UOB 3Q11 revenue fell to S$1.36b

JP Morgan - Price Target: S$18.00

UOB announced 3Q net profits of S$522mn, down 18% q/q, 24% y/y, 13% below street estimates of S$596mn and 6% below JPMe of S$556mn. Results details are on page 3. We expect the stock to open lower on back of weak results. DBS stays our top pick in the sector as earnings momentum and valuations are in favor of the bank. UOB has outperformed STI by 4% YTD, which should start reversing on back of these results.

- Key negative surprise was non-interest income down 15% q/q on back of treasury losses, lower loan related and rental income. Also, associate income (primarily brokerage) was down 60% q/q. The bigger risk for the stock from disappointment on treasury revenue is reevaluation of ‘preferred pick in the current environment’ status of the stock within Singapore banks.

- NIM came down 3bps q/q to 1.89%, primarily due to lower loan yields and higher deposit costs. NII was flat q/q. The basic banking spread (loan-deposit spread) declined 16bps q/q to 2.31%. This points to further NIM pressure in forthcoming quarters, in our view.

- Loan growth was solid at 22.4% y/y and 7% q/q, broadly in-line with industry. Growth was firm across the board, with General Commerce and Mortgages key contributors. LDR went up marginally to 87%.

- Costs went up 3% q/q, 14% y/y, leading to CIR moving up to 46.4% on revenue weakness. Staff costs were contained at 1.4% q/q growth but other costs went up 5.6% q/q.

- Credit costs came in lower than expected at 30bps annualized. NPL ratio was stable at 1.5% but NPLs went up 9% q/q in absolute terms, with increases in Singapore and Malaysia. Coverage ratio declined to 117% from 126% last quarter.


PhillipCapital - SGD 14.50

UOB 3Q11 results disappoint, missing our estimates for two consecutive quarters. Headwinds are seen on few fronts. 1H11 revenue and NPAT were 5% short of our full year forecast and by 3rd quarter, missed estimates were 8% and 11% respectively. We revise our earnings forecast to be in line with actual results. EPS is reduced to S$1.50 and fair valuation to S$14.50.

Overview:
- 3Q11 revenue fell to S$1.36b (-5.0% y-y; -5.4% q-q)
- Net interest income increased to S$915m (+3.6% y-y; +0.2% q-q). NIMs declined by 3bps to 1.89% from 1.92% in previous quarter.
- Fee and commission income gained, to S$323m (+13.9% y-y; -4.2% q-q)
- Other noninterest income declined to S$122m (-54% y-y: -34% q-q)
- Expenses increased to S$631m (+13.6% y-y; +3.1% q-q). Cost to income ratio climbed slightly from 42.6% in 2Q11 to 46.4% in 3Q11.
- NPAT declined to S$522m (-24.2% y-y; -17.9% q-q)
- Loans grew to S$137.6b (+22% y-y; +7% q-q)
- Deposits grew to S$158.4b (+11% y-y; +7% q-q) LDR increased from 79% in previous year and 86.6% in previous quarter to 86.9%.

Earnings were significantly lower and given the challenges seen in 3Q11, we are concerned about the group’s ability to navigate through the challenging terrain.

UOB faced the following issues while attempting to grow in 3Q11:
a. Increased funding costs
b. Slowing loans growth
c. Greater competition
d. Falling NIMs

Margins in Indonesia have declined by 40 bps to 5%, Malaysia and Thailand both fell by about 15 bps to 2.52% and 3.12% respectively. Margins pressure came about due to increase in competition in these lucrative markets. Despite the intense competition and the falling NIMs, when we compare to NIMs in Singapore which are only 1.5%, these countries remain good places to ramp up loans. We believe the decline in margins was also partly due to the negative SORs in Singapore.

Funding cost increased because UOB had shifted their funding source overseas to reduce mismatches in currencies between the deposits and loans. They have also extended the duration of deposits, again to reduce duration mismatches. As a result, funding costs increased and reduced their NIMs in 3Q11.

Management also saw loans approval slow regionally and markedly in Singapore. As a result of slowing loans growth and funding issues, UOB is choosing to lend only to credit worthy clients and to pick those with better margins. There is however often a trade off between credit quality and margins. It is a fine line.

e. Rising NPLs
In 4Q10, we saw rising NPL in the transportation industry. In 3Q11, the situation worsened and NPL reported was 7.4% versus 5.3% in previous quarter. It appears that the Australia client/s had suffered in the face of growing macroeconomic risks and UOB had to write down the loans again. Though management said it was the bank’s decision to downgrade and not a matter of portfolio degradation, we do think this could be the first sign of credit deterioration arising from headwinds in the macroeconomic environment.

f. Higher cost to income ratio

g. Lower NPM
The group saw the ratio increased from 42.6% to 46.4%. Management had guided cost income ratio of 45% but given the lower denominator this quarter, it is inevitable that the ratio soared. As for actual expenses, UOB is indeed spending more to improve infrastructure and platform. It has also added more headcount in 3Q11.

Rising cost and lower earnings resulted in lower net profit margins, which declined from 44% to 38%.

h. Hits in USD-SGD hedging
In 3Q11, UOB also took hits in its hedging book due to the rapid appreciation of USD against SGD.

Thailand’s Floods Management guided that they had taken S$500 million general provision few years for Thailand’s operations and had not utilize the provision to-date. They believe this provision to be ample for any potential losses arising from Thailand’s floods hence do not think there will be earnings impact.

Exposure to Eurozone
UOB AFS portfolio is about S$145 million below par. Their exposure is largely to UK, Netherlands, Germany, Sweden and Switzerland. The most vunerable amount identified is a S$200 million exposure to France.

Fed’s impact on banking sector
FED’s decision to maintain low interest rates for extended period means continued pressure on NIMs in future, through 2013. Flattening yield curve means lesser gapping opportunities for the banks. Both are detrimental for banks’ earnings and as it is, UOB is somewhat reeling from these impact already.

UOB missed our FY11 estimates by a wide margin. To reflect reality, we reduced earnings estimates by 13% to S$2.41 billion for FY11. Earnings in FY12 are also reduced by 25% to S$2.26 billion to reflect weaknesses in revenue streams. On a valuation front, we changed our parameters by increasing the Beta from 0.96 to 1.1. We expect the banks to be more volatile than the key index as the latter is anchored by defensive telco stocks. We downgrade UOB from Hold to Sell. Fair valuation is revised from S$20.12 to S$14.50. Given its current growth trajectory, it appears that UOB will have difficulties maintaining its lead over a key competitor. UOB has shown signs of negative impact arising from economic risks and we hold the opinion that the stock should trade at lower PB value to reflect its weaknesses. At S$14.50, UOB will be trading at about 1.13x PB versus 1.31x at current price. Previously, we pegged it to 1.5x PB.