• 1Q17 PATMI of SGD807mn missed our estimate by 6.7%.
• Surprise came from higher than expected trading income in 1Q17. But the q-o-q growth of 2.0% in net interest income was in line with our expectations.
• Maintain “REDUCE” with a higher target price of S$19.20 (previously S$18.92) pegged at unchanged 0.95x FY17F PBR (excluding preference shares).

• Loans grew 9% year-on-year (“y-o-y”). Strong loans growth led by building and construction loans (+13.0% y-o-y) and financial Institutions, (+27.2% y-o-y). We see that Singapore customer loans growth is beginning to show some fatigue as it was flat quarter-on-quarter (“q-o-q”). We allude the quarterly slowdown to UOB turning down some customer loans because of poor margins.

• Net interest income (“NII”) was marginally higher at SGD1.3bn (+2.3% y-o-y) driven primarily by loans volume growth offset by poorer rates dynamics. The average rate on Customer loans which make up c.74% of interest earning assets declined 26bps y-o-y. At the same time, average rate and volume of Customer deposits, which make up c.87% of interest bearing liabilities, decreased 4bps y-o-y and increased 4.2% y-o-y respectively. On a y-o-y basis, we opine that the strong funding liquidity and low deposit costs had supported the loans growth and net interest income growth more than the bank’s pricing power on the customer loans side. But on q-o-q basis, we see the NII improvements had come from better rates and volume growth because of UOB’s exercise of pricing power.

• Non-performing loans (“NPL”) inched higher q-o-q. Non-Performing Loans increased from S$3.3bn in 4Q16 to S$3.4bn in 1Q17 mainly because of increases in unsecured NPL. While NPLs associated with Marine Vessels declined. We opine that UOB’s NPL formation is beginning to shift away from the offshore space but is gathering pace in Singapore’s SME and consumer loans space.

• Stellar Non-interest Income increased. The improvement was mainly due to a 39.5% y-o-y increase in Fund Management, 56.1% y-o-y increase in Wealth Management, 9.3% increase in Credit Cards and 58.8% y-o-y increase in Net Trading Income. But the improvements were offset by a net loss of S$19mn from Investment Securities.

Investment Actions

We like UOB’s control over their exposure to risky loans and how they manage provisions for non-performing loans. We see that UOB is beginning to exercise some pricing power in the loans business by turning down low margin businesses. However, we remain cautious that the tailwind of strong funding liquidity and low deposit costs may not continue indefinitely. We see that the improvements to the NPL formation within the offshore oil and gas largely priced in. Excluding the outperformance in trading income, net profit would have been flat. Maintain “REDUCE” with a higher target price of S$19.20 (previously S$18.92). Our target price is based on unchanged 0.95x FY17F book value (excluding preference shares).