3Q11 loan momentum strong but we expect sharply slower FY12 loan growth. The three banks recorded 3Q11 sequential loan growth of between 7% and 10%. The strength came particularly from Greater China loans eg DBS said they took advantage of the demand for trade financing loans from Chinese corporates. Most of these loans were disbursed in US$, which led to US$ loans surging in 3Q11. UOB has indicated that their loan approvals have fallen sharply in 3Q11, which will suggest significantly slower loan expansion by 2Q12, given the lagged effect. Hence, we are forecasting FY12 banking sector average loan expansion of a slower 9%, versus our FY11’s 25% forecast.  

DBS’ earnings beat expectations while other two banks missed street’s forecasts slightly – weaker outlook reinforces our NEUTRAL weight on banking sector. DBS’ 3Q11 earnings beat market expectations due to stronger income from financial instruments, which is a volatile income segment. On the other hand, both OCBC and UOB marginally missed street estimates due to weakness in trading income. For the more stable net interest income segment, OCBC outperformed its peers with a 5.7% sequential growth, despite a 2 bp QoQ NIM squeeze.

Looking ahead, we expect continued soft SIBOR, which will keep the three banks’ NIM narrow. Global economic weakness would also slow loan expansion and raise provisioning requirements as we move into 2012. We are less bullish than market and this shows up in our earnings forecasts being ~10% lower than consensus.

Given the headwinds, we are NEUTRAL weight the banking sector. Our best pick remains UOB (S$16.43/BUY/TP S$19.20) as we believe its asset quality is high : (1) UOB was the least aggressive lender over the past 36 months, with a loan CAGR of 11.1%, versus 15.1% average for its other two peers; (2) 27.5% of UOB’s loan book is to the low-risk home mortgages, versus 22.7% average for its two peers. We believe UOB’s loan is less susceptible to NPLs going forward. The soft SIBOR environment is a negative for DBS (S$12.66/NEUTRAL/TP S$13.31), with its S$ loan deposit ratio of a low 62%. Valuation is not attractive for OCBC (S$8.53/NEUTRAL/TP S$8.30).