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.

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