3 key things investors should know about UOB's latest earnings report

United Overseas Bank Ltd, or UOB, released its earnings a few days ago.

It was the second bank to release earnings after DBS Group Holdings Ltd.

Total income for UOB remained flat year on year, while net profit plunged 19 per cent year on year due to allowances set aside for potential bad loans.

The bank also provided its insights into how the Covid-19 pandemic is affecting its business and prospects.

All eyes are now on the credit quality of the bank's underlying borrowers as the pandemic threatens to wreak significant economic damage.

Here are three observations from UOB's latest earnings report.

1. Fall in net interest margin

Although UOB's loan book grew 3 per cent year on year to $278 billion, net interest income was flat year on year.

Loan growth was driven mainly by Singapore (up 2 per cent year on year) and North Asia (up 5 per cent year on year).

However, the fall in interest rates globally has negatively impacted the bank's net interest margin (NIM).

NIM fell from 1.79 per cent in the first quarter of 2019 to 1.71 per cent in the current quarter.

It was this fall in NIM that erased the positive effects of the growth in loans.

In contrast, DBS reported just a slight drop in NIM from 1.88 per cent to 1.86 per cent, while its loan book grew 6.4 per cent year on year.

As a result, DBS saw net interest income rise 7.4 per cent year on year.

2. Negligible exposure to oil and gas

The oil and gas industry is seeing a second wave of potential defaults after oil prices crashed to its lowest level since 1999.

Hin Leong, one of Singapore's largest independent oil traders, is struggling to repay debts totalling US$3.85 billion (S$5.4 billion).

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The oil trader is also under investigation by the police for failing to disclose hundreds of millions in losses over several years.

UOB's exposure to the oil and gas industry is not significant, making up just 3.6 per cent of its total loan book at $10.2 billion.

DBS has a much higher oil and gas exposure at 6.1 per cent of its loan book.

Still, there may be a domino effect at play once a large, prominent player gets into trouble.

Just this week, Zenrock Commodities Trading, a trader in crude, oil products and petrochemicals, was petitioned by HSBC to be placed under judicial management.

The troubles suffered by Hin Leong and Zenrock could well affect other oil and gas companies in the months to come, potentially leading to more write-downs and provisions by UOB.

3. Increase in cost-to-income ratio

UOB's cost to income ratio, a measure of expense efficiency for a bank, rose to 45.1 per cent from 44.6 per cent a year ago.

However, this ratio was down from 45.9 per cent that was reported in the fourth quarter of 2019.

Though revenue-related expenses fell from $159 million to $142 million, this was offset by a rise in staff costs by $12 million and higher IT-related expenses of $13 million.

Though DBS also reported higher staff costs and other expenses on a year on year basis, the rise in the bank's income meant that cost-to-income fell to 38.9 per cent from 42.2 per cent a year ago.

Get Smart: Pre-emptive provisioning

UOB has earmarked a portion of its loans are potentially non-performing, in line with the deterioration in the macro-economic environment.

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This pre-emptive move is positive as it shows that the bank is serious in reviewing each loan to assess its credit quality.

Total credit costs rose to 0.36 per cent of total loans for UOB, in line with DBS' specific provisions that came up to 0.35 per cent of its total loan book.

UOB also has a larger proportion of its loan book dedicated to SMEs (15 per cent) compared to DBS (10.4 per cent), and this may be another area of weakness as SMEs are more vulnerable to cash flow issues due to lockdowns and social distancing.

Moving forward, the key would be to monitor if conditions in other sectors worsen, and how it may impact the bank.

This article was first published in The Smart Investor. Disclaimer: Chin Hui Leong owns shares in DBS Group Holdings Ltd and United Overseas Bank Ltd.