SINGAPORE (May 27): Over the past 20 years, United Overseas Bank has gradually built up a regional presence, differentiating it from DBS Group Holdings and, to a much lesser extent, Oversea-Chinese Banking Corp. DBS’s presence is mainly in Singapore and Hong Kong. OCBC’s focus is on the flow business between North Asia and Southeast Asia, and here, there is an overlap with UOB, as both banks believe that trade and capital flows between the regions are the megatrends for the next decades. OCBC has a large wealth management platform that includes a private bank and life insurance subsidiaries.
On May 15, UOB’s Corporate Day, CEO Wee Ee Cheong told an audience that the banking group has three priorities. The first is to focus on regional connectivity.
Wholly-owned subsidiary UOB Malaysia is one of the largest foreign-owned banks in Malaysia, and its Thai counterpart, UOB Thai, has a growing market share by assets. In 2014, UOB, along with OCBC, was among the first nine foreign banks to be granted foreign bank licences in Myanmar. In August 2018, UOB became the first Singapore bank to open a foreign-owned subsidiary bank in Vietnam.
UOB also has a presence in Indonesia. Although the Indonesian bank’s asset size is modest, it has 181 branches and will eventually roll out TMRW, its Asean digital bank, in the sprawling archipelago. TMRW has been launched in Thailand.
“We have transformed these banks into an integrated regional network backed by our standardised platform. [Our] vision is to develop a seamless experience for our customers as they move across the region. [Our network] gives us scale and speed to market in growing services and it also ensures that we maintain robust risk management,” Wee says.
The bank’s second priority is to collaborate with like-minded partners to build “best-in-class solutions”. To support this, UOB set up a Foreign Direct Investment Advisory unit in 2011; it now has nine FDI Advisory offices across Southeast Asia besides China and India. UOB’s management often talks about an ecosystem. “We believe in an open rather than closed-loop approach when sharing the growth benefits with other like-minded ecosystem partners,” Wee says. For instance, UOB’s FDI Advisory unit has in the past partnered with other banks such as Santander UK and Shanghai Pudong Bank, and agencies and organisations such as BKPM, or the Indonesian Investment Coordinating Board, and the Vietnam Singapore Industrial Park.
The third priority is to maintain a strong balance sheet and deliver quality earnings, Wee says.
Regionalisation, ratings are priorities
In FY2018, UOB’s cross-border revenue rose 15% y-o-y and accounted for 25% of wholesale banking revenue. The bank’s FDI Advisory unit contributed $46 billion of deposit flows, according to UOB’s May 15 presentation.
In an interview on the sidelines of UOB’s Corporate Day, chief financial officer Lee Wai Fai says the bank’s Southeast -Asian footprint and its connectivity will be key to driving growth. For its latest quarter to March 31, 41% of UOB’s profit before tax (PBT) of $1.33 billion was from its overseas markets. Of the 41%, 32% was from the Asean countries.
“We hope to get above 50% of PBT from the region, but we need to control the [growth] because of our AA rating. In [the Asean region], we have to be careful. That’s why we are spending so much to improve risk management,” Lee says. Apart from Singapore, which has an AAA rating, the remainder of the Asean members comprise emerging economies at various stages of development. Emerging markets are likely to have lower sovereign ratings and viewed as more risky to do business in.
UOB’s AA credit rating has helped to keep funding costs low. Singapore banks are largely funded by deposits and UOB has a 21% market share of Singapore’s deposits. Its current account savings account makes up more than 42% of total deposits. Wholesale funding remains small, at around 12.5% of total funding. Total funding costs in 1QFY2019 stood at 1.78%, up 11 basis points q-o-q and 50bps y-o-y, mainly owing to the rise in deposit costs as interest rates rose. However, this was at a faster clip than yields on assets, which rose 10bps q-o-q but only 42bps y-o-y, leading to a decline of 1bp q-o-q and 5bps y-o-y in net interest margins to 1.79 % in 1QFY2019.
Lee emphasises that UOB is a commercial bank and hence, big margin expansion, including for net interest margins, should not be expected.
UOB’s stated target is a return on equity (ROE) of 13% by 2021. “We are trying to hit 13% and that depends on two things: first, how fast we can scale in the region and, second, the capital treatment in some of the countries in the region is different from that in Singapore,” Lee says.
While asset quality in Malaysia is holding up, growth there has slowed pending more clarity on policies.
In terms of prospects, Thailand appears to be better than Malaysia. The Kingdom of Smiles has just had an election and a coronation. “We have a 2% market share and we can reach 3% to 3.5% market share [of loans],” Lee says.
Indonesia has the clearest trends and economic policies, following an election in which incumbent president Joko Widodo was re-elected. “This year, we are focusing a lot on [transferring] the technological capabilities. Indonesia will grow, but not in an accelerated manner,” Lee says.
As at end-2018, Vietnam turned profitable, and Lee is expecting the fast-growing Indochinese economy to remain profitable. UOB was awarded a foreign-owned subsidiary bank licence in 2017 and opened its first full branch in 2018. “Vietnam is still very new. We’ve got a second branch approved in Hanoi,” Lee says, adding that it should open within the next couple of months. “For Vietnam, we are looking at funding the asset shift for the supply chain [owing to the US-China trade war]. There is an increase in demand, but [the supply chain shift] will be a three- to five-year story,” Lee says.
“Vietnam has always been a digital approach for us. [But] for customer acquisitions, the authorities need a ‘wet’ signature, and we use courier services to get that signature. We are looking at changing this process as the local law changes,” he says, adding that UOB can onboard more small and medium-sized enterprise customers through digital channels.
Currently, Vietnam looks a lot more promising than Myanmar, where the initial euphoria over the foreign banking licences awarded in 2014 has given way to a wait-and-see approach. In terms of customer flow, there is not much, Lee says, although UOB is involved in infrastructure financing in the country.
UOB’s business in North Asia includes financing tycoons, developers and jewellers with regional businesses. “We understand [gold financing],” Lee says. UOB also does business with financial institutions and private-equity property funds. “The margins are extremely fine, as these are financial institutions, but the return on risk-weighted assets is very decent,” Lee notes. He says Hong Kong could see a moderation in growth following double-digit expansion in 1QFY2019.
In Hong Kong, net interest income and non-interest income account for 50% each of total income compared with a ratio of 65:35 between net interest income and non-interest income as a percentage of total income for the UOB group.
As part of its regionalisation, UOB is adopting a hub-and-spoke type of model. For instance, its customer Southland Rubber Group operates 16 factories in Thailand and another 21 factories in the region, all of which are managed by the company’s subsidiaries in Singapore, Indonesia, Malaysia, Vietnam, Myanmar, India and China. UOB provides an umbrella facility covering holistic banking services for the customer’s group of companies, offering flexibility to seamlessly support the customer’s financing needs across Asia-Pacific. This also helps garner new customers for UOB.
For trade finance, UOB has introduced financial supply chain management, which provides an integrated approach to drive greater working capital efficiency and support its customers’ supply chain stability. In this model, UOB supports the supply chain of its customers and companies in its customers’ supply chain, including suppliers and distributors.
Cost control
With a sprawling regional presence, it is no surprise that in 1QFY2019, UOB’s cost-to-income ratio (CIR) of 44.6% was the highest among the local banks. DBS’s was 42.2% and OCBC’s was 40.9% for the same period.
For now, UOB’s costs continue to rise. In FY2018, costs increased 7% y-o-y to $4 billion, but IT costs rose at a faster clip of 13% y-o-y to $414 million. In 1QFY2019, total costs (excluding depreciation) rose 8% y-o-y to $413 million, with IT-related costs surging 16% to $119 million.
“Our CIR target is for a decline to 42% in three years on a flat margin. With [business] volume coming in, we might beat that,” Lee says.
Elsewhere, he says, the bank has -taken adequate provisioning for its oil and gas (O&G) portfolio. In FY2016, UOB made total provisions, including specific provisions, of $690 million, and in FY2017, it made total provisions of $660 million. In 1QFY2019, total provisions rose 17% y-o-y to $93 million.
“For us, we think most of the big bad O&G provisions have been taken and we are a lot more confident we will not have chunky hits,” Lee says. “So, if there is an improvement in our model, we will write back gross provisions.” UOB wrote back $32 million in GP in 1QFY2019.
UOB will have to be consistently more conservative than, say, DBS, because DBS’s presence is in Singapore and Hong Kong, which are developed countries that have moved to the equivalent of International Financial Reporting Standard (IFRS) 9. The Singapore banks moved to Singapore Financial Reporting Standard (International) or SFRS(I) 9, the equivalent of IFRS 9 in January 2018.
Since UOB has a presence in regional markets that have not completely adopted IFRS 9, its regional subsidiaries would have to report higher GP levels. For instance, China stipulates that GP should be 1.5% of loans, and is raising that to 2% of loans. Thailand’s is around 1.5% and Indonesia’s is higher. “We built a regulatory model with a differentiation reserve because regulators say [provisioning] must be more than [what is stipulated in] IFRS 9 —because every region we operate in has higher provisioning, we have additional GP,” Lee explains. “For the first quarter, for the first time, we are below 1% [of total loans] and we put $47 million to regulatory loss allowance reserve [RLAR].”
The revised Monetary Authority of Singapore regulation effective from Jan 1, 2018 requires the locally listed banks to maintain a Minimum Regulatory Loss Allowance equivalent to 1% of the gross carrying amount of the selected credit exposures net of collaterals. Where the loss allowance provided for under SFRS(I) 9 for the selected credit exposures falls below the MRLA, an additional loss allowance is required to be maintained in a non-distributable RLAR through an appropriation of retained earnings.
Balance between dividends, RoRWA and capital
UOB’s annualised ROE in 1QFY2018 was 11.2%. This is calculated net of distributions to its perpetual security holders. The bank’s management has also guided for a Common Equity Tier 1 ratio of 13.5%. In 1QFY2019, CET-1 stood at 13.9%.
To maintain CET-1 at 13.5% and to maintain a dividend payout ratio of 50%, the bank needs to generate a return on risk-weighted assets of around 1.8%. UOB’s RoRWA in 1QFY2019 was 1.88%. Based on its retained earnings after paying dividends, UOB will have enough to sustain 7% to 8% growth.
Even at an RoRWA target of 1.8%, UOB is unlikely to attain a CIR of 40% because its regional banking franchise is not sufficiently large. But once the bank has reaped economies of scale from its integrated platform, ROE should meet the 13% target.
“From a dividend policy perspective, we note that management had previously said that if RoRWA of 1.9% could be sustained and CET-1 remains above 13.5%, the group could continue to sustain a dividend payout of close to 50%,” notes a recent Credit -Suisse report.
Credit Suisse is forecasting a 5.4% rise in net profit to $4.225 billion for FY2019, and a further 7.2% growth to $4.53 billion in FY2020, giving ROEs of 11.6% and 11.7% respectively. “A key driver of RoRWA expansion has been the improvement in RoRWA of its wholesale bank, whose superior asset quality and cross-selling opportunities make up for the slimmer interest spreads [vis-à-vis the retail segment],” Credit Suisse observes.
“If the region’s economy improves, it will help me because I’m a commercial bank. Commercial banks have three models: retail, wholesale and trading. And as people move activity to Southeast Asia, we will benefit, which is why we should focus on wholesale banking because the flow business is so important,” Lee concludes.
This story appears in The Edge Singapore (Issue 883, week of May 27) which is on sale now. Subscribe here
