United Overseas Bank (UOB SP)
Building a green franchise
Green Strategy supports competitive positioning
We recently hosted an investor call with UOB’s Chief Sustainability Officer –Mr. Eric Lim. UOB is positioning its strategy to leverage its balance sheet together with advisory, wealth and solutioning capabilities to support customers transition to sustainable opportunities. UOB is also transforming culturally within the organisation as it looks to build a sustainable growth strategy that serves all stakeholders. This should drive long-term competitive advantage for UOB, we believe. In the near term, an improving operational outlook and potential provision write backs should drive earnings momentum. Maintain BUY.
Leveraging franchise to drive stakeholder transition
At the individual level, customers may not be able to make a material impact on sustainability. However, UOB’s position as a financial intermediary with a strong balance sheet together with advisory and solutions capabilities gives it a strong platform to support customers transition to sustainable opportunities. SGD12bn is already invested in sustainable finance with a goal of reaching SGD15bn by 2023E. This is likely to be surpassed in 2021E, in our view. The Group’s wealth management business is also driving sustainable themes, while other fee generating sources such as transaction banking are innovating Green-services.
Aligning culture for internal transformation
There is growing competition in the sustainability financing space, leading to what appears to be lower margins than conventional assets. This is the wrong comparison, according to UOB. Non-green assets may offer higher margins now, but over the long run they could become un-fundable. Some may become stranded assets, which could lead to high provisioning risks. Therefore, it is important to align Group strategy towards funding sustainable assets. This requires a major cultural and mind-set shift internally. Senior management supports this and the Group is making strides in enhancing diversity and inclusion to further strengthen this journey. Importantly, UOB identifies that it needs to recognise the needs of each of its stakeholders and guide its strategy to serve all of them.
Maintain BUY. 12% upside
An improving operating outlook –especially in Singapore and North Asia –together with better than expected asset quality could drive upside surprises to earnings and provision write backs going forward. Its execution of its digital banking strategy together with Green financing opportunities could further support medium term growth, in our view. Maintain BUY.
§Largest SME lender, with strong, legacy relationships, resulting in higher lending yields than peers.
§Conservative, focused on traditional, commercial banking. Headed by founding family, who have not historically made aggressive overseas or trading bets.
§Wide SE Asian regional footprint through fully-owned operations in Malaysia, Thailand, Indonesia as well as HK providing diversified earnings growth.
§Well integrated regional operation providing cross-border services to an increasingly regional client base.
§We expect Gross NPLs to rise from 1.5% in 2019 to 1.6% in 2021E
§Falling interest rates will drive NIMs to fall from 1.74% in 2019 to 1.54% by 2021E.
§Loan growth, which expanded 5% YoY in 2020, should pick up steam to 8% in 2021E supported by North Asia, SG
§Credit charges should fall to 26bps in 2021E after rising to 57bps in 2020
1.Weaker than expected 2H15, sharp CNY devaluation in August and O&G/commodity NPL worries.
2.Positive sentiment from interest rate hikes, USD strength and economic recovery. Risks from O&G have abated.
3.Concerns of global-trade war, falling loan growth from property cooling measures.
4.Beginning of the Covid-19 pandemic
5.Vaccine led recovery optimism kicking in
§A V shaped recovery should overall business volumes
§Write-backs of excess provisions as asset quality conditions improve
§Market share gain opportunities from leveraging USD liquidity
§Focus on three stock specific drivers –keep it MICRO
§Prolonged Covid-19 epidemic stressing system liquidity
§Sharp decline in value of trading securities and shocks in fixed-income portfolio.
§Faster than expected rise in NPLs as customers exit moratoriums.
Business Model & Industry Issues
§The nature of UOB’s business exposes it to multiple ESG risks –directly and through its clients. Particular risks include environmental, governance, money laundering and corruption.
§14% of incremental lending in 2019 were for sustainable uses, which lags UOB’s Singapore peers who averaged 35%. Its total sustainability portfolio is around 2% of total loans.
§Around 36% of corporate loans at end-2019 to businesses classified as SMEs. This creates notable social risks, given this is amongst the most impacted segments under the current economic backdrop. Additionally, the banking sector is being used as a transmission mechanism for government COVID-19 stimulus programs, where social priorities are being elevated over shareholder returns.
§UOB has invested significantly in a standardised IT platform across all its regional operations (IT expenses +16% CAGR 2011-2019). This has helped it to build scale and deploy financial inclusion solutions quickly and effectively. On the flip side, this exposes UOB to data, cybersecurity and privacy risks.
§UOB displays no exceptional risks typical for a large, regional D-SIB for ESG. Compared to its Singapore peers, it is marginally below average in disclosures in terms of adhering to ESG standards. It is rated A by MSCI ESG and this is complemented by a strong balance sheet (rated AA-) and proactive regulatory oversight by MAS.
Material E issues
§UOB is integrating sustainability considerations to its credit approach through its Responsible Financing Policy. In 2019, it discontinued new financing of coal plants and Greenfield thermal coal mines and palm oil plantations. Specific exposure disclosures to these sectors are not available.
§It set up a working group to drive its Group Sustainability Principals in 2019 and aim to have 90% of suppliers in Singapore adhere to it by 2021.
§UOB increased renewable energy, green transport, water, waste management financing by 94% in 2019.
§It has established a 2030 target of achieving green building certification for all UOB owned buildings, a 6% reduction of Scope 2 Greenhouse gas emission intensity and a 14% electricity use intensity reduction (all on a 2018 base).
Material S issues
§As a bank with significant Singapore SME market share, UOB has elevated social risks –particularly in extending support to small business owners as some emerge from COVID-19 loan moratoriums.
§UOB offered flexible work options for key employee segments such as mothers, students, caregivers, even prior to COVID-19. It was investing in digital tools consistently as part of its long-term productivity strategy.
§The Group launched its digital banking product –TMRW –In Thailand and Indonesia to improve financial inclusivity and is training frontline employees to provide digital support for the less digitally savvy as part of financial inclusion.
§The group has a long-standing history of supporting the development of the Arts with YoY growth in spending on related causes.
Key G metrics and issues
§Between 2018-2019, five UOB Personal Bankers have been jailed and/or sanctioned on separate cases of mis-selling and cheating. While in each case the bank took action, it raises material Fair Dealing risks. The group has a Fair Dealing Guidelines Committee comprising of senior management that is appointment by the CEO. The Board also overseas this through the Risk Management Committee and Risk & Capital Committees.
§The group is exposed to data security risks. It has established cross-border guidelines on dealing with personal data transfers. Additionally, an Enterprise Data Ethics Team as well as a Data Governance & Data Quality Team has been set up ensure responsible data handling. A Data Quality Centre of Excellence was established in 2019.
§UOB’s asset management businesses –UOBAM, UOBVM, UOBGC –follow Singapore Stewardship Principles for responsible investing and have established sub-committees to overseas ESG related investments.
§The Group has also established an ESG Committee that reports to the Management Executive Committee –although this sits one notch below Board level.
§Diversity Risks. Women make up just 35% of senior management roles. At Board Level women make up just 10% -the lowest amongst its Singapore peer group
§Corporate Governance Risk: 60% of Board composition is Independent Directors. This increases to 90% when non-executive directors are included.
§UOB is a signatory to the UN PRI. It includes a section on sustainability as part of its Annual Report, which is prepared under GRI and SGX standard with recommendations under TCFD.
Maybank Kim Eng recently hosted Mr. Eric Lim as part of its Captains Speak Corporate Access Series. Mr. Lim is Managing Director, Chief Sustainability Officer and Head of Group Finance at UOB. He leads UOB’s Corporate Sustainability Office and is the Chairman of the Group ESG Committee as well as a member of the ALCO and the Management Committee.
·The tonality and intensity of conversations around sustainability changed vastly from just 5-years ago. Sustainability has gone mainstream.
·However, as a business, UOB has to ensure that the business of sustainability is sustainable. It needs to be in line with the national agenda, support profitability while also being accountable to investors, asset managers and the broader community
·Organisations have to be clear about who their stakeholders are. Once this is clear, companies cannot ignoring any stakeholder just to priorities the needs of another stakeholder
·UOB is aligning itself to the sustainability agenda by placing the customer at the centre. UOB has the ability to use its balance sheet to help its customers build green assets and transform their businesses towards energy efficiency. UOB can act as an intermediary and a platform to help its customers make a positive impact on climate change
·UOB is also embarking on impact investing within the Group to broaden its sustainable funding footprint. Its venture management arm manages the Asia Impact Investment Fund with mandates to invest in agriculture, healthcare and microfinance. Here, UOB is not only focusing on financial returns, but also the value of the impact it creates
·In terms of quantitative targets, UOB is looking to build a SGD15bn sustainable finance portfolio by 2023. They have already deployed SGD12bn, so it should be able to meet that target way ahead of the target
·In terms of UOB’s existing portfolio, 8% can be classified as High Risk. However, only a small percentage is extremely high risk. For example, coal exposure is only 0.2%-0.3% of the loan book. They contributes only a small portion of income. The reason the Group has not dropped these customers is because it sees opportunities to support customer transitions
·Green Buildings and Renewable Energy are key opportunities and the Group thinks it can drive growth through its Sustainability Frameworks. In addition, there is about an USD1trn of investing or financing opportunities in ASEAN related to sustainable energy and resources, food agriculture, green connected cities, and efficient energy. These are key areas the Group is looking for growth
·As a financial intermediary, UOB has a large role to play in helping companies transition. It can finance companies that are green and promote sustainability, while withdrawing financing from companies that are not sustainable. Through this the Group has the ability to become a platform for change and help shape economies to move towards greater sustainability.
·Currently, there is a lot of competition and interest on green assets. Therefore, margins may appear lower than conventional assets historically. However, UOB believes that the conventional assets with high margins no longer exist and on a risk-adjusted basis, the margins are not that high. As a result, investing in Green assets is not really discounting –especially on a risk-adjusted basis.
·As regulations grow, companies that are not sustainable will see their funding costs increasing. Therefore, even if the margin are high now, in the long run it will erode. In fact, some of these companies could become un-fundable leaving stranded assets on books of banks that have not transitioned.
·In non-interest income, UOB is incorporating sustainability. In wealth management, Green themed investment solutions and products are becoming increasingly important. Helping clients understand where the market is trending and supporting them to make informed decisions is a key value proposition for UOB’s wealth product. The Group is seeing an increasing trend towards ESG themes, sustainable companies, future economies and new economies.
·From a corporate culture perspective, the Group is tied in with ESG. That can be seen through the Board appointing a Chief Sustainability Officer. The Group is also linking strategic management KPIs in the Wholesale bank to sustainability. While the rest of the banking pillars will follow, the Wholesale bank is first because the Group believes this is where the biggest impact on sustainability can be actioned in the immediate term. UOB has balanced scorecards that embed sophisticated and holistic sustainability KPIs. The KPIs focus on getting the sustainability finance numbers balanced with more value based goals. Examples of this include having the right conversations with clients to build a complete sustainable eco system for their business. This involves more advisory and soltutioning across the different service offerings of the Group.
·There are risks. Regulators are pushing new sustainability guidelinesat various speeds. Countries such as Singapore may be able to achieve targets earlier, but may create an uneven playing field. Other countries may lag behind and this may result insituations where Singapore institutions could face competitive disadvantages -at least in the short term.
BUY by Maybank Kim Eng Securities Research. Share price closed at $26.31.