United Overseas Bank - Challenging environment ahead (OCBC)

Maintain HOLD

Previous Rating: HOLD

Current Price: S$18.80

Fair Value: S$19.30

2Q slightly above market expectations. UOB posted 2Q11 net earnings of S$636m, up 4.1% QoQ and 5.6% YoY, and slightly above Bloomberg analysts' poll of S$630m. Loans grew 7% QoQ and 24% YoY to S$128.5 billion. Growth in loans growth was broad-based and came mostly from businesses, with high QoQ growth rates from manufacturing and non-bank financial institutions at 11% each. Housing loans grew 20% YoY and 4% QoQ to S$36.6b.

Net interest income grew 3% YoY and 5% QoQ to S$913m. Net interest margin (NIM) saw a 2bp increase to 1.92% from 1Q11 - the only bank to see an improvement in NIM. Noninterest Income fell 5% QoQ to S$525m. Fee and Commission income improved 18% YoY and 2% QoQ to S$338m. As the group continues to build up its regional presence, costs remained high (up 13% YoY and 5% QoQ) and cost-to-income ratio moved up from 41% in 1Q11 to 42.6% in 2Q11. The group has declared an interim divided of 20 cents (same as last year) and this will be paid on 15 Sep 2011.

Healthy loan growth. Management is expecting loans growth to be in the high teens for this year. The higher margin for this quarter was due to its ability to focus on higher yielding assets, although challenging market conditions going forward could cap margin at current level or lower. In addition, as it continues to grow its regional businesses and increase productivity and risk management controls, cost-to-income ratio is likely to stay at current level or higher. Management also outlined that it is on track to tap on the growth in the wealth management business. It is aiming for 65-70 centres in the region by 2015, up from about 35 centres currently with asset under management of S$50b.

Maintain HOLD; cutting fair value estimate to S$19.30. With the current headwinds in the market and higher risks of further revisions in economic growth both in Singapore and for most of the key developed countries, we have revised down some of our assumptions and moderated our 2H11 forecasts, dropping our FY11 estimate from S$2665m to S$2433m. In addition, we have also lowered our FY12 estimates by 6.6% to S$2545m. As a result of the adjustments, we are lowering our fair value estimate from S$19.70 to S$19.30. We are maintaining our HOLD rating on UOB, but would turn buyers at S$18.20 or lower.