• 2Q18 PATMI of S$1,077mn is in line with our forecast of S$1,067mn.
• NIM expansion, loans growth, and lower allowances were the key earnings drivers.
• NII grew 13.7% YoY on the back of strong loans growth of 9.7% YoY and expansion of NIM by 8bps to 1.83%.
• Upgrade to BUY (previously ACCUMULATE) with a higher target price of S$34.50 (previous TP S$31.70), as we raised our ROE and earnings estimates (+6%).

The Positives

+ Net interest income enjoyed 13.7% YoY growth. NIM expanded 8bps YoY to 1.83% on a rising interest rate environment. NIM shrunk by 1 bps QoQ but excess funds are expected to be deployed effectively to raise NIM back up above 1.84%, supported by 2 more rate hikes.  We have modelled in NIM of 1.86% for FY18e.

+ Loans growth jumped 9.7% YoY, highest in almost 4 years. Loans growth was fairly broad-based and mainly driven by double-digit growth in loans from manufacturing and financial institutions. Greater China was a standout with a 36.9% YoY growth. Due to market headwinds, guidance is still maintained at high-single-digit loans growth for FY18 (PSR estimate +10% YoY).

+ Credit cost at 13bps, a decline of 19bps YoY. After an aggressive provisioning in 2Q17, ECL declined 50% due to a recovering O&G sector. Ongoing O&G recoveries will keep credit cost subdued. But offshore contractors still face the core issue of structural overcapacity. Hence, we forecast credit costs of 19bps for FY18, slightly lower than the guidance of 20bps.

The Negatives

– Non-interest income declined for the first time in 6 quarters. Non-interest income declined 3.4% YoY. Fees income was down 3.7% YoY as wealth management fees retracted 2.9% YoY as customers turned more risk averse due to uncertain market conditions. Net gain from Investment securities declined almost 100% YoY due to a one-off gain on disposal of investment securities in 2Q17.

– Expectations of higher dividend payout may be let down. Despite industry high CET1 ratio of 14.5%, the 50 cents per share dividends declared is slightly lower than 50% pay-out guidance. With a new Digital Bank franchise being introduced, capital might be diverted to fund large initial IT expenses. Market uncertainties have made management more vigilant in deploying capital.

Outlook

UOB has introduced a new regional franchise called the Digital Bank. The existing digital banking is an omnichannel way to bank, that serves mainstream customers across all ages. While the new Digital Bank is a mono-channel, mobile-only way to bank that targets mainly the tech-savvy generation Z and Y, by providing an intuitive artificial intelligence interface that remembers and understands your needs. CIR of the new Digital Bank is expected to operate at 35%.

Due to property cooling measures, property transaction volume is expected to slow down in the near term but more noticeably next year. However, housing loans growth this year should still remain strong due to the drawdown of previously approved loans. The balance sheet of major developers remains strong and their credit risk is low. Mortgage loans and building and construction loans contributed to 50% of total loans.

The slowing Chinese economy may contribute to a slight slowdown in trade loans. However, the exposure to Greater China loans is small at 15% of total loans, with domestic loans accounting for 52% of total loans. This slight negative impact could be offset by higher NIM.

All in all, the rising interest rate environment together with higher loans growth and elevate NIM. UOB still maintains a high single-digit loans growth target. The bulk of the growth in FY18e will come from margin expansion and lower impairments.

Investment Actions

Upgrade to BUY (previously ACCUMULATE) with a higher target price of S$34.50 (previous TP S$31.70) based on Gordon Growth Model. The improvement in target price was due to our higher ROE assumption (previously 11.1%). Our FY18e earnings forecast is revised upwards by 6.1%.

Source: Phillip Capital Research - 06 Aug 2018