UOB - Hit by trading income and costs

■ 2Q15 earnings were below expectations dragged by lower trading/investment income and higher costs

■ Cautious outlook; earnings lowered on higher costs and slower loan growth

■ 35 Scts interim DPS declared; full year core DPS should remain at 70 Scts

■ Maintain HOLD; TP trimmed to S$25.00

Highlights

Earnings dented by lower trading income and higher expenses
· NIM rose marginally by 1bps q-o-q; most of its loan re-pricing occurred in 1Q15. Loan growth was flat q-o-q, up 5% y-o-y. Non-interest income was dented by lower trading income amid a volatile quarter but fee income was fairly strong, driven by fund management and credit cards. Expenses were higher due to staff and technology related costs. The weaker revenues in 2Q15 caused cost-to-income ratio to rise above 45%. This should normalise to the average of 42-43% over time.

Higher SP offset by GP write-back; NPLs stayed stable
· Higher specific provisions (SP) were booked due to weakness in its mortgage book. In addition, NPL classification was accelerated in Malaysia and Indonesia due to concerns in the respective economies. As there was a general provision (GP) write-back, overall credit costs remained at 32bps (annualised).

Earnings trimmed by 3-4% over FY15-17F
· We raised expenses for FY15-16F as the bank increases spending on technology particularly related to digitisation of its processes and products. In addition we lower loan growth to 5% (from 6%) in FY15F given that 1H15 YTD loan growth was only 1.5%. No change to other assumptions. TP is lowered to S$25.00 accordingly after our earnings revision.

Interim DPS quantum changed; full year should be the same
· UOB raised its interim DPSto 35 Scts from 20 Scts. We believe this is just a redistribution of its semi-annual DPS to even it out. Full year core DPS is expected to remain at 70 S cts. Special DPS, if any, would depend on performance.

Outlook

Conservative guidance
· Unlike peers, UOB is guiding for a flat NIM going into FY15 despite the higher interest rate scenario as it believes funding costs would likely offset positives it might gain from the rate hike. Liability management would be crucial going into 2015. Loan growth is guided at 5% for FY15, while credit cost should remain within the 30-35bps band. Cost-to-income ratio is targeted at 40% over the longer term. Fee income should improve from 1Q15 particularly from credit cards, wealth management and fund management fees. Separately, now that UOB is more comfortable with its funding position, it may lengthen the duration of its non-loan portfolio which could provide some NIM uplift.

Relooking its regional agenda
· Regionalisation remains core to UOB’s strategy. However, it is relooking at its operations in Indonesia. Its Indonesian onshore books still face funding pressures. Expenses would likely be on an uptrend as it invests in infrastructure at its branches to further optimise revenue generation. In Malaysia, asset quality position remains comfortable and it takes pride that its NPL ratio is among the lowest vs other key foreign banking peers operating in Malaysia While there are concerns that it may not gather enough RMB deposits compared to peers (due to its smaller Greater China presence), management believes that it would have sufficient avenues to deploy its excess RMB deposits. UOB’s key expansion theme remains “going organic”. Although it appears that the bank would shy away from acquisitions, it would still consider M&As if the pricing is right.


Technical Analysis
Daily Chart
Valuation:
Our S$25.00 TP is based on the Gordon Growth Model, implying 1.3x FY16F BV. While UOB’s regional footprint in ASEAN is more complete vs peers, near-term headwinds, particularly in managing its funding cost, could hamper growth.

Key Risks:
High proportion of loans in mortgages. With mortgage approvals sliding after several property cooling measures, we believe UOB may face more downside risks on mortgage growth once previous approvals for drawdowns taper off.

Regional funding costs, a near-term challenge . UOB has been facing funding cost pressures in its regional operations, particularly in Indonesia and Malaysia. Near-term pressure on funding costs could curb NIM upside. (Read Report)

Read Related Reports
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Source : DBS Group Research

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