Don’t celebrate just yet as challenges remain in banking

Cumulative loan growth for the three banks is expected to decelerate to 10% from 27% in 2011.

Kim Eng Research said:

Having declined 23-25% from their 2011 peaks, Singapore banks appear cheap. We would nevertheless argue that present valuations largely reflect and justify the cyclical downturn in returns that the industry is witnessing, as well as flat earnings this year.

The primary risk is of economic growth under-shooting expectations while from an operational standpoint, we see little change in the challenging operating environment this year to warrant a more positive stance just yet. We retain our Sell calls on DBS, OCBC and UOB.

Returns are proving more elusive amid i) competitive pressures and NIM compression; ii) capital market volatility; iii) increasing risk aversion; and iv) rising costs. We estimate a blended ROE of 10.5% for 2012 which is not only lower than the long-term mean of 12%, but also below average returns achieved during the GFC.

Against the backdrop of Singapore’s GDP growth tapering to 3% in 2012 from 4.8% (est) in 2011, we expect cumulative loan growth for the 3 banks to decelerate to 10% this year from 27% in 2011. NIM compression is likely to persist but we expect a more moderate compression of 3 bps this year from 11 bps in 2011.

Other challenges include potentially higher charge-off rates amid asset quality deterioration, as well as capital market volatility which could impact fee income expansion and fair value reserves.

Taking the above factors into consideration, we expect the cumulative operating profit of the 3 banks to grow by a marginal 5% in 2012. On the back of higher credit charge rates, we expect cumulative recurring net profit to be flat YoY. In contrast, cumulative operating profit for the three banks stalled with growth of just 1.9% back in 2008. With rising credit costs, total net profit contracted by 15.4% in that year.

Trading at an average 2012 P/BV of 1.1x presently against a long-term mean of 1.5x, valuations appear attractive from a historical perspective. We would nevertheless argue that this is very much on par with the cyclical downturn in returns for the industry.

Moreover, at a prospective 2012 PER of 10.7x for 2012, valuations are marginally higher than the regional average of 10.0x ex Taiwan & South Korea. This is not entirely appealing given the fact that earnings are expected to meander along with growth at just about 0.6% versus 7.3% for the region in 2012.