Singapore banks could still brace themselves for positive trends in 2015

3 trends are likely to be seen.

Singapore banks’ 2Q14 core earnings were flattish compared with 1Q14, but three key positive trends are seen.

According to a research note from OSK|DMG, these three trends are: asset quality was healthy with no major issues in their China books; NIM held up better than expected; and loan growth may strengthen in 2H14.

Overall, the report noted that sector earnings are expected to grow 10% in FY14F and 8% in FY15F. DBS is the top pick while UOB was cut to NEUTRAL (from Buy).

Here’s more from OSK|DMG:

OCBC strongest, DBS and UOB in line. For the banks’ just concluded 2Q14 results, OCBC beat expectations, while earnings from DBS and UOB were broadly in line.

Sector core net profit was flat q-o-q but 1H14 earnings improved 16% y-o-y. Our upgrade in OCBC’s earnings forecast lifted sector net profit growth to 10% (from 7%) for FY14F while growth for FY15F is unchanged at 8%.

Three key takeaways: i) Asset quality was resilient and China books were healthy while sector gross impaired loans (GIL) fell 2% q-o-q and 6% YTD, lowering the GIL ratio to 0.92% (Dec 2013: 1.03%).

Loan loss coverage improved to 149% from 135% in Dec 2013. More importantly, banks’ China books (c. 15-19% of total loans) were healthy, with no sign of stress.

This points to stable to slightly lower credit costs for FY14F.

ii) NIM held up better than expected. Contrary to expectations, net interest margins (NIMs) were relatively stable in 2Q14.

DBS and OCBC were helped by their ability to price up loans in Singapore and China, while UOB saw a 2bps slip due to NIM compression at its Indonesian operations.

Banks expect some margin pressure in 2H14 but NIM for the full year would be stable to slightly better than 2013.

iii) Loan growth to strengthen in 2H14. Sector loan growth moderated further to 2% q-o-q in 2Q14 (1Q14: 3% q-o-q), with the annualised increase of 9% a little behind targets.

But banks maintained their guidance as a strengthening US economy and early signs of recovery in China provide optimism for stronger loan growth in the coming months.

UOB cut to NEUTRAL, DBS our only BUY. DBS is our top pick as we like the bank for its stronger earnings growth relative to peers and well-managed China trade loans.

Receding concerns over China’s macro issues is another positive. We downgraded UOB to NEUTRAL (from Buy) as we see early signs of slowing income growth momentum while asset quality data-points weakened relative to peers.

These suggest limited share price upside, given the stock’s outperformance YTD. We also maintained our NEUTRAL rating for OCBC.

Its strong 1H14 profit performance is a positive, but any share price re-rating could be capped until there is greater clarity on its integration and funding plans for newly-acquired Wing Hang Bank (302 HK, NR).

Key risks to the sector include: i) economic recovery in the US and China stalling, which may dampen income growth prospects; and ii) intense competition for deposits that may exert downward pressure on NIM.