Singapore Banking Sector

2Q13 Pre-results Updates Multiple Upgrades

Phillip Securities Research Pte Ltd 8 July 2013

Report type: Update

Sector Overview The Singapore Banking Sector provides traditional lending and depository functions, as well as other services in the areas of commercial banking, financial advisory, asset management, insurance broking and capital market services. The three local banks will be announcing their 2Q13 results in the upcoming weeks NIMs are expected to stabilize, while loans growth expected to be healthy Fees and commission expected to remain strong but lower q-q from high base. Non interest income likely to remain volatile. We upgrade DBS and UOB to Accumulate, and OCBC to Neutral based on undemanding valuations, strong fundamentals, and high quality growth potential. What is the news? The 3 local banks will be announcing their 2Q13 results, with UOB on 1 Aug, and OCBC on 2 Aug. DBS has not released the date of results announcement. How do we view this? We expect the banks to post a decent set of results. Net profits are generally expected to be lower q-q from a high base. Net interest margins are expected to bottom, while loans growth are expected to be in line with FY13 guidance but weaker q-q but healthy. We therefore expect q-q higher net interest income. Fees and commission is expected to remain strong, but lower q-q from a high base. A few large one-off transactions were registered by UOB and DBS in the previous quarter. Non interest income remains a wildcard, but we expect DBS to post a strong set of Non Interest Income (NonII), while OCBCs NonII may face a drag from MTM losses on LT fixed income investments. Investment Actions? The banks remain fundamentally strong. NIMs decline, which has been the major drag on earnings, is also expected to bottom out. A gradual increase in Net Interest Income is expected, both from NIMs increase in the medium term per elaborated above, and continued loans growth. Fees and Commission are also expected to grow. While the economic environment continues to be uncertain, we expect a shift in preference towards high quality growth stocks. This includes the Singapore Banking counters. We therefore upgrade DBS and UOB to Accumulate and OCBC to Neutral as valuations are undemanding. We present a more detailed analysis of DBS, UOB and OCBC in our reports dated 8 Jul 2013. We have a preference for DBS over UOB and OCBC due to the current lower relative valuations, and continued strong growth potential comparable to its local peers.
Singapore Banking Sector Com pany Rating DBS Group Holdings Ltd Overseas Chinese Banking Corp United Overseas Bank Source: Bloomberg, PSR Analyst Ken Ang Kenangw y@phillip.com.sg Tel : (65) 6531 1793 Price TP Upside M.Cap. (S$) (S$) (%) (US$'m n) Accumulate 15.90 17.20 8.2% 30,438 Neutral 9.90 9.75 Accumulate 20.33 21.35 -1.5% 5.0% 26,627 25,097

MCI (P) 194/11/2012 Ref. No.: SG2013_0118

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Singapore Banking Sector Singapore Equities Research 8 July 2013 NIMs to stabilize Higher Overseas contribution Banks guided for NIMs to stabilize at current levels Having experienced significant NIMs decline in FY12, the banks guided in 1Q13 for this to stabilize. Continued pressure from Mortgage loans is expected, while growth of higher yielding overseas loans growth is expected to provide relief to the Mortgage pressure. Long term interest rates rising in anticipation to eventual increase in Fed rates With US announcing possible tapering of QE in end CY2013, Fed rates are expected to rise thereafter, possibly in end CY2014. We see an increase in long term interest rates, as markets react in anticipation of Fed rates increasing. This has led to a bear steepening of the yield curve, as seen from the SGD Swap Yield Curve per Fig 1 below. We expect NIMs to increase gradually in the medium term We note that most loans are priced based on shorter termed floating rates. The impact of current rising long term rates may therefore not increase Interest income significantly yet, as short term rates remain lower. Fig 1: LT interest rates (%) rising significantly
4 3.5 3 2.5 2 1.5 1 0.5 0
5Y 4Y 3Y 2Y 18 1Y 9M 6M 3M 2M 1M 1W 1D
OCBC

1) (+ve) Gradual increase in Interest Income Floating rate loans are typically priced by a Benchmark + Spread. A typically Benchmark may be 3-months SIBOR. The spread would however vary. While interest rate increase will directly increase the Benchmark, previous downward spread adjustments would however require more time to be adjusted upward. This is especially so for Mortgage loans of the three banks, for which previous lower spreads would remain as they have been locked in for the short term. 2) (+ve)on shift away from Bond issuance towards bank loans for high quality companies While previous market demand for yields in low interest rate environment led high quality companies to raise capital from bond markets, we expect a shift towards taking bank loans as the difference between bank rates and bond yields decrease. With the wide suite of transaction banking products, customers who take on bank loans may also enjoy rebates or discounts on transaction banking fees and commission. This increases both loans growth and overall Fees and commission. 3) Fixed rates loans will not be adjusted upwards However, these likely constitute a smaller proportion of total loans, or have short maturities. 4) (-ve) NPLs may rise with higher interest rates NPL ratios are at extremely low levels, as companies are able to pay off the low interest expenses despite the challenging macro environment. The three banks have also improved overall quality of the loan books. We however continue to expect NPLs to increase when interest rates increase, as some businesses struggle with loan repayments. Fig 3: NPL ratios currently extremely low
3.00 2.50 2.00 1.50 1.00 0.50 3Q09 1Q10 3Q10 1Q11 3Q11 1Q12 3Q12 1Q13
OCBC DBS UOB

04 Jul 13 04 Jun 13 29 Mar 13 01 Jan 13

7Y

10Y

12Y

15Y

20Y

30Y

-0.5

Fig 2: Potentially reversing previous NIMs decline

2.50 2.40 2.30 2.20 2.10 2.00 1.90 1.80 1.70 1.60 3Q09 1Q10
DBS UOB

Source: Company data, Phillip Securities Research

3Q10 1Q11 3Q11 1Q12 3Q12 1Q13

Source: Bloomberg, Company data, Phillip Securities Research

5) (-ve) Higher Specific provisions leading to higher credit cost An increase in NPL is expected to lead to an increase in bad debts, thus increasing credit cost. 6) (-ve) Higher General provisions leading to further credit cost increase Along with the decrease in NPLs, the banks decreased General provisions (GPs) made as per the Red line in Fig 4. GPs made were lower but adequate in the current low NPL and interest rate environment. However, an expected increase in interest rates and NPLs would lead to higher GPs over total loans being required. This will lead to a short-term large increase in credit cost when interest rates and NPL starts to rise.

Expected impact of Interest rates increase mixed but overall gradually higher earnings for all three banks We expect a few positives and negatives when interest rates rise, and list them here for discussion. In broad, interest income is expected to increase. However, past savings in credit cost, which had enabled the banks to cushion the NIMs decline, is expected to unwind as NPLs increase and higher loan provisions are required. Magnitude of normalizing would depend on the portfolio of loans.

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Singapore Banking Sector Singapore Equities Research 8 July 2013 Fig 4: General provisions declined with lower NPLs
120 100 80 60 40 20 0
2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13

160

OCBC
127 94

140 120 100 80 60 40 20 160

While DBS enjoyed strong General Commerce loans growth in 1Q13 as borrowers took advantage of the RMB/USD carry trade, the strengthening of the USD in June may result in the unwinding of this carry trade, thus reducing loans growth. Fig 5: Q-Q Loans growth to be weaker
12% 10% 8% 6% 4%
OCBC DBS UOB Total

-20 700

DBS
500 300 100
2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13

140 96 120 100 80 60 40 20 160

2% 0% -2% 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13

103

Fig 6: USD strengthening may lead to lower loans growth for DBS as RMB/USD carry trade unwinds
0.163 0.162 0.161 0.160 0.159 0.158
01 Jan 15 Jan 29 Jan 12 Feb 26 Feb 12 Mar 26 Mar 09 Apr 23 Apr 07 May 21 May 04 Jun 18 Jun 02 Jul

-100 -300 500

CNY / USD

400 152 300 200 100 0

2Q09

UOB
123

140 120 100 80 60 40 20 -

3Q09

4Q09

1Q10

2Q10

3Q10

4Q10

1Q11

2Q11

3Q11

4Q11

1Q12

2Q12

3Q12

4Q12

-100 -200

1Q13

Source: Company data, Oanda, Phillip Securities Research

Others (S$M) - LHS General Provision (S$M) - LHS Specific Provision (S$M) - LHS General Allowance/ Total Cust Loans (Bps) - RHS Specific Allowance/ Total Customer Loans (Bps) - RHS
Source: Company data, Phillip Securities Research

Fees and Commission revenue driver in FY2013 Fees and Commission from Wealth management, Traderelated and Loan-related fees are expected to continue growing in FY2013, as the three banks increase their touch points and establish stronger relationships. The wide range of products and expertise will also allow greater cross selling capabilities. Q-q, Fees and commission for DBS and UOB may decrease from a high base, which was driven by a few large one-off transactions. We however expect y-y increase as growth of Fees and Commission remains strong. Fig 7: Fees and Commission to be strong
550 500 450 400 350 300 250 200
3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13

We expect gradually higher earnings when interest rates increase While it is too early to identify the bank that will benefit most due to the impact in numerous areas as per above, we expect overall increase in earnings. Increase in net interest income is expected to be larger than that of credit cost. Interest income is expected to increase gradually, while higher credit cost, specifically GPs in the short term, is expected to reduce the impact of higher interest rates. Loans growth expected to meet FY13 guidance While we do not expect a repeat of the high loans growth in 1Q13, we expect the banks to meet their FY13 guidance of high single digit loans. Key risks to loans growth include a weaker macro environment, specifically China. Chinas economic outlook has been uncertain. A weaker China may have spillover effects on the ASEAN region, reducing economic growth and demand for loans.

OCBC

DBS

UOB

Source: Company data, Phillip Securities Research

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Singapore Banking Sector Singapore Equities Research 8 July 2013 Non-interest income a wild card Non-interest income remains volatile, as can be observed by the fluctuations in Fig 8, and remains rather low quality and market-dependant. Fig 8: Q-Q Non-interest Income a wildcard
600 500 400 300 200 100 0
3Q09
6 4 2 0 -2 03 -4 May -6 -8 -10 -12 -14
30 0 04 Jan -5 -10 04 Feb 04 Mar 04 Apr 04 May 04 Jun 04 Jul
OCBC DBS UOB

25 20 15 10 5 OCBC DBS UOB STI

6 months rebased

1 Year rebased
OCBC DBS UOB STI

Source: Company data, Phillip Securities Research

For the individual banks, we think DBS is likely to post high non-interest income, although lower q-q from a high base. DBS is expected to benefit from Foreign Exchange related activities, such as from the appreciation of RMB relative to USD for the most of 2Q13. For OCBC, we think it likely to post poorer non-interest income due to mark to market losses for investments held by Great Eastern. Insurance companies, such as Great Eastern, is likely to hold long term fixed income investments, so as to match forecasted cash flow payouts for its longer term liabilities. With the sharp increase in long term interest rates per Fig 1 above, we expect mark to market losses on these long term investments. However, OCBC may still surprise on trading income. Income may be higher from realizing gains on AFS investments, and other activities. Fig 9: DBS and UOB trades below STI since our downgrade during the last results season
3 May 13 rebased

10 May

4Q09

1Q10

17 May OCBC DBS UOB STI

2Q10

3Q10

24 May

4Q10

31 May

1Q11

2Q11

07 Jun

3Q11

4Q11
14 Jun

1Q12

21 Jun

2Q12

3Q12

28 Jun

4Q12

05 Jul

1Q13

25 20 15 10 5 0 -5 Jul 12 -10 -15

Sep 12

Nov 12

Jan 13

Mar 13

May 13

Jul 13

Source: Company data, Phillip Securities Research

Valuations During the last results season, we downgraded DBS and UOB to Neutral as valuations were high. We maintained our Reduce rating on OCBC. Share price for the three banks have corrected since, as per Fig 9 above. Looking ahead, the banks remain fundamentally strong. NIMs decline, which has been the major drag on earnings, is also expected to bottom out. A gradual increase in Net Interest Income is expected, both from NIMs increase in the medium term per elaborated above, and continued loans growth. Fees and Commission are also expected to grow. While the economic environment continues to be uncertain, we expect a shift in preference towards high quality growth stocks. This includes the Singapore Banking counters. We therefore upgrade DBS and UOB to Accumulate and OCBC to Neutral as valuations are undemanding. We present a more detailed analysis of DBS, UOB and OCBC in our reports dated 8 Jul 2013. We have a preference for DBS over UOB and OCBC due to the current lower relative valuations, and continued strong growth potential comparable to its local peers.

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Singapore Banking Sector Singapore Equities Research 8 July 2013

Com pany Market price as of: 5-Jul-13 DBS Group Holdings Ltd Overseas Chinese Banking Corp United Overseas Bank Source: Bloomberg, PSR est.

Rating

Accum ulate Neutral Accum ulate

Upside Market Cap. (%) (S$'m n) Dec 15.90 17.20 8.2% 38,838 Dec 9.90 9.75 -1.5% 33,975 Dec 20.33 21.35 5.0% 32,023

FYE Price

TP

Market Cap. (US$'m n) 30,438 26,627 25,097

Equity Multiple (X) Net Incom e Book Value FY11 FY12 FY13E FY11 FY12 FY13E 12.8 11.6 11.0 1.4 1.2 1.1 14.9 12.0 12.6 1.6 1.5 1.4 13.8 11.4 10.9 1.5 1.4 1.3

Dividend Yield (%) FY11 3.5% 3.0% 3.0% FY12 FY13E 3.5% 3.5% 3.3% 3.3% 3.4% 3.4%

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Singapore Banking Sector Singapore Equities Research 8 July 2013 Oversea-Chinese Banking Corp Insurance wildcard
2,500 2,000 1,500 1,000 500 0 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13

- Growth of Non interest income to be muted in FY2013

8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 FY2010 FY2011 FY2012 FY2013 Net Profit PPOP Non Int Inc Fees and Comm NII

DBS Group Holdings Relatively consistent growth

2,500 2,000 1,500 1,000 500 0 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13

- Strong non-interest income growth expected

8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 FY2010 FY2011 FY2012 FY2013 PPOP Net Profit Fees and Comm NII Non Int Inc

United Overseas Bank Ltd Strong Fees and Commission

2,500 2,000 1,500 1,000 500 0 2Q11
1.8 1.7 1.6 1.5 1.4 1.3 1.2 1.1 1.0 0.9 0.8

- Fees and Commission guided to grow 15% y-y in FY2013

8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 PPOP FY2010
1.7 1.6

Non Int Inc Fees and Comm NII Net Profit

3Q11

4Q11

1Q12

2Q12

3Q12

4Q12

1Q13

FY2011

FY2012
UOB - PB ratio

FY2013

OCBC - PB ratio SD+1 1.57 1.43 1.38 SD-1 1.20

1.5 1.4 1.3 1.2 1.1 1.0 0.9 0.8

SD+1

1.48 1.33

SD-1

1.18

Jul-08 Mar-09 Nov-09 Jul-10 Mar-11 Nov-11 Jul-12 Mar-13 1.4 1.3 1.2 1.1 1.0 0.9 0.8 0.7 0.6 0.5 0.4 DBS - PB ratio SD+1

Jul-08 Mar-09 Nov-09 Jul-10 Mar-11 Nov-11 Jul-12 Mar-13 19.0

1.23 1.19 1.05

OCBC - PE ratio SD+1 14.62 SD-1 13.08 11.54

17.0 15.0 13.0 11.0 9.0 7.0 Jul-08 Mar-09 Nov-09 Jul-10 Mar-11 Nov-11 Jul-12 Mar-13

SD-1

0.88

Jul-08 Mar-09 Nov-09 Jul-10 Mar-11 Nov-11 Jul-12 Mar-13

Source: Company data, Bloomberg, Phillip Securities Research

Source: Company data, Bloomberg, Phillip Securities Research

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Singapore Banking Sector Singapore Equities Research 8 July 2013

20.0 DBS - PE ratio 18.0 SD+1 16.0 15.05 14.0 12.13 12.0 SD-1 10.0 9.20 8.0 6.0 4.0 2.0 Jul-08 Mar-09 Nov-09 Jul-10 Mar-11 Nov-11 Jul-12 Mar-13

20.0 18.0 16.0 14.0 12.0 10.0 8.0

UOB - PE ratio

SD+1 14.07 12.19 SD-1 10.32

6.0 Jul-08 Mar-09 Nov-09 Jul-10 Mar-11 Nov-11 Jul-12 Mar-13

6 4 2 0 -2 03 -4 May -6 -8 -10 -12 -14

3 May 13 rebased
25 20 15 OCBC DBS UOB STI

6 months rebased

10 May

17 May OCBC DBS UOB STI

24 May

31 May

07 Jun

14 Jun

21 Jun

28 Jun

05 Jul

10 5 0 04 Jan -5 -10 04 Feb 04 Mar 04 Apr 04 May 04 Jun 04 Jul

0 -104 Jun -2 -3 -4 -5 -6 -7 -8 -9 OCBC DBS UOB STI 10 Jun

1 month rebased
30

1 Year rebased
OCBC DBS UOB STI

16 Jun

22 Jun

28 Jun

04 Jul

25 20 15 10 5 0 -5 Jul 12 -10 -15

Sep 12

Nov 12

Jan 13

Mar 13

May 13

Jul 13

15 10 5 0 05 Apr -5 -10 20 Apr OCBC DBS UOB STI

3 months rebased
30 20 10 0 OCBC DBS UOB STI

2 Year rebased

05 May

20 May

04 Jun

19 Jun

04 Jul

Jul 11 -10 -20 -30

Dec 11

May 12

Oct 12

Mar 13

Source: Company data, Bloomberg, Phillip Securities Research

Source: Company data, Bloomberg, Phillip Securities Research

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Singapore Banking Sector Singapore Equities Research 8 July 2013 By Geographical location Profit before Tax Oversea-Chinese Banking Corp
500 400 56% 300 200 100 0
2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13

- Contributions from Malaysia improving

90%
1,500 1,300 1,100 900 700 500 300 100 -100 FY2010 FY2011 FY2012 FY2013 59% 59% 63% 68% 72% 70% 68% 66% 64% 62% 60% 58% 56% 54% Sg PBT/ Total PBT Malaysia Other Apac Greater China Rest of SEA ROW

63% 54%

65% 58%

80% 64% 62% 59% 70% 60% 50% 40% 30% 20% 10% 0%

-100

DBS Group Holdings

500 400 300 200 100 0
2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13

- Volatile but improving contributions from HK

70% 64% 66% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%
1,500 1,300 1,100 900 700 500 300 100 -100 FY2010 FY2011 FY2012 FY2013 62% 62% 65% 66% 72% 70% 68% 66% 64% 62% 60% 58% 56% 54% Sg PBT/ Total PBT Hong Kong Greater China S&SEA ROW

63%

66%

60%

58%

58%

-100

United Overseas Bank Ltd

500 400 300 200 100 0
2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13

- Stable contributions from all regional markets

81% 64% 90% 80% 62% 70% 60% 50% 40% 30% 20% 10% 0%
1,500 1,300 1,100 900 700 500 300 100 -100 FY2010 FY2011 FY2012 FY2013 62% 65% 71% 67% 72% 70% 68% 66% 64% 62% 60% 58% 56% 54%
Sg PBT/ Total PBT M'sia G. China Indon Thai ROW

65%

65%

64%

65%

60%

-100 -200

Source: Company data, Bloomberg, Phillip Securities Research

Source: Company data, Bloomberg, Phillip Securities Research

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Singapore Banking Sector Singapore Equities Research 8 July 2013

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Singapore Banking Sector Singapore Equities Research 8 July 2013

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HONG KONG Phillip Securities (HK) Ltd 11/F United Centre 95 Queensway Hong Kong Tel +852 2277 6600 Fax +852 2868 5307 Websites: www.phillip.com.hk

CHINA Phillip Financial Advisory (Shanghai)Co. Ltd No 550 Yan An East Road, Ocean Tower Unit 2318, Postal code 200001 Tel +86-21 5169 9200 Fax +86-21 6351 2940 Website: www.phillip.com.cn UNITED KINGDOM King & Shaxson Capital Limited 6th Floor, Candlewick House, 120 Cannon Street, London, EC4N 6AS Tel +44-20 7426 5950 Fax +44-20 7626 1757 Website: www.kingandshaxson.com SRI LANKA Asha Phillip Securities Limited Level 4, Millennium House, 46/58 Navam Mawatha, Colombo 2, Sri Lanka Tel: (94) 11 2429 100 Fax: (94) 11 2429 199 Website: www.ashaphillip.net/home.htm

THAILAND Phillip Securities (Thailand) Public Co. Ltd 15th Floor, Vorawat Building, 849 Silom Road, Silom, Bangrak, Bangkok 10500 Thailand Tel +66-2 6351700 / 22680999 Fax +66-2 22680921 Website www.phillip.co.th UNITED STATES Phillip Futures Inc 141 W Jackson Blvd Ste 3050 The Chicago Board of Trade Building Chicago, IL 60604 USA Tel +1-312 356 9000 Fax +1-312 356 9005 INDIA PhillipCapital (India) Private Limited No. 1, C Block, 2nd Floor, Modern Center , Jacob Circle, K. K. Marg, Mahalaxmi Mumbai 400011 Tel: (9122) 2300 2999 Fax: (9122) 6667 9955 Website: www.phillipcapital.in

AUSTRALIA PhillipCapital Level 12, 15 William Street, Melbourne, Victoria 3000, Australia Tel +61-03 9629 8288 Fax +61-03 9629 8882 Website: www.phillipcapital.com.au

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