected asset quality deterioration. DPS of 14cts was maintained in 1Q09, implying a high 68% payout. Lower dividends later this year are possible, in our opinion. We raise our FY09-11 EPS estimates by 7-24%, building in higher non-NII forecasts and lower costs. Our target price has been raised from S$11.57 (1.1x P/BV) to S$13.20 (now based on 1.25x P/BV), on raised earnings forecasts. Maintain Outperform.