• 1Q20 earnings was 19% below our previous estimates due to higher GP during the quarter to strengthen allowance coverage in the face of the pandemic.
• NII was held flat as NIM compressed 8 bps YoY to offset loans growth of 3% YoY.
• Fee income continues to gain momentum (+8% YoY) on higher WM fees (+28% YoY) to bolster revenue from lower trading an investment income (-17% YoY).
• Allowance of $286mn was charged for the quarter, with an additional $260mn shifted into RLAR as GP reserves.
• Maintain ACCUMULATE with a reduced target price of S$20.70 (previously S$27.90). We increased credit costs by adding $350mn in allowance per quarter while compressing margins by 10 bps over the next two years.

Positives

+ Fee income enjoys momentum (+8% YoY) with stronger WM fees (+28% YoY). Fee and commission income saw sustained business momentum with WM fees bolstering impact from lower loan-related fees (-11% YoY).

+ 1Q20 earnings impact from allowances bolstered by RLAR. Despite taking on $546mn of allowances to cater to the impact from the pandemic, $260mn of the charge was taken through RLAR, lessening the impact on earnings. Cumulative GP reserves stand at $2.3bn, with $400mn as management overlay. Increase in reserves brings NPA coverage to be stable at 88%. As a result, the capital position remains strong with CET-1 ratio at 14.1% compared to 13.9% a year ago. RLAR is now 1.7% of performing loans and above the regulatory 1%.

Negatives

– NIM fell 8bps YoY to dampen NII. Despite experiencing healthy loans growth of 3% YoY, NII remained stable as NIM compressed 8 bps in the first quarter YoY. Further downward pressure on NIM is expected as margins continue to compress after interest rate cuts in March. As benchmark rates fall, the bank will aim to reduce funding costs on corporate and fixed deposits to reduce impact on NII.

Outlook

Maintaining balance between stakeholders’ expectations. UOB’s decision to take $260mn of GP by way of RLAR will help meet their target of 50% payout ratio while ensuring CET-1 do not fall below desired levels. The bank has a target CET-1 level of between 12.5-13.0% to maintain a strong credit rating and support their loan book. Excluding the RLAR, the coverage ratio of NPA would have dropped to 83%. This may have raised concerns from rating agencies. The bank will continue reviewing policy to ensure that operational activities are not disrupted moving forward.

Credit costs set to rise over the next two years. UOB expects credit costs to come in between 50-60 bps per year (approx. S$1.5bn per year) for the next two years as the impact from the COVID-19 pandemic ripples through the economy. With credit costs of 36 bps in 1Q20, credit costs will rise at a faster pace in the quarters ahead, with greater impact of allowance charges on earnings subsequently.

Investment Actions

We maintain our ACCUMULATE recommendation with a reduced target price of S$20.70 (previously S$27.90). We have modelled in additional allowances of $350mn per quarter for the next 2 years as well as for NIM to compress by 10 bps over the next 2 years.