Resilient pre-provision profits. 1Q09 results came in much better than expectations, owing mainly to non-interest income. Provisions increased but mainly skewed towards higher collective impairments, while specific provisions were lower. We saw NPL ratios and absolute NPLs inch up this quarter. Key stressed areas include manufacturing and general commerce. We note capital ratios remain robust for the quarter. NIMs were a tad lesser due to lower gapping profits. Loan yields were lower due to low SIBOR during the quarter.

Brighter outlook. Moving away from savvy capital market products, we believe banks would garner close to 70% of operating income from net interest income. As banks price in risks to their lending yields, there is potential upside to NIMs. We project NIMs to rise to 2.2%in FY09 and 2.3% for FY10, and there could be upside to our 2009 estimates. We believe loan growth will hold up, aided by the positive budgetary measures announced in Jan 09 despite the significant contraction in GDP. In addition, the pull back by foreign banks would open business and market share opportunities to Singapore banks, which could enjoy higher loan growth. NPL increases are a foregone conclusion; the question now is to what extent. We reckon while asset quality may deteriorate, it would not revert to Asian crisis levels. We believe NPL increases would be manageable as banks’ risk management policies are more stringent now compared to the Asian crisis. Moreover, corporates are less geared and interest rates are at its lowest levels.

Reverting to mid-cycle valuations. As sentiments improve and fundamentals find their way back to normalised levels, we believe Singapore banks should revert to mid-cycle valuations. Our Buy calls on both UOB (TP S$16.50) and OCBC (TP S$7.60) reflect mid-cycle P/BV of 1.6x. Resurging confidence in earnings would be the next re-rating factor possibly pushing banks to higher P/BV levels. Banks are currently trading at 1.3x BV, which is close to the early mid-cycle P/BV multiple. Prefer UOB for relatively cheaper valuations and higher beta vs OCBC. OCBC is also a Buy for its strong Tier-1 capital ratios, sustainable dividends and upside from its Malaysian operations. Key risk to our call would be a protracted global recession.