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.

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