EUR 850.00 For Business Accounts Only

Morningstar | Stronger Loan Growth Offsets Lower Margins in UOB's 3Q Result; the Bank Is Undervalued

Contrary to the cautious second-half guidance given at the first-half result, narrow-moat-rated United Overseas Bank posted a reasonable third-quarter result as stronger loan growth underpinned net interest income growth. The bank has prudently increased its Singapore dollar deposit base on concerns over tighter liquidity going forward. This has come at the cost of 2 basis points decline in net interest margin to 1.81%, as an increase in customer deposits rates outpaced asset yields. Management is securing funding to avoid competition in the fourth quarter and net interest margin should steady and improve into 2019 as the funds are deployed. While the market is disappointed on the weaker net interest margin and quarterly profit decline of 3.7%, we note this is temporary and we continue to assume net interest margin to increase as U.S. interest rates continue to normalise. The decline in quarterly profit was mainly due to weaker trading income, which is inherently volatile. Our assumptions are adjusted but not enough to change our fair value of SGD 30. A pullback in the bank’s share price from the result, along with general weakness in the equity market, sees our recommendation at 4-star. The bank is currently trading on a fiscal 2018 dividend yield of close to 5% on our estimate and we believe the bank is undervalued.

Credit quality was steady with new nonperforming assets, or NPA, edging slightly higher against last quarter at SGD 475 million but a higher level of recoveries helped offset. NPA was SGD 4.4 billion, or 1.7% of total loans. Common equity Tier 1 ratio dipped slightly to 14.1% while the redemption of perpetual securities saw Tier 1 ratio declining to 15.1% from 16%. The bank is well capitalised and from a liquidity standpoint, its loan/deposit ratio was steady at 85.7% and regulatory liquidity ratios comfortably met. This also applies to its major regional subsidiaries.

On the regional operations, Indonesia and Malaysia are challenging as pressure on funding saw net interest margin compressing across both geographies. Stronger loan growth in Malaysia lifted net interest income and offset weaker margins. In contrast, Thailand performed well with management noting a stable macroeconomic and political environment.

Management elaborated on the virtual bank strategy announced last quarter by noting the platform can leverage off the existing infrastructure and the development is only the front-end interface. As such, the cost is mainly attributable to the acquisition of customers, who are generally from a younger demographic below the age of 30. Within that segment, the bank is targeting on the higher end and higher quality demographic. Further incentives are also needed for the users to transact on the platform. The bank is also developing a credit engine specifically for the virtual bank to provide personal financing.