Singapore banks’ earnings cut by 4-5% on fears of looming recession

Mirroring 2008-09? Singapore banks are stronger now compared to 2008 in terms of asset quality and capital but recessionary concerns are bound to create jitters in the equities market and weigh down share price performance. With this backdrop, we would remain relatively cautious in the next six months.

We believe similar events as seen in 3Q08-1Q09 are likely to be repeated. We advocate buying on dips but it may be too early for a strong re-rating to take place. A technical recession is currently not within our economists’ central scenario but we are forecasting a slower 5.5% GDP growth in 2012 vs. 6.2% in 2011.

Earnings cut by 4-5% to reflect slower growth assumptions. Slower GDP growth, recessionary fears and uncertainties prompt us to further fine-tune our loan growth and NIM assumptions leading to an additional 4-5% cut to our FY12-13F earnings. The prolonged benign interest rate environment could take a toll on NIM although to a much lesser extent than before as SIBOR and SOR are already low (vs. 2008).

Competition prevails but we would not discount the likelihood of higher credit spreads should recessionary risks emerge (as seen in 2009). We are not expecting asset quality weakness in the near term unless there is a recession. If at all, we think asset quality risks would be minimal (and would not reach 2009 levels). Capital levels are much stronger now and banks could rely on scrip dividend as a buffer.

TPs lowered but Buys maintained; stick to OCBC. With earnings trimmed, we have also revisited our Gordon Growth Model assumptions. We reduced ROE to 12% (from 13%), growth to 5% (from 7%) while keeping cost of equity at 11% (UOB) and 10% (OCBC). Our TP for OCBC is lowered to S$10.50 (1.6x FY12 BV) from S$12.10 and UOB to S$20.00 (1.4x FY12 BV) from S$23.50, which are equivalent to mean PBV multiples over the past 10 years. Maintain Buy for UOB and OCBC. Between the two, we still prefer OCBC.

Stocks are now at fair value if there’s a recession. Assuming there is a recession, we add a 100bps risk premium to our Gordon Growth Model assumptions, similar to what we did in 4Q08, to reflect the higher level of uncertainty in earnings visibility. Our recessionary-case TP for UOB is S$17.30 (1.2x FY12 BV) and S$8.90 (1.4x FY12 BV) for OCBC, indicating stocks are at fair values currently if recession looms.