Summary

• United Overseas Bank's focus on Southeast Asia and acquisition of Citi's retail business enhance growth prospects, offering a 5% dividend yield and steady earnings growth.

• Despite the lowest CET1 CAR among peers, UOB's fully phased-in CET1 CAR of 15.2% aligns with peers, indicating potential for increased shareholder returns.

• UOB's current valuation is fair, with potential for a premium due to excess capital and the prospect of increased shareholder distributions.

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United Overseas Bank (OTCPK:UOVEF) (OTCPK:UOVEY) is one of the three major banks based in Singapore. While its peers have substantial exposure to China, UOB has focused more on expansion in Southeast Asia, including through the acquisition of Citi's retail business in several Southeast Asian countries. The bank also offers a highly attractive dividend yield of just over 5% and steady earnings growth for income focused investors.

Asset quality and capital

At the time of my previous article on UOB, I noted that Singapore was in the process of reforming its banking regulations to align with Basel IV, revising the methodology for calculating risk-weighted assets. These changes aim to reduce banks' control over risk-weighting and promote a more standardized approach. These changes have not yet been fully implemented, but most of the banks already report on what their capital adequacy ratios would be on a fully phased in basis. Importantly, while UOB has the lowest Common Equity Tier-1 Capital Adequacy Ratio [CET1 CAR] of the major Singapore banks as depicted in the chart below, it's fully phased in CET1 CAR at 15.2% is on par with DBS’ fully phased in CET1 CAR of 15.2% and only slightly below OCBC’s fully phased in CET1 CAR of 15.6%.

Author created based on data from Company Filings

What this indicates is that UOB’s existing approach to risk weighting assets is already substantially closer to the new approach to be followed in terms of Basel IV. While its peers see their CET1 CAR decline by around 2 percentage points each under the new model, UOB’s CET1 CAR declines by a much lower 0.3 percentage points in terms of the new model. Earlier this month, Michael Makdad, an analyst at Morningstar, observed that –

We think the market has perceived UOB as having less excess capital than DBS and OCBC, so the disclosure of a fully phased-in ratio that's not much different from peers' suggests UOB may have more room for expanded future shareholder distributions than the market has been assuming”

Therefore, the disclosure earlier this month is likely to be a driver of more positive investor sentiment in the months ahead. This positive sentiment will be further aided by management's indication of its intention to return more capital to shareholders as the fully phased in CET1 CAR is above management's targeted range of 13.5% - 14%. This leaves around SGD2.5 billion on the table for distribution to shareholders in the form of potential share buybacks or a special dividend. Management will announce the full capital management plan along with its 4th quarter results early next year.

UOB’s non-performing loan ratio at 1.5% is the highest of the major Singaporean banks. Its NPL ratio has been affected by the takeover of Citi’s business in Thailand, which also saw the bank increasing loan loss provisioning. Management currently expects these numbers to stabilize within the next two quarters. Nevertheless, investors in UOB would need to monitor NPLs closely, as any sudden increase in NPLs would almost certainly have a negative impact on investor sentiment.

Author created based on data from Company Filings

Net interest margin and earnings

The market reacted positively to UOB’s 3rd quarter results earlier this month, with positive sentiment seeing the share price increase by around 5% on the back of the announcement. Net income came in at SGD1.61 billion, well above analysts' median estimate of around SGD1.5 billion. The higher-than-expected earnings were driven by a substantial increase in fee and trading and investment income. For the first 9-month period, net fee income increased by 10% on a year-over-year basis. Similarly, fee income for the third quarter increased by 2% on a quarter-over-quarter [QoQ] basis.

The higher-than-expected net income was also partially driven by an increase in net interest income. The bank reported a 2% QoQ increase in net interest income for the third quarter of 2024. This increase came about as the bank’s net interest margin [NIM] remained stable while the loan book is also expanding. These positive results also saw Goldman Sachs double its earnings growth forecast for UOB over the next three years. Goldman Sachs now expects UOB’s earnings to grow at a compounded annual growth rate of around 3% over the next few years.

Valuation

UOB is currently trading at a forward price to earnings ratio of around 10.01 which is broadly in line with that of its peers. It is also broadly in line with the bank's 5-year average forward P/E ratio of around 9.7.

Author created based on data from EquityRT

Likewise, its price-to-book value at 1.29 is broadly in line with that of its peers, being almost on par with OCBC and lower than the 1.79 for DBS. Given these factors, I currently consider UOB to be fairly valued. The prospect of increased shareholder returns from excess capital may even merit a slight premium to its current valuation levels.

Conclusion

In my view, UOB presents a compelling investment case supported by strong fundamentals, stable earnings growth, and an attractive forward dividend yield of 5.05%. While UOB's CET1 CAR is currently the lowest among Singapore's major banks, its fully phased-in CET1 CAR of 15.2% is broadly in line with that of its peers and above management's targeted range. This higher than targeted capital position also opens up the possibility of increased distributions to shareholders, with management hinting at a return of excess capital to shareholders in the region of SGD2.5 billion.

UOB’s better-than-expected third-quarter performance has also increased investor confidence in the near term. These factors, coupled with Goldman Sachs' revised forecast of 3% compounded annual earnings growth over the next three years, underline the bank’s stable earnings growth sustaining its dividend. Given these factors, I currently rate UOB as a buy.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.