Can Singapore banks achieve post-Asian financial crisis peak P/Bs again?

In May 2007, just before the credit crisis struck, Singapore banks traded at post-Asian-financial-crisis high P/B multiples (DBS 1.9x, UOB/OCBC 2.2x). In a detailed report, we analyse whether Singapore banks can reach those valuation multiples again.

To achieve those multiples again, DBS would need an ROE of 12.8% (CS 2011 forecast 10.2%), UOB 13.2% (CS 12.9%) and OCBC 12.2% (CS 11.0%) using Gordon Growth. So, even in 2011 (a “normalised” year), banks may not reach their recent peak P/B.

Although Singapore banks are enjoying some of the strongest consensus earnings upgrades among the Asian banks, 2011 profits are projected to be only marginally ahead of 1H07 (annualised).

We find bull-case ROEs in 2011 could be 1.5% higher than our base case. In that case, DBS would still fall short of the 12.8% needed to reach 1.9x P/B, while UOB/OCBC would be comfortably ahead.

UOB remains our top pick; while DBS should perform well when rates start rising. UOB is the highest ROE bank in Singapore and has built a sustainable 200-300 bp ROE lead over peers.

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Singapore Banking Sector: Turning the corner

Better set of results. Overall, 2Q09 results were better than expected. OCBC’s strong results were driven by higher non-interest income and lower specific provisions. UOB’s results were mildly better than expectations but still dragged by higher collective impairments. DBS’ results were also above street estimates. All banks declared interim dividends.

Sentiments improving. We gather that loan demand is back. Positive signs in the rejuvenation of housing loan demand were apparent in the Jun-09 banking stats where housing loans grew by 4.1% YTD. We also note that loan spreads for the corporate and SMEs have peaked while loan rates for consumer loans, especially housing loans, remain competitive. Specific provisions are starting to trend down although NPL ratios may still inch up. However, we believe the worst of spiking NPLs are over. We expect NPL ratio to peak at 3% for FY09. Capital ratios for banks remain robust.

Pegged to mid-cycle valuations; further upside depends on sustainability of capital markets and clear signs of macro recovery. Our target prices are still pegged to mid-cycle valuations based on FY10 book value. Further upside to our valuations would depend on the recovery in book values as credit market normalizes. Our preference lies with UOB as its valuation lies in the recovery of its book value. In the longer term, UOB’s ROE stacks up better than its peers. Maintain Buy for UOB with TP at S$18.60. Meanwhile, we have a Hold call for OCBC with TP at S$8.00 as we believe most good news have been priced in.

DBS - May He Be The Right Choice

DBS has appointed Piyush Gupta as its new CEO. (It is no surprise that none of the oft-touted local candidates was the chosen one.)

Gupta, a Singapore PR, is a 27-year veteran in the banking industry, of which 8 years were spent here, briefly as Citi’s Country Head. He was also country head for Malaysia (2002-2007) and Indonesia (1998-2000). He is currently CEO for Citigroup’s South East Asia Pacific, including Australia, New Zealand and Guam.

We do not expect the market to react materially one way or the other, to Gupta’s appointment. (DBS’ share price had recovered to around $12.90 yesterday before the announcement, from $12.64 the day before. It hit $13 but ended at $12.72.)

All his predecessors over the last 10 years - from John Olds, P Paillart, Jack Tai, to the late Richard Stanley were veteran bankers, from JP Morgan and Citibank, and with different expertise, eg Jack Tai, an investment banker, when the Bank had IB ambitions, and with a good grounding in optimal capital structure; Stanley for his intimate knowledge of Hong Kong / China, particularly important with the rising importance of China, and after the acquisition of Dao Heng Bank 8 years ago, and which has yet to produce the “desired” returns. (Gupta unfortunately lacks this exposure, even though he had spent some time in HK.)

After all the hustle and bustle, it will be down to execution, to maintain DBS as one of the strongest financial institutions in the region. We maintain BUY.

Singapore Banking Sector - Hold UOB, OCBC, Sell DBS

n the midst of the economic recession, Singapore system loans growth remained lackluster with total loans outstanding higher by 2.2% to S$271.8bn over the year. Business loans contracted 2.1%, as we believe lower economic activities caused many SMEs to reduce their short term financing. However, consumer loans managed to offset some of that contraction as it recorded resilient growth of 8.3%, boosted mainly from the housing loans.

We expect consumer loans segment to expand; especially the mortgage loans (70.3% of consumer loans, 31.0% of total loans) as the number of private properties transacted in Singapore remains elevated in 2009 despite the economic recession. Mortgage loans are usually disbursed over 3 years and thus provide a healthy loans pipeline for the Singapore banks.

However, we currently rate UOB and OCBC as HOLD and DBS as SELL. This is due to the recent run-up in the banks’ share prices and that the risk reward is not as attractive as before. UOB and OCBC are currently trading close to the 5 year average price to book ratio, whereas DBS is trading at a lower P/B valuation. The lower rating of DBS is due to the lower growth assumption, and lower ROE expectation relative to its listed competitors. Moreover, we believe that the increase in non-performing loans remains as a key risk shadowing the banking industry.

DBS - Buy: New Target S$15.50; Raising EPS Estimates 2%-18%

Target S$15.50 (1.46x '09E P/B): DBS has retraced 10% from recent highs on concerns of sharply rising NPLs. But DBS' provisions-hit 2Q09 ROAE of 9.3% belies record pre-provision operating profits, and a PPOP ROAA of 1.73%, back to the 2007 peak. The P&L provisions cycle should start to normalize over 2010E for a 2011E ROAE of 12%. Our 12-month target has been reset to DBS' mid-cycle P/B multiple of 1.46x.

2Q09 pre-provision profit a record S$1.16bn: DBS' 2Q09 PPOP is up 30% vs. 2Q07 (the last economic cycle peak). Loan growth +29% over 2 years drove 8% net interest income growth despite NIM pressure from low S$ SIBOR, while basic bank fees remained resilient. Markets-related income has been a key boost to 2Q09 revenues, but operating costs are 4% lower than in 2Q07 despite a much larger balance sheet, for a 2Q09 cost-income ratio of just 35%.

2Q09 NPLs, +36%qoq, the area of concern: NPLs rose to S$3.7bn on a S$1bn rise in "rest of world" (Middle East and shipping) NPLs, but as "substandard" NPLs, mgmt do not expect large losses, stressing that 38% of all NPLs are fully current. We expect NPLs to peak by end-2010E, and provisions to return to "normalized" levels by 2011E, markets pricing in normalization ahead of that.

Raising 2009-11E EPS estimates 2-18%: We now project profit growth of +25% in '10E and +22% in '11E on [1] 3-7% loan growth; [2] modest NIM improvement to 210bps; [3] PPOP ROAA of 1.7%, [2] provisions falling from 133bps in '09E to 50bps in'11E. Our 2009E profit forecast of S$2bn remains 12% above Bloomberg consensus estimates.

UOB - New Target S$18.60; Raising EPS Estimates 2%-20%

Target S$18.60 (1.76x '09E P/B): On the back of high 2Q09 provision charges, UOB has sold off 9% from recent highs. But despite annualized provisions of 188bps of net loans, UOB still reported a 2Q09 ROAE of 12.8% Our pro forma analysis suggests that UOB could achieve a 15% ROAE with provisions of 50bps. Two-thirds of 2Q09 charges were general provisions, which could fall rapidly if the economy improves. Our 12-month target has been reset to a P/B multiple of 1.76x vs. a 2009E ROAE of 13%.

2Q09 pre-provision profit a record S$937m: UOB's 2Q09 PPOP is up 18% vs. 2Q07 (the last economic cycle peak). Loan growth +23% over 2 years has driven net interest income growth of 19% on improving NIMs. Basic bank fees remained steady, other income has been lifted by investments gains. Operating costs are up just 3% vs. 2Q07, for a 2Q09 cost-income ratio of 36%.

2Q09 provisions 188bps, overly conservative? NPLs rose to S$2.5bn for a still reasonable 2.5% NPL ratio. Mgmt reiterated that there were a few lumpy NPLs, but no trend asset quality deterioration. We expect NPLs to peak by end- 2010E, and provisions to return to "normalized" levels by 2011E, but markets should price in normalization well ahead of that.

Raising 2009-11E EPS estimates 2-20%: We project EPS growth of +17% in '10E and +21% in '11E on [1] 2-7% loan growth; [2] NIMs easing to 233bps; [3] PPOP ROAA of 1.9%, [2] provisions falling from 130bps in '09E to 50bps in'11E. Our 2009E forecast of S$1.9bn is 9% above Bloomberg consensus.

Great Eastern - Raising Target to S$15.30 on Improving Outlook

set at 1.25x P/EV: Recovery of equity, and stabilization of debt markets should lift GEH's performance, and we now view 1Q09 was the cycle trough for premium sales and new business value. We treat the 3Q09E S$250m provision for "GreatLink Choice" redemption as a one-off, just like the S$213m Malaysia RBC gain in 1Q09. A possible 30% sale of GE Life Malaysia (GELM) may cost S$43m in FY08 profit (15% of group) but generate over S$0.5bn in proceeds.

2Q09 profit S$98m, in line: (1Q: S$237m; S$42m core) premiums +6%qoq to S$1.25bn. Core insurance profit S$128m (1Q: S$65m): par fund profit S$27m, non-par profit S$77m, ILP profit S$23m. 1Q had S$213m (S$195m net of tax) gain from change to risk-based capital in Malaysia. 1H09 DPS S$0.05/share.

GreatLink Choice redemption offer: GEH is making a one-time redemption offer to policyholders of this product, whose market value remains at a steep discount to par due to its underlying CDO investments. The 5 tranches of this product had invested premiums of S$594m, a Jun-09 NAV of S$217m and coupons paid of S$48m. Making some assumptions on redemption, GEH will make an estimated S$250m provision to be reflected in its 3Q09 results.

Possible GELM 30% divestment: With a FY2008 EV of S$1.64bn and FY2008 net profit of S$144.7m, 30% of GELM may generate over S$0.49bn (S$1.04 per GEH share) in sale proceeds, but at the loss of about S$43m in income contribution based on FY2008 profits (15% of GEH FY2008). In July 2009, GELM began a formal bancassurance partnership with OCBC Malaysia, distributing life products through its 29 bank branches.