EUR 850.00 For Business Accounts Only

Morningstar | UOB Posts Solid 2Q Result; Launches Digital Bank Strategy. See Updated Analyst Note from 03 Aug 2018

Narrow-moat-rated United Overseas Bank, or UOB, posted a solid second-quarter result but provided generally cautious guidance for the remainder of the year. Net interest income growth was strong, while softer fees and commission against last quarter were expected, as weaker capital market conditions resulted in lower wealth management income.

The underlying trends and outlook were similar to larger peer DBS Group’s result on Aug. 2. UOB maintained its high-single-digit loan growth guidance but projected net interest margin to be flat at 1.84% for the remainder of the year. DBS lifted its net interest margin guidance by a range of 1%-2% yesterday. On loan growth, UOB noted mortgages will sustain current growth for the remainder of the year as preapproved loans will be progressively drawn down, but admitted that the implementation of the restrictive measures in recent months will see volume growth slow thereafter. We clip back our fiscal 2018 loan growth assumption to 7.5% from 8%, and we expect medium-term loan growth of 7%, slightly lower than our previous assumption of 7.5%.

Credit quality was steady, with new nonperforming assets of SGD 436 million steady against last quarter. Overall nonperforming loans were stable at 1.7% of total loans. As such, credit cost was 11 basis points of total loans and below unchanged guidance of 20 basis points. While this suggests a higher level of nonperforming assets in the second half, management noted that there should not be any significant deterioration in asset quality in the second half, as its oil and gas exposures were previously recognized, and credit cost is unlikely to trend up to the historical average of 27 basis points of total loans. We adjust our credit cost assumption downward, and combined with slower loan growth assumptions, our fair value estimate of SGD 30 is unchanged. The bank is slightly undervalued, though we require a larger margin of safety, and our 3-star rating is reaffirmed.

UOB also announced its digital bank strategy for five countries in which it is already operating, including its home market of Singapore. The new digital platform will target 3 million-5 million new customers. While the initiative will likely require higher expenditure in the near term, we expect the bank’s overall costs to be controlled. In our view, the three Singapore banks’ operations are already efficient, and a rising income level allows the banks to invest in new ventures. The digital bank targets a steady-state cost/income ratio of 35%, which we believe is attractive relative to group cost/income of 40%.

Management noted that a total failure would see the project shut down, but investment would not totally go to waste, as the underlying technology would be shared and applied to UOB’s existing online platforms. Management also noted that not acting in the digital space is not an option, and we agree with this assessment, given the technology disruption already evident in other sectors and human behavioral changes as demographics shift. The most obvious examples are the impact of online retail on the excess level of shopping malls in the United States and over-the-top video content providers resulting in subscribers cutting their pay-TV services. Starhub’s pay-TV subscriber base has fallen 17% since its peak in first-half 2015. Given the tight regulation and the high level of switching cost for customers, we do not think the disruption is as significant in the financial sector as in other sectors. The tight regulation and the inherent position of financial institutions will likely force startups to partner with banks and financial institutions. UOB and its peers have launched incubator funds in recent years.

Services offered on the platform will include some basic functions, such as unsecured lending of small denomination and tenure. The products and services are already available in other geographies such as China, where unsecured lending without any collateral is available through Tencent’s Weixin platform. Loans between CNY 500 and CNY 300,000 are offered by various Chinese banks and financial institutions. Average loan rates range between 17% and 18% with platform commission at 5%.

More on the result: Quarterly net interest income increased to SGD 1.54 billion from SGD 1.47 billion, underpinned by an acceleration in quarter-on-quarter loan growth of 3.7%. This was driven by loans to financial institutions and the building and construction sector. As noted above, we have lowered our loan growth assumptions slightly. Net interest income growth was also supported by a largely steady net interest margin. While net interest margin declined slightly to 1.83% from 1.84% last quarter, this was due to a 3.8% increase in average interest-bearing liabilities. The bank has secured funding across customer deposits and in the wholesale market ahead of loan demand. Management stated that the conservative net interest margin guidance is underpinned by the timing of the next U.S. interest-rate increase.