UOB on track towards ASEAN expansion

Constant eye on liquidity risks
“You cannot just depend on capital to grow.” Our takeaways from a recent UOB non-deal road show include the bank’s consciousness of liquidity risks, having positioned for an environment where liquidity might disappear suddenly. As the western world prepares for a banking shock, management believes that Asia has to be readied for a macroeconomic jolt that will logically transpire. Management reiterates that its regional growth prospect is intact, though limitations today stem not only from capital limitations but increasingly, liquidity constraints. UOB stresses that efforts to build a deposit franchise and integrate regional operations are all essential to position it for steady growth ahead.

Impact on liquidity and margins. Clients asked if the impact of the current liquidity squeeze would equate to a margin contraction, particularly as US$-SIBOR rates have been climbing and S$ deposit competition seems to be bubbling. UOB noted that US$ funding has certainly gotten more difficult but is still far from Lehman days. Recent funding costs and SOR trends could mean a little margin pinch in 3Q11. This is in line with new guidance (of margin contraction) from peers in recent weeks.

However, UOB noted the recent initiatives to raise loan pricing, so margins might not be bad beyond 3Q11. Interestingly, corporates are willing to accept higher pricing, many having gone through the 2008 global financial crisis and believing in the value of securing credit lines ahead of potentially tough times. Piecing data points from other sources, we understand that OCBC has also raised its lending spreads to corporates and SMEs recently. We remind investors that tighter liquidity is not necessarily bad for margins. Singapore banks did achieve some of their highest lending spreads ever in the period 3Q08-2Q09.

UOB noted that the new breed of competitors in Asean is not western banks, but regional Asian banks with the ambition to expand out of their home territories. No signs of credit-quality hiccups yet, but still early days. Queries on asset quality drew little insight. Management noted that it is still early days and the picture will only be clearer in two months’ time. What is certain is that credit costs will not be in the range of 10-15bp as before. Current allowances run rate is about 30bp.

Credit costs are expected to trend up to 30-50bp. On potential property NPLs, management
pointed out that the two big determinants are unemployment and interest rates. As in 2008, we believe the government will implement policies to stem the rise of unemployment when recession strikes, so the first factor is taken care of. The second requires the assumption that interest rates will stay low.

We believe the risk of dramatically higher interest rates is low for now, so long as both the US and Europe do not resort to unrestrained money printing to solve their problems. In Singapore, the mortgage servicing ratio is about 27-28% as interest rates are low. During the Asian financial crisis, this ratio had topped 60% when interest rates spiked;
property NPLs were unavoidable.

In our opinion, UOB certainly looks to be managing its liquidity risks better than peers, though the same cannot be said for credit risks. UOB’s credit costs were the highest in the sector (63bp cumulative) through the global financial crisis.

Regionalisation and growth
Plans to build Asean platform have not stopped. Profits from markets outside Singapore made up 36% of group profits in 1H11, implying the bank is on track to meet its 40% regional contribution target. UOB seems to be most bullish on Indonesia, having identified the customer segments to target for credit cards and wealth management. UOB said identifying market segments is key to managing credit costs in a downturn. It has similarly adopted a targeted approach in the Malaysian mortgage business. As with all business lines, the push in private banking is segment-oriented.

UOB’s target here is not the uber-rich but the upper-high-end, mass affluent. In contrast to the targeted approach in the consumer space, it has opened up more in business lending, moving into selected major industries in each Asean market. Industry expertise is crucial here. UOB is not running after market share but the right, profitable segment that will ensure lower credit costs in a downturn. Impact on loan growth. Clients also asked if there is any impact on loan growth.

Management noted that current annualised growth rates of more than 20% will not be sustainable. The strong pipeline prior to August suggests that 2011 will be strong. However, loan growth should certainly slow ahead. Business loans prior to August were for new business expansion and working capital; business expansion loans should certainly slow after August.

YTD outperformance underscores perceptions of its defensiveness. Investors tend to perceive UOB as the more defensive stock among the three, which explains its outperformance leading into tougher times. We believe this perception is not wrong. UOB does have one of the highest capital buffers among major Asian regional banks. Its liquidity position is also well taken care of. Among Singapore banks, UOB’s ROEs are commendable after taking into account its capital buffer. Such qualities reinforce the perception of its defensiveness.