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.

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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.

Adjusting forecasts to DBS, UOB and OCBC

DBS

We adjust our FY09 and FY10 earnings forecasts upwards by 5% and 13% respectively, on an improved NIM and mortgage growth outlook (see Singapore banks: Bettering record margins; Well placed for property upswing dated 22nd Jun. 2009 for more details). We also marginally adjust upwards our market-sensitive income sources, given improved equity and creditmarkets. Our new 12-month target price, which is based on a Gordon growth model (ROE-g)/ (COE-g), is S$14.00, from S$12.80 previously.

Risks to this stock include the prospect of a dilutive acquisition, external shocks or operational risk such as DBS's hedging strategy and management's positioning on the bank's currency mix/duration of its bond portfolio relative to the yield curve. Another downside risk is the possibilty of losses on DBS' trading and investment portfolio, especially given the current volatile investment environment.

OCBC

We adjust our FY09 and FY10 earnings forecasts upwards by 6% and 6% respectively, on an improved NIM and mortgage growth outlook (see Singapore banks: Bettering record margins; Well placed for property upswing dated 22nd Jun. 2009 for more details). We also marginally adjust upwards our market-sensitive income sources, given improved equity and credit markets. Our new 12-month target price, which is based on a Gordon growth model (ROE-g)/ (COE-g), is S$5.80, from S$5.30 previously.

A downside risk is if economic growth significantly slows and asset qualityworsens, resulting in a rise in bad debt expense. Loan growth could also be hampered. An upside risk is if investment markets recover earlier than expected, thus benefitting OCBC's insurance income. Net interest margins could also rise by more than expected as corporate lending spreads rise.

UOB

We adjust our FY09 and FY10 earnings forecasts upwards by 9.8% and 7.3% respectively, on an improved NIM and mortgage growth outlook (see Singapore banks: Bettering record margins; Well placed for property upswing dated 20 Jun. 2009 for more details). We also marginally adjust upwards our market-sensitive income sources, given improved equity and credit markets. Our new 12-month target price, which is based on a Gordon growth model (ROE-g)/ (COE-g), is S$14.50 from S$11.30 previously.

Key downside risks to our valuation and target price are an adverse impact on loan growth and asset quality from a stronger-than-expected slowdown in the global economy and risk that asset quality problems will continue to adversely impact global financials. Key upside risks to our valuation and target price are an earlier-than-expected economic recovery, if regional governments start to guarantee the credit risks of SME loans, and if confidence starts to return to investment markets, with this benefiting market-sensitive income sources

What is the cost of a recession to Banks?

In a downturn, the main issue for banks is the cost of the recession—the level of provisioning necessary, and whether the banks can cope with that level. We studied 753 companies for this report. Our findings suggest upside risk to consensus earnings estimates, as provisioning is likely to be significantly lower than it was during the 1998 Asian financial crisis, despite this being a global recession. We believe this is a potential catalyst for further rerating.

To estimate the level of provisioning, we compared the 2008 balance sheets of companies listed on the Singapore stock exchange with 1996. We identified the stronger companies and the weaker ones using a scorecard we designed based on net debt-to-equity and interest coverage ratios.

We found that only 4% of companies were in the ‘stressed’ category in 2008 and 29% were in the ‘strong’ category. This contrasts with 7% and 16%, respectively in 1996. We believe the significantly smaller percentage of stressed companies, plus the current low interest rates, will cap provisioning to only 2.6% of loans. This compares with 5.2% during the 1998 recession. However, as in 1998, we expect the most stressed companies to be SMEs.

We expect all the Singapore banks to comfortably absorb the provisioning, but our top pick is DBS Group Holdings (DBS) as: 1) it offers exposure to the more dynamic Greater China region; 2) we expect it to take market share by using its new capital; and 3) it trades at only 1.11x P/BV.

DBS Group - Bonanza From Rights Issues

Standing by core customers. DBS Group Holdings (DBS) has benefitted from the slew of rights issues from government-linked companies by securing the lion’s share of mandates in these fund-raising exercises. DBS is the lead manager and underwriter for CapitaLand’s and CapitaMall Trust’s rights issues launched in 1Q09 and CapitaCommercial Trust’s and Neptune Orient Lines’ rights issues launched in 2Q09. By cultivating relationships with core customers in both good and bad times, DBS is well positioned to clinch these investment banking deals when the opportunities arise.

We expect contributions from the rights issues of CapitaLand and CapitaMall Trust to be recognised in 2Q09 and that from CapitaCommercial Trust and Neptune Orient Lines to be recognised in 3Q09. We estimate net commission from investment banking to increase 67.6% qoq to S$28.5m in 2Q09 and taper off to S$19.1m in 3Q09. We fine-tune our 2009 net profit forecast by +0.5% to S$1,492m.

Maintain BUY. DBS is a high-beta play on the eventual economic recovery. Our target price of S$13.83 is based on a P/B of 1.30x and is derived from the Gordon Growth Model (ROE: 10%, payout ratio: 50%, required return: 8% and constant growth: 4%). We have rolled forward our target price based on end-10 NAV/share estimate of S$10.64.

Singapore banks: Rising NPLs will take a toll on earnings

Regionally, Singapore banks compare well on balance-sheet safety, boasting low gearing and high liquidity. However, for investors looking to reward growth, we believe the banks will disappoint as non-performing loans (NPLs) rise to levels similar to emerging economies resulting in negative earnings momentum, falling ROEs and an impetus to preserve capital. We Underweight Singapore banks with UOB our top pick.

Safe, liquid balance sheets. Regionally, Singapore banks’ balance sheets offer relative safety. Balance sheet liquidity is strong (77% loan-to-deposit ratio) compared to other developed markets such as Australia (118%), Taiwan (98%) and Korea (140%). Similarly, gearing levels are low with equity-to-assets at a healthy 8%, compared to peers in Australia (5%) and China (6%). But these ratios are particularly vital only for growth which is important in a recovery, but current macro conditions mean the medium term will be defined by the provisioning cycle.

Loan quality risks . . . Emerging-market style credit growth over the past two years means Singapore NPLs (3.7% FY09) will be akin to developing market levels (for example 4.1% in Indonesia and 5% Philippines). This is even higher than China (1.9% FY09) where lending growth is resilient (especially towards state-owned enterprises (SOEs)) underpinning a low NPL ratio. There are no such backstops for Singapore, where lending is focused on large corporates and small- and medium-enterprises (SMEs). Here banks have to take on individual credit risks rather than sovereign risk; hence the appetite for loan growth is limited. But FY08 total provisions to loans is at 2.3% for the sector; lower than countries with similar NPL levels.

Indeed provisioning levels in Indonesia (4.4%), Philippines (4.0%) and Malaysia (3.5%) are significantly stronger. As macro conditions continue to deteriorate, expect banks to aggressively build up provisioning. Note UOB (UOB SP - S$14.34 - BUY) and DBS (DBS SP - S$11.68 - SELL) were adding to provisioning from 2Q08 when macro conditions were significantly more benign. Even then we expect the FY09 provision cover to fall below 100% for the first time since 2006. Compare this with Indonesia which will see a provisioning cover of 147% and Korea at 133% in FY09. Hence, expect Singapore credit charges to be in the higher end regionally.

. . . will disappoint growth. While improving net interest margins and trading income are structural positives, regionally Singapore fares poorly in pre-provision operating profits to equity (19% versus HK: 25% and Indonesia: 38%). This is driven off low interest rates and a corporate biased lending book versus a higher margin consumer book in developing regional peers. In addition, expect headwind to fee income, which has a strong capital market component at c. 45% of non-interest income (excluding insurance). While in cost management Singapore is top-of-the-class, this isoffset by high credit charges (recall DBS saw 124bps and UOB 148bps in 1Q09 alone). This means FY09 earnings will contract -29% YoY vs. HK (+16%), Australia (+8%). While FY10 will see a modest recovery (+8%), this will still lag HK (+14%).

Remain Underweight. The sector trades at 1.3x FY09 PB, cheaper than history, but FY09-11 ROEs are 250bps lower than history, too. UOB is our only pick in the sector given proactive provisioning since 2Q08 which can potentially support an early write-back cycle. Similarly, the group’s asset quality is the strongest compared to peers based on recent Pillar 3 disclosure. With the lowest provisioning level amongst peers (2.2% vs. 2.5%) and a loan book which is c. 20% exposed to construction lending, we remain negative on OCBC (OCBC SP - S$6.78 - SELL).

Singapore Exchange - Buy: Raising Target to S$9.50 on STI Target 2700

Assumes 2010E ADT S$2.1bn, 23x PER — We raise our target price on SGX to S$9.50 (from S$8.00) based on a new 12-month STI target of 2700 (from 2400). We raise forecasts 7-19% on FY10E average daily turnover (ADT) of S$2.1bn. The recent STI rally, up 65% in 14 weeks, saw ADT triple from Feb lows to S$2.1bn/day in May, suggesting a forecast 61%qoq jump in 4Q09E (June 2009) profit. Our revised FY10 forecast of S$444m is 28% above consensus. Key risk is after a nearly 100% price jump SGX is vulnerable to price corrections.

Past market cycles suggest that the STI "normalizes" toward mean P/B levels as expectations of recovery set in, and may even overshoot the mean during periods of ample liquidity.

How far could the STI rally eventually go? It is important to note that we are just 14 weeks into this new recovery cycle. Our study of past STI cycles shows that with one exception (post Sept-01) every STI bull market recovered at least 90% of the prior bear market points lost, which in the current cycle implies returning to 3590 on the STI.

Investment risks: Having already rallied c.100% in 14 weeks from its S$4 trough, SGX is susceptible to near-term price volatility and market corrections. A fundamental medium-term risk would be the entry of a competitor exchange, which could materially affect SGX's equity pricing structure.

Our target for UOB is S$16.5

UOB is Singapore's second-largest bank by group assets (S$183bn as of Dec 2008). Its primary business focus is Singapore (70% of group pre-tax profit) and Malaysia (11% of group profit). In recent years the bank has made significant investments in both Thailand and Indonesia. UOB is primarily an SME and consumer-focused bank.

We rate UOB Buy/Low Risk, with a target price of S$16.50 (from S$14). We are positive on all of the Singapore banks given our view that the Singapore economy is passing its point of worst contraction, and our strategist expects the Singapore STI could recover to the 2400 level. Past market cycles suggest that banks will tend to lead an STI recovery as valuations normalize from trough levels, P/E multiples expanding in anticipation of earnings recovery. UOB is best known as an SME lender and hence exposed to a slowdown in this segment of the economy. UOB also has the largest holding of equity AFS securities, giving concern over book value erosion in a falling market, but equally could be beneficial in a market recovery.

Our target for UOB is S$16.5. (1) Using a dividend discount model (DDM), assuming a 2009E net DPS of S$0.60, and cost of equity of 10.7% and 7.1% long-term growth rate, gives a fair-value P/E of 14.1x 2009E, which when applied to our 2009E EPS of S$1.17 derives a fair value of S$16.5, which equates to a 2009E P/B of 1.6x (vs. 12.9% ROAE). We use DDM as a primary valuation tool, as we view it reflects sustainable earnings, dividend growth and excess returns relative to cost of equity, and also factors in liquidity/sentiment impact on valuations. It is also consistent with the methodology underpinning our P/E investment cycle analysis framework. (2) Using our P/E cycle analysis, which suggests an average trough-peak P/E range for the Singapore banks of 11-18x (for UOB 10.8-15.2x, average 13.0x) on one-year forward consensus estimates, our target price P/E is above the cycle mean for UOB.

We rate UOB Low Risk, to reflect the capital strength and financial regulation of the Singapore bank sector. This is in-line with our quantitative risk-rating system, which tracks 260-day historical volatility of shares. Possible downside and upside risks to our target price include: 1) the extent of impact of the US/global economy on Singapore's domestic economy and job growth; 2) the level of short term interest rates and shape of the yield curve; 3) changes to the (currently benign) asset quality position of the bank and in turn provision charges; 4) market liquidity/ investor risk appetite; 5) the outlook for Thailand and pace of recovery of UOB's Thai operations; and 6) capital management. These risks could impede the stock from achieving our target price.

Our target price for OCBC is S$8

OCBC is Singapore's third largest bank by group assets (S$181.4bn as of Dec 2008). Its primary business focus is Singapore (67% of profit before tax) and Malaysia (25%), but in recent years OCBC has made investments in Indonesia, China and Vietnam. OCBC is a balanced corporate, SME and consumer bank, with a leading position in life insurance and public housing ("HDB") mortgages, plus an orientation towards the mass market consumer.

We rate OCBC Buy/Low Risk, with a target price of S$8 (from S$6.50). We are positive on all of the Singapore banks given our view that the Singapore economy is passing its point of worst contraction, and our strategist expects the Singapore STI could recover to the 2400 level. Past market cycles suggest that banks tend to lead an STI recovery as valuations normalize from trough levels, P/E multiples expanding in anticipation of earnings recovery. OCBC is typically viewed as the least operationally leveraged of its peers to economic recovery and rising interest rates, and conversely it has greater earnings resilience in a less favourable outlook and falling short-term rates, in part due to its capital strength and diversified earnings.

Our target price for OCBC is S$8. (1) Using a dividend discount model (DDM), assuming a 2009E net DPS of S$0.28, cost of equity of 9.8%, and a long term growth rate of 6.3%, gives a fair-value P/E of 15.8x 2009E, which when applied to our 2009E EPS of S$0.51 derives a fair value of S$8, which equates to a 2009E P/B of 1.6x (vs. 10.7% ROAE). We use DDM as a primary valuation tool, as we view it reflects sustainable earnings, dividend growth and excess returns relative to cost of equity, and also factors in liquidity/sentiment impact on valuations. It is also consistent with the methodology underpinning our P/E investment cycle analysis framework. (2) Using our P/E cycle analysis, which suggests an average trough-peak P/E range for the Singapore banks of 11-18x (for OCBC 12.4-17.6x, average 15.0x) on one-year forward consensus estimates, our target price P/E is above the cycle mean for OCBC.

We rate OCBC Low Risk to reflect the capital strength and financial regulation of the Singapore bank sector. This is in-line with our quantitative risk-rating system, which tracks 260-day historical share price volatility. Possible downside and upside risks to our target price include: 1) the extent of impact of the US/global economy on Singapore's domestic economy and job growth; 2) the level of short term interest rates and shape of the yield curve (generally lower S$ SIBOR is at the margin positive for OCBC, and conversely); 3) changes to the (currently benign) asset quality position and in turn provision charges; 4) market liquidity risk appetite; and 5) dividend policy and capital mgmt. These risks could impede the stock from achieving our target price.

Our target price for DBS is S$14

DBS is Singapore's largest bank by group assets (S$257bn at Dec 2008). Its primary focus is Singapore (c62% of group profit before tax) and Hong Kong (c21% of group PBT). It also has exposure to several other parts of Asia, including Thailand, Taiwan, India and Greater China. DBS is known as a corporate- and consumer-focused bank, as well as for its treasury operations.

We rate DBS Buy/Low Risk, with a target price of S$14 (from S$12). We are positive on all of the Singapore banks given our view that the Singapore economy is passing its point of worst contraction, and our strategist views that Singapore STI could recover to the 2400 level. Past market cycles suggest that banks tend to lead an STI recovery as valuations normalize from trough levels, P/E multiples expanding in anticipation of earnings recovery. DBS is typically viewed as the most operationally leveraged of its peers to economic recovery and interest rates, and conversely it has the highest operating risk to a deteriorating macroeconomic outlook.

Our target price for DBS is S$14. (1) Using a dividend discount model (DDM), assuming a 2009E net DPS of S$0.54, cost of equity of 10.9% and 7% long- term growth rate, gives a fair-value P/E of 16.6x 2009E, which when applied to our 2009E EPS of S$0.84 derives a fair value of S$14. This equates to a 2009E P/B of 1.3x (vs. 9% ROAE). We use DDM as a primary valuation tool, as we view it reflects sustainable earnings, dividend growth and excess returns relative to cost of equity, and also factors in liquidity/sentiment impact on valuations. It is also consistent with the methodology underpinning our P/E investment cycle analysis framework. (2) Using our P/E cycle analysis, which suggests an average trough-peak P/E range for the Singapore banks of 11-18x (for DBS 10.6-16.7x, average 13.6x) on one-year forward consensus estimates, our target price P/E is above the cycle mean for DBS.

We rate DBS shares Low Risk to reflect the capital strength and financial regulation of the Singapore bank sector. This is in line with our quantitative risk-rating system, which tracks 260-day historical volatility of the shares. Possible downside and upside risks to our target price include: 1) the impact of the US/global economy on Singapore and Hong Kong's domestic economy and job growth; 2) the level of short-term interest rates and shape of the yield curve (generally low S$ SIBOR and high HIBOR are negative for DBS net interest margins, and conversely); 3) changes to the asset quality position of the bank and in turn provision charges; 4) capital position and potential regional M&A; and 5) the long-term strategy and direction for the bank. These risks could cause the stock to deviate from our target price.

Singapore Banks - Probability-of-default is at the high end

Pillar 3 disclosures by the Singapore banks show the probability-of-default on corporate/SME exposures is at the high-end, especially for DBS and OCBC. Credit risk mitigation, on the other hand, does not lower risks to the same level as the likes of StanChart. Together with worsening macro data (April bankruptcies and liquidations are at record highs), this does not bode well for asset quality. Hence expect credit charges to rise further, while ROEs will remain depressed. Maintain UNDERWEIGHT.

Probability-of-default is at the high end
- All three Singapore banks have provided Pillar 3 disclosure for the first time
- Other bank exposures and mortgage exposures are benign coming in at the lowest probability of default bucket for all three
- However, on corporate/SME exposure a dichotomy exists, with UOB having 82% of exposure in the lower risk bucket, while this is 40% and 35% for DBS and OCBC
- Their aggressive expansion in to SME lending during the boom years is a likely cause here. Recall OCBC grew SME customers by 15% YoY each in FY07 and FY08

Risk mitigation good, but not great
- Credit risk mitigation (CRM) lowers risk for assets under the foundation IRB category by 5-9% for the three banks
- Similarly, risks for assets under the standard approach are lowered by 4-11%
- While good, there is significant room for improvement to catch up with the likes of StanChart who is seen as far more aggressive than the Sing banks
- We believe this spells a more conservative lending attitude from the Singapore banks going forward

NPL cycle set to get worse
- The NPL cycle has only just started and hence will get worse as the cycle progresses; hence rising credit charges (143ps in FY09)
- Bankruptcies have risen 38% YoY in April; the worst since the data series began
- Pawn broker loans are up 16% MoM in February signifying rising levels of indebtedness away from the formal banking sector; this is a concern

Stay UNDERWEIGHT
- The sector is now at 1.4x 12-month forward PB vs. 1.7x long term, but long term ROE was 11%; we expect just 8.5% for FY09-11CL
- UOB is our top pick for the sector, based on stronger asset quality vis-à-vis peers. SELL OCBC given low provisioning levels.

Singapore Exchange: Raising the bar

Raising volume assumptions. SGX¨s average daily volume and value rose to 3.2bn and S$2.3bn in May-09 respectively (Apr-09: 1.8bn; S$1.3bn). Even for the past week, volume and value appear sustainable and high at 3.1bn and S$2.2bn respectively. Annualised velocity up to May-09 was 78%. We further raise our volume and value assumptions for FYJun10 to 2.5bn and S$2.4bn (from 1.8bn and S$1.7bn) respectively, amidst the market rally, which we believe is sustainable. Hence, our earnings for FYJun10-11 are raised by 16%.

4Q Jun09 quarter the strongest for this financial year. The upcoming 4QFYJun09 results would be the strongest for SGX in this financial year. YTD-FYJun09 average daily volume and value at 1.4bn and S$1.2bn respectively, has run ahead of our earlier assumptions of 1.2bn and S$1.1bn. We are tweaking our FYJun09 volume and value assumptions to match this, given that it is less than a month away from the financial year-end. Our FYJun09 earnings is revised up by 5%.

Reiterate Buy; clearly a proxy to the market. SGX is currently trading at 17x forward PE and is still the cheapest stock exchange in the region. In view of the bullish market sentiment, we further raise our TP for SGX to S$9.10 based on 20x forward PE and 85% velocity assumption. Our target PE is derived from a correlation with market velocity, similar to our valuation methodology for HKSE. Reiterate Buy.

United Overseas Bank Ltd - Still our favourite

Although UOB has been an outperformer since our upgrade in mid-April, we continue to prefer it to its peers. We believe there could be upside surprises to its book value from a reversal of MTM losses in its AFS portfolio. With equity markets having rallied so strongly and credit spreads having come off so sharply, the potential for a BV spike is significant. We maintain our S$16.18 target price (1.7x CY09 P/BV) and Outperform rating.

We worry less over the fact that UOB's P/BV has approached its historical P/BV means, because of its book-value surprise potential. We believe the first catalyst for UOB could come in July when US banks announce large MTM gains. The second catalyst could come in early August when UOB itself unveils large MTM gains.

Singapore Banks - Could We Be Heading for a V-shaped GDP Recovery?

Top picks DBS, UOB — Banks still trade 8-27% below mid-cycle P/B despite rising 75-82% from March lows (STI +57%). Banks outperform the STI in the first 9-12 months of a new cycle as the economy moves from recession to recovery. Our economist Wei Zheng Kit models a U-shape profile in his recently upgraded GDP of -5.2% in 09E and +6.4% in 10E, but concedes that strong April Industrial Production data (+24.7% mom sa) presents further GDP upside risk. Consensus bank forecasts rose 4-13% since 1Q results. More upgrades could come from improving loan growth, margin expansion and lower than expected provisioning.

Upward revision to 1Q GDP — Singapore MTI revised 1Q09 GDP to -10.1%yoy (from -11.5%), better than our (-10.7%) and consensus (-10.9%) numbers. Our economist noted that while there was no change to official GDP forecast of -6 to -9%, the tone of the press statement noted that the revised estimates present a less pessimistic picture than the advance estimates, and that “things have stopped getting worse”. He maintains his view that that the economy will be out of recession by 4Q09, returning to pre-recession levels by end 2010 or early 2011.

April-09 loan data — Domestic loans fell 0.3% mom to S$270bn, but 7.6% higher versus a year ago. Business lending dropped by 0.1%mom with greatest declines in manufacturing, non-bank FIs and others. Consumer lending rose by 0.8%mom, with mortgages growing by S$0.5bn (+0.6%mom, +6.3%yoy). IE Singapore data shows that 1,834 SME-related loans, with total value of $1.06bn, were approved in April, bringing the total value of loans approved since Dec-08 to S$2.5bn.