UOB and DBS surprised with larger-than-expected provisions Though DBS and UOB’s 2QFY2009 earnings were higher than expected, the bulk was driven by lower-quality income (i.e., investment gains, trading income). While the lackluster core banking franchise including OCBC’s was within our expectations, the key negative surprise was UOB and DBS’s larger-than-expected provisions. We are less concerned about UOB, as a lot of the provisions were not loan-related, and we think were made largely to offset significant one-off gains in 2Q. However, for DBS, while asset quality in core markets remains well within our expectations of an NPL-lite cycle panning out, provisions in 2Q were driven by NPL formation outside of core markets, relating to Middle Eastern corporates, and shipping loans. Visibility on these loans continues to be weak, but we believe DBS has been prudent in recognizing the NPLs early. Its loan loss coverage at 66% is low vs. UOB’s 100% and OCBC’s 97%. OCBC had better- than-expected results, largely on lower-than-expected credit costs.

Market starting to price in benign credit cost outlook With the exception of DBS, despite relatively resilient asset quality trends at UOB and OCBC, higher but not substantial NPL hikes, lower loan credit costs in 2Q vs.1Q, vs. the Street’s elevated credit costs expectations, there was not much positive reaction by the market. We think it may be starting to price in a more benign credit cost environment, in line with an improving macro outlook, and we expect the strong 2QFY2009 results to trigger positive earnings revisions by the Street. However, following a detailed review of 2QFY09 results, we revise our FY09-11E core EPS estimates by -18% to +3% for all three Singapore banks on largely on higher provisions made year to date and moderating corporate loan spread expansion, and also roll over our TPs to end-2010.

Downgrade DBS to Neutral, OCBC is our only Buy in the sector We continue to see an NPL-lite cycle for Singapore banks. But for DBS, we remain concerned on NPLs outside of the Singapore/Hong Kong core market, the limited visibility of which will likely pose an overhang on the shares. Following our price target revision, we remove DBS from our Conviction Buy list and downgrade to Neutral on limited upside. OCBC is our only Buy in the sector, given risk-reward we view as attractive, resilient loan book asset quality, and strong insurance income. Sector downside risks: Double-dip economy, larger-than-expected NPL/credit costs.