Risks of Higher Credit Charges for Longer

• UOB (SGX:U11)’s 1H20 PAT missed MKE expectations on weaker trading income. Pressure on NIMs and non-interest income in 2H20 are likely to remain given low interest rates and slow easing of lockdowns in ASEAN.
• Importantly, 16% of UOB's loan book is under moratoriums - a bulk of which are set to expire between 3Q20-4Q20. Mostly these are for SMEs and prolonged weak economic conditions may drive some to turn sour. This may drive higher credit charges in 2021E (and 2022E). Such a scenario may prompt MAS to extend the recently announced dividend caps to next year as well, in our view.
• Lower dividends, increased asset quality risks and tighter operating conditions in ASEAN, has us downgrading UOB to HOLD with new Target Price of SGD20.79.
• We prefer DBS for stronger franchise value.

Asset Quality Weakness May Spill to 2021-22E

• Management claims 10-15% of loans under moratorium may potentially become NPLs. In a worst case scenario, this can increase bad loans by 148% (to 4% Gross NPL ratio). We believe this risk may start to express largely in 2021 following moratorium expiry.
• Given 22% of the loan book is ASEAN, where some countries may not have the capacity to continue extending fiscal and monetary assistance, we expect a higher risk of NPLs viz-a-viz North Asia. We have raised 2021-22E credit costs by 23-24% as a result.

Near Term Operating Pressure

• UOB saw 2Q20 ex-fee, non-interest income fall 11% y-o-y despite conducive market conditions. Fee income fell 15% y-o-y. While easing lockdown conditions may support growth here, it is unlikely to normalise in the near term, we believe.
• Loan growth came in better than expectations, and UOB’s integrated regional presence may support some market share gains.
• Overall, while we have raised 2020-2022E loans balances by 3-7%, we have lowered non-int income by 4-8% for weaker trading and fees.

Lower Dividend Outlook. Downgrade UOB to HOLD

• Overall, our post 1H20 changes have resulted in cuts to 2020-22E PAT of 6-11%. We have lowered payout to 43% to stay in-line with MAS’ dividend guidance and maintain the same absolute payment in 2021E given macro uncertainty. As a result, we lower our multi-stage DDM (COE 9.7%, 3% terminal) Target Price to SGD20.79 (from SGD22.42).
• With 7% upside, downgrade UOB to HOLD.

Source: Maybank Kim Eng Research - 6 Aug 2020