What do UOB 2Q results mean for DBS and OCBC?

TL;DR

• UOB's 2Q net profit of S$1.11bn met consensus expectations, as an improvement in its interest margins was offset by higher non-performing loans and weak fee income.
• UOB was able to benefit from rising interest rates to earn higher margins in 2Q22. The Fed's aggressive rate hikes in recent months bode well for its margins in the coming quarters.
• Worryingly, UOB's non-performing loans rose due to its exposure to a Chinese property company.  This will continue to be a risk to watch as interest rates rise and economic growth slows. 
• With DBS and OCBC reporting in the coming week, what UOB has showed us is that 2Q22 earnings may be a mixed bag for Singapore banks. 

What happened?

UOB recently reported 2Q22 net profit of S$1.11bn, which met market expectations.

But what caught our attention was that while the stock price had initially opened higher by about 0.7%, it eventually closed 2.5% lower at $27.55 by the end of 29 July.

This led us to try to find out what was the disappointment in the results that caused the sell-off over the day. 

And what does this means for DBS and OCBC which will be reporting their results in the coming week. 

What we learnt from the 2Q22 results

#1 – Increase in interest rates leading to higher margins

To us, one clear positive was how UOB was able to benefit from rising interest rates to earn higher margins in 2Q22

Its net interest income rose 18% YoY to S$1.9bn, as net interest margins rose to 1.67% in 2Q22 from 1.56% in 2Q21. 

Singaporean banks typically earn a higher net interest margin in an interest rate upcycle, as they are able to reprice their loans upwards. 

The good news here for UOB shareholders here is that interest rates have continued to go up since the end of the 2Q22. 

The Fed raised its benchmark rates by 0.75 percentage points twice in the months of June and July. Interest rates in Singapore have risen with the increase in US interest rates.

This could bode well for UOB’s net interest margins in the coming quarters as the loan repricing flows through to its profit. 

#2 – Higher non-performing loans

The worrying development from UOB’s 2Q22 results, is that non-performing loans have risen to 1.7% from 1.5% from a year earlier. 

Management of UOB explained that this was due to its exposure to a Chinese property company. 

While this Chinese property company was not named, Bloomberg reported on the same day that distressed China developer Shimao was being sued by UOB.

Shimao is ranked as China’s 22^nd largest property developer by sales in 1H22. It met with its first default on a public note earlier this month when it missed payment on a US$ 1 billion security. 

According to UOB, its direct exposure to Chinese developers is 1% of its loan book, of which half are to state owned enterprises (SOEs) which are generally seen to be less risky.

As interest rates go up and economic growth slows down, there are also now higher risks of an increase in non-performing loans.

Borrowers in certain segments of the economy, such as small and medium enterprises (SMEs) and consumers might find it more challenging to repay their loans. 

This could in turn drive a further increase in non-performing loans and hurt UOB’s profitability. 

#3 – Lower fee income

UOB’s wealth management business has also not done as well as the economic outlook weakens.

As investors have stayed on the sidelines with lower risk appetite, the sale of investment products has also slowed down. 

As a result, UOB’s net fee income fell by 2.4% YoY, representing its second consecutive quarter of decline.

What would Beansprout do?

With the volatility in UOB’s share price following the release of its 2Q22 results, the question that many of you might have will be what does this mean for DBS and OCBC?

OCBC will be reporting its results on 3 August, and DBS will be reporting its results on 4 August. 

The short answer is that as the economic outlook remains more blurred, it’s no longer so clear that Singapore banks will be able to benefit from higher interest rates. 

We’d also have to watch out for the risks from higher non-performing loans. 

The consolation here is that such defaults have not increased significantly, and investors of Singapore banks are still getting a decent dividend in the meantime. 

#1 - It’s a mixed bag

What UOB has showed us is that its 2Q22 results are a mixed bag, with improvement in its interest margins offset by higher non-performing loans and weak fee income.

Investors are likely expecting the same trend for the other Singapore banks as well, which was why both DBS and OCBC also fell following UOB’s results.

DBS is generally seen by investors to be the key beneficiary from higher interest rates, and its net interest margin is expected to grow in 2Q22. 

However, DBS could also see a greater impact from weakness in the wealth management business, leading to lower fee income. 

#2 – Dividends could provide some support

UOB declared an interim dividend per share of S$0.60, unchanged from the previous year. 

Based on analysts expectations, UOB is expected to announce another S$0.60 dividend per share at its full year results, which will bring its total dividend per share this year to S$1.20.

This would represent a dividend yield of 4.4%, based on its latest closing price of S$27.55 (as of 29 July 2022).

DBS and OCBC are expected to offer an even more attractive dividend yield of 4.6% and 4.8%, respectively, based on consensus estimates. 

What this means is that Singapore banks offer a higher dividend yield compared to the Singapore index, which offers a dividend yield of 3.8% (as of 7 July 2022).