OREANDA-NEWS. United Overseas Bank Limited's (UOB, AA-/F1+/Stable) underlying operating trends remained resilient in 1Q16 despite weaker earnings, which fell largely because of lower income from wealth management, and market-sensitive operations, Fitch Ratings says.

Pre-tax profit fell 1.2% to SGD927m from a year earlier, due to weaker wealth management, trading and investment income, and higher operating expenses. Fitch believes that UOB's overall loan quality remains sound with specific impairments of just 25bp on average gross loans.

UOB's exposure to China fell to SGD19.5bn (63% of total equity) at end-March 2016 from SGD21.1bn at end-2015, but this segment remains a potential source of NPLs should China's economy falter. The largest component of the exposure - SGD10.1bn - is to Chinese banks, of which about 75% derive from the top five Chinese banks and policy banks. This is followed by non-bank exposures (SGD8.2bn), which are mainly to top-tier state-owned enterprises, large local corporates and foreign investment enterprises. The quality of the non-bank book remains healthy, with a low NPL ratio of 0.9% at end-March 2016.

The tenor of its China loan portfolio is short. Roughly 99% of bank exposure and half of non-bank exposure mature in less than one year. Debt securities of SGD1.2bn made up the remainder of the bank's China exposure.

The other key area to monitor is the bank's exposure to the commodity sector (71% of total equity) given the sharp decline in commodity prices. This exposure rose marginally to SGD21.8bn at end-March 2016 from SGD21.0bn at end-2015. Much of the increase over the quarter stemmed from exposures to traders and other downstream industries, while the bank's exposures to upstream industries and other commodity segments were flat to slightly lower. Loans accounted for SGD15.5bn of the total and contingent liabilities accounted for SGD6.3bn.

UOB's asset quality is holding up reasonably well to date despite broader economic uncertainty. The effect of commodity price weakness on credit quality has been modest thus far, and the overall NPL ratio remained unchanged at 1.4% of gross loans at end-March 2016 from a quarter earlier. Gross non-performing assets (NPAs) improved to SGD3.0bn at end-March from SGD3.1bn at end-2015, as write-offs, recoveries and NPLs that turned performing exceeded the formation of problem assets.

However, softer economic conditions in Singapore are likely to weaken the bank's asset quality in the near term. We expect the deterioration to be moderate rather than severe, and the bank's healthy provision buffer of 131.4% of NPAs - of which roughly 77% are general provisions - should cushion any potential asset quality slippage, if the current uncertain operating conditions persist in the medium term. Because of this, we expect profitability to remain reasonably resilient despite potentially higher credit costs.

The bank's liquidity remained strong with healthy deposit growth across key markets. This reflects the bank's disciplined funding, where all subsidiaries have to be self-funded on a sustainable basis. Furthermore, UOB's foreign currency and US dollar loan-to-deposit ratios (LDR) at 1Q16 were 75% and 57% respectively, the lowest among the three Singaporean banks. This suggests that UOB is able to absorb significant US dollar deposit outflow.

Its average Singapore-dollar and all-currency liquidity coverage ratios (LCR) of 169% and 139% respectively slipped from 4Q15 average levels (217% and 142% respectively) but remained well above the regulatory end-point minimum of 100%.

The bank's capital position remains sound in Fitch's view. The fully loaded common equity Tier 1 ratio reached 12.1% at end-March 2016 (end-2015: 11.7%, March 2015: 12.8%) and the leverage ratio of 7.0% (end-2015: 7.3%, March 2015: 7.6%) remains solid. Strong capitalisation will help to compensate for greater economic uncertainty. We expect the bank's capital ratios to stay high, considering the moderate internal capital generation and slow loan growth ahead.