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.

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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