UOB or DBS?

UOB has underperformed the index YTD from mark-down concerns on investment securities. These are balance sheet charges, while we believe the more critical issue for the sector is NPLs and P&L credit charges. With unseasoned loans nearly half that of peers and the slowest loan growth during the bull years, the potential for a negative surprise on asset quality is lower for UOB relative to peers. With strong capital and a liquid balance sheet, UOB remains our top-pick. For traders, we recommend a switch from DBS to UOB as the PB differential here is reverting to mean.

Amidst emerging market style credit expansion in Singapore where system loans grew 40% between FY06-08, UOB saw a more modest 29% increase. Of the loans during this period 23% of credit was for mortgages in UOB. Compare this with ~40% for construction at OCBC or 12% for manufacturing at DBS. Indeed, unseasoned loans as a percentage of total loans make up just 7% for UOB vs. a sector average of 11%. While NPLs saw the largest QoQ expansion for UOB in 4Q08 this was mostly driven off higher substandard NPLs whereas peers saw higher doubtful NPL classifications.

UOB’s tier-1 ratio of 10.9% is amongst the highest regionally. Management claims there are no plans to raise additional capital. We estimate that NPLs will need to reach 24% before MAS tier-1 minimums are reached. Separately, UOB has one of the most liquid balance sheets regionally (11% cash).

60% of UOB’s available-for-sale securities are corporate bonds and equities (<45% for others). With ~68% of this biased towards financial institutions further mark-to-market charges on equity is a significant concern (FY08 equity contracted by 19% YoY). Another risk is goodwill at nearly one-third of equity for all three banks. We believe the risk here is higher for DBS who bought Dao Heng for 3x PB vs. UOB who purchased OUB for 1.1x PB in 2001.

UOB has been a consistent relative outperformer during past US recessions. With a strong balance sheet and conservative management this should be no different in this cycle, we believe. Separately, the PB premium between UOB and DBS is rapidly approaching historical mean and as a result we expect the short term LONG DBS, SHORT UOB trade to reverse.

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