We have downgraded our sector rating to Negative from Positive and our rating for DBS Group Holdings (DBS) to 4 (Underperform) from 3 (Hold). We maintain our 3 (Hold) ratings for United Overseas Bank (UOB) and Oversea-Chinese Banking Corporation (OCBC).

We have revised down our recurrent (cash) EPS forecasts by an average of 5.3% for FY10 and 1.8% for FY11, after lowering our loan-growth and NIM assumptions slightly and raising our provision assumptions. We have also revised up our non-interest income forecasts.

We have adjusted down our Gordon Growth model valuations, the basis for our six-month target prices, by 11.5% to S$10.90 for DBS and 6.3% to S$16.99 for UOB. For OCBC, we have raised our target price by 1.8% to S$8.03. These changes are relative to our pre-2Q09 announcement forecasts.

We expect UOB and OCBC to outperform DBS, as we expect DBS to experience weaker recurrent cash-EPS growth for FY09 and FY10 as the company grapples with building up its provision coverage. The short-term differentiator is provision coverage, in our view, with UOB having the highest NPL coverage (100%) and DBS the lowest (67.6%) as at 30 June 2009.

We prefer OCBC slightly to UOB, from a Gordon Growth model valuation perspective. Fundamentally, UOB enjoys a higher overall provision coverage, but this could change from quarter to quarter. Over the current downturn, OCBC’s NPL and provision recognition has been more consistent, in our opinion, but the implementation of its scrip dividend scheme could prove to be ROE-dilutive.

We believe investors should accumulate UOB shares if they correct below S$14.0 and OCBC shares if they fall below S$6.50.