• UOB's 3Q19 net profit of S$1,118m (+8% y-o-y/-4% q-o-q) beats consensus by 2%.
• NIM declined 4bps q-o-q to 1.77% due to lower interest rates and competitive loan pricing environment.
• Credit costs continued to normalise to 23bps (2Q19: 8bps); S$600m impairment taken on Evergrowing Bank’s stake.
• Maintain BUY and Target Price of S$29.20 amid slower growth environment.

Strong Dividend Yield to Support Share Price

• We maintain our BUY call on UNITED OVERSEAS BANK (UOB, SGX:U11) and Target Price of S$29.20. The stock remains supported by a high dividend yield of 4.7%. See UOB Dividend History.
• We believe that current valuations of 1.1x FY20F P/BV below 10-year historical mean valuation remain undemanding as UOB’s book continues to be well supported by stable lending and funding base, albeit with NIM pressures and normalising credit costs.
• UOB's share price tends to outperform in weaker market conditions and has a defensive franchise which is less exposed to volatility in wealth management fees. We believe UOB will continue to leverage on its strong capital position to capture cross-border loan growth opportunities as it continues to target broad-based commercial loan growth amid a slower growth environment.

Earnings Grew on Higher Interest Income and Non-interest Income, Despite Lower NIM

• UOB's 3Q19 net profit was S$1,118m (+8% y-o-y/-4% q-o-q), ahead of consensus by 2%. Net interest income of S$1,687m improved 5% y-o-y/ 2% q-o-q. Net interest margin (NIM) declined 4bps to 1.77% in 3Q19 (2Q19: 1.81%) as interest rates declined in 3Q19. See UOB Announcements.
• Further, loan pricing environment is competitive. Operating costs were slightly higher at 2% q-o-q, bringing cost-to-income ratio to 44.2% (2Q19: 43.7%), in line with full-year guidance of 44%.

Wealth and Trading Income Holds Up

• Non-interest income of S$922m was up 26% y-o-y/down 1% q-o-q. While net fee and commission income of S$551m continued to improve 14% y-o-y/ 5% q-o-q on better wealth management, loan-related and credit card fees, other non-interest income of S$371m was up 52% y-o-y/ down 8% q-o-q, largely due to absence of seasonal dividend income received in 3Q19.
• Notably, wealth management grew 38% y-o-y/ 15% q-o-q on the back of higher sales (unit trust, FX, bancassurance) and net new money inflow.

Loans Continued to Grow 1% Q-o-q

• Loan book grew 8% y-o-y/ 1% q-o-q, led by ex-Singapore loan growth.
• Meanwhile customer deposits were up 7% y-o-y/ flat q-o-q, resulting in LDR of 89.3% (2Q19: 88.5%).

Higher Quarterly Credit Costs Due to Special Provisions

• Credit costs for 3Q19 were higher at 23bps (2Q19: 8bps), special provisions charges were 21bps (2Q19: 11bps). Special provisions largely arose from Singapore, in relation to building and construction as well as a small oil-and-gas-related account.
• Also recall that credit costs were lower in 2Q19 as UOB saw write-back in allowances for non-impaired assets coupled with recoveries. For 9M19, total credit costs were at 17bps vs guidance of normalising credit costs to 20-25bps.

NPL Ratio Unchanged

• Absolute NPLs were marginally higher at S$4,191m (2Q19: S$4,030), largely attributed to Singapore. NPL ratio was unchanged at 1.5% (2Q19: 1.5%). New NPL formation was lower at S$180m (2Q19: S$357m), compared to average of S$286m for the last six quarters.

Strong Capital Levels

• Capital ratios stood strong with CET1 ratio at 13.7% (2Q19: 13.9%), and total CAR at 16.9% (2Q19: 17.2%). ROE for 3Q19 was 11.8% (1H19: 12.0%, 3Q18: 11.7%).

Key Takeaways From Analyst Briefing

Lower NIM ahead.

• According to UOB, there may be 5-10bps decline y-o-y on the back of falling interest rates. During the quarter, UOB managed to shift more fixed deposits (-1.8% q-o-q) into savings deposits (+3.3% q-o-q). UOB continues to look towards adjusting its funding cost as it continues to shift into savings deposits. UOB is comfortable with its existing liquidity position to tide it through the year-end when liquidity typically becomes tighter.

Targets broad-based mid-single-digit loan growth.

• UOB believes that a mid-single-digit loan growth diversified across all countries is achievable in FY20F. In Singapore, UOB intends to slow down big chunky loan growth for Financial Institutions and Real Estate-related exposures. UOB has separately disclosed its S$12bn Real Estate Hong Kong loan book which it intends to slow down loan growth into FY20F, of which loans are well-collateralised with LTV of 40-50% with short tenures linked to strong names, with the exception of two smaller customers with some weakness.

Normalising credit costs.

• UOB expects FY19F credit costs to be below 20bps. For FY20F, UOB expects deterioration in the macroeconomic environment to translate into higher general provisions and for credit costs to normalise to 20- 25bps. We are expecting 18bps and 20bps total credit costs for FY19F and FY20F, respectively.

Updates on Evergrowing Bank.

• In 3Q19, UOB did a S$600m impairment of its investment in Evergrowing Bank, pending further clarifications on the recapitalisation exercise. In FY18, UOB has previously mentioned that a significant discount to Evergrowing’s book value was taken when valuing the investment on UOB’s books (as of FY16, book value of Evergrowing Bank is S$12bn, out of which UOB owns 12%). We believe that a substantial portion of UOB’s investment has been impaired (adjusted in other reserves).

Valuation

• Maintain BUY, Target Price S$29.20. We arrive at our Target Price of S$29.20 based on the Gordon Growth Model (12% ROE, 3% growth, 10% cost of equity). This is equivalent to 1.1x FY20F P/BV, which is below its average 10-year forward P/BV multiple. See
• Our earnings revision of -1% to -2% is largely on the back of lower NIM assumptions. We now assume 3-bp and 5-bp decline for FY19F and FY20F respectively.

Where We Differ

• We continue to believe that UOB’s earnings growth will be more than supported by strong non-interest income growth.

Potential Catalyst

• Sustained positive deliveries. Lower–than-expected credit costs could drive earnings. Sustained ROE improvement will continue to drive UOB's share price.

Source: DBS Research - 1 Nov 2019