UOB our top banking pick for 2008

SYNOPSIS : UOB’s earnings growth in 2008 is projected to be the highest of the three banks. With 12.4% projected 2008 ROE, UOB is worth S$22, offering another 7% upside from the current level.

CDO EXPOSURE – DBS STILL THE MOST VULNERABLE
With close to 90% coverage for Singapore banks’ exposure to the US sub-prime mortgages, we can safely say that the bulk of what has to be provided has already been made. Any further deterioration in the US subprime market should have little impact on the Singapore banks’ bottomline. However, what we are now more concerned with, is the potential spillover effect to the other currently healthy corporates should the US subprime issue drag the US economy into a deep, long-drawn recession. With banks more reluctant to lend to preserve their capital, cost of borrowing has been rising. Corporates could go bankrupt if there is a prolonged credit squeeze.

Although we believe the Fed is trying its best to save the US economy and hence the financial market with all kinds of aid packages, most economists see the lowering of rates as an ineffective way to solve the US subprime crisis. As long as consumer spending is curtailed with rising unemployment, more companies will fold up. It is therefore hard for the US to evade a recession. In fact, some would argue that the US is already in a recession, and likely an extended one at that.

Table 1 sets up the additional amount of provisionings required of the Singapore banks should their non-ABS (ie corporate CDOs) portfolio be also affected by rising bankruptcy in US and Europe where the bulk of these CDOs are exposed to.

We are the least concerned for UOB and OCBC as even if 100% of its non-ABS is to be provided, it would shave off less than 1% of UOB’s shareholders’ funds and only 2% for OCBC. DBS is the most vulnerable of the three banks as currently only 3% of its non-ABS portfolio is provided, compared to 37% for UOB and 14% for OCBC.

Note that only 15% of DBS’ portfolio are currently rated AAA, with 42% AA rated and another 42% A rated. The credit risk can therefore be pretty high should the US go into a severe recession.

2007 BEST OPERATING PERFORMANCE BANK - OCBC
OCBC reported the best operating results for the year, thanks to the following factors:- (1)NIM widened by 10 bp (the largest margin improvement amongst the three banks) (2)Above industry loans growth – 19% y-o-y and 7% q-o-q, second highest of the 3 banks, after UOB in 4Q07. (3)Fees & commission rose 35% y-o-y, the highest of the three banks. Even if we exclude stockbrokerage income, OCBC posted 28% y-o-y growth, on par with UOB and much higher than DBS’ 20% growth.

A S$231m provision was charged against OCBC’s profit & loss for its CDO exposure but writebacks from its office buildings in Singapore which are now carried at original acquisition cost, resulted in only a S$36m provision compared to UOB’s S$300m and DBS’ S$431m provision, with the CDO exposure accounting for nearly half of the latter two’s provisions.

EARNINGS OUTLOOK
The 3-month interbank rates have fallen below 2% compared to an average of 2.75% in 2007. Economists are projecting the rates to fall further to around 1% (from 1.3% currently) before bottoming out in 2H08.

With the interbank rates expected to stay low in the most part of 2008, UOB which has the highest loan-to-deposit ratio amongst the three local banks, will see its NIM least affected by the falling interbank rates compared to OCBC and DBS.

The strong brokerage income in 2007 is also unlikely to repeat for OCBC and DBS. As for UOB, although we can expect to see a slowdown or even a drop in UOB’s funds management income in 2008, fee income generated from loans, trade, credit card and service charges which grew strongly in 2007 is expected to stay firm in 2008.

RECOMMENDATION & CONCLUSION – PREFER UOB AND OCBC
UOB continues to stand out as our top banking pick, both in terms of valuation upside and earnings growth momentum. Despite our projection of a more than 40% fall in funds management fees in 2008, we can still expect a decent 6% net profit growth in 2008 versus 4% for OCBC and a 5% earnings decline for DBS. OCBC is our second banking pick, with a similar 7% upside from the current levels.

Of the three banks, UOB is forecast to generate the highest ROE of 12.4% in 2008; followed by OCBC at 12% and DBS at 11.4%. UOB therefore deserves to trade at higher P/B valuation (see valuation table below).

[This article is contributed by NRA Capital Pte. Ltd., a licensed Financial Adviser by the MAS. Readers of this content are bound by the same terms & conditions of our website www.netresearch-asia.com .]