UOB performed the worst as compared to the other local banks yesterday. While DBS and OCBC closed -0.9% and +0.1% respectively, UOB plunged 1.5%. Macquarie Equities Research (MER) previously released a research report (on 27 January 2015) with an ‘Outperform’ rating on the stock and a 12-month price target of $26. Based on UOB’s closing price of $23.16 yesterday, MER’s price target is 12.3% higher.

Event
MER believes the commodity finance exposure of UOB accounts for 9% of total loans. Based on MER’s stress test, MER believes that S$1.4bn of commodity-related losses are possible.
 
Impact
Quantifying the commodity finance exposure – UOB has commodity finance exposure (incl off balance sheet and derivatives) of S$21bn, which is about 0.9x of tangible book value based on MER’s estimates.
 
Stressing the commodity finance exposure – Based on MER’s assumptions of (i) 10% defaults in the commodity finance-related exposure and 60% specific impairments and (ii) S$85m revenue losses on these defaults MER estimates S$1.4bn total pre-tax losses in MER’s stress test. This compares to 34% of MER’s pre-tax profit estimate for 2015E.
 
Lower probability of stress test losses occurring – In MER’s valuation, MER discounts for a 50% probability that these losses will occur. Part of the commodity finance exposure is trade finance and UOB has conservative underwriting standards, which suggests that the exposure is of low risk.
 
Earnings and target price revision
Changed earnings per share (EPS) estimates marginally last Monday (26th January). MER slightly reduced its Target Price to S$26.00 from S$26.50 by discounting for potential commodity finance-related losses.
 
Price catalyst
12-month price target: S$26.00 based on a Price to Book methodology.
 
Catalyst: stronger fee and commission income growth, currency depreciation in Malaysia, high Sing dollar loan-deposit ratio
 
MER’s action and recommendation
MER maintained its Outperform recommendation on UOB with a Target Price of S$26.00.
 
UOB is less of a consensus buy, market earnings growth expectations are relatively less aggressive, real estate related asset quality worries look overrated to MER and the bank is making good progress to drive fee and commission income in MER’s view.
 
The unlevered balance sheet (12.6% fully loaded Common Equity Tier 1 (CET1) ratio as at 3Q14) is a major support for future dividend payments and organic growth. UOB has the highest CET1 ratio among the Singapore banks and is therefore in the best position to surprise positively on dividend payments in MER’s view.
 
Strategically, UOB stands out, given its disciplined approach towards overseas expansion and China-related worries are less of an issue for UOB.
 
UOB is priced ex-growth (more than 12% normalised return on equity vs 1.30x price per book value for 2015E) in MER’s view and the stock remains as MER’s top pick among the Singapore banks.

Source: Macquarie Research - 4 Feb 2015