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DBS and UOB

All three local Singapore banks have released quarterly results last week with variations in their disclosures. Whilst DBS and OCBC came up on top – with both registering solid profit increases with key business units and metrics reported to be firing well - UOB floundered, revealing a rare drop in its quarterly net profits. As a result, UOB stock suffered yet another slide yesterday, adding to the loss of its Friday’s plunge as it continues to test its 10-month low here – it closed at SGD21.96 on Monday, with a loss of 1%. Collectively, UOB has given up more than 5% over the last week. On a one-year basis, UOB has loss over 5% against DBS’s gain of more than 10% and OCBC’s 6%. Singapore’s three banks operate in similar geographical zones and compete in similar business areas. As such, they are all equally vulnerable to any significant slowdown to the regional economy and are likewise, equal beneficiaries of any ‘rising tide’ that a recovery in the economy may bring.

A probable smoothing out, risks elimination

That said, the disparity in UOB’s underperformance (versus the other banks, especially DBS) over this extended period of time is a slight anomaly and we could see this widening disparity in performance reverse itself in the future. Whether the economic or business conditions for Singapore’s banks improve or deteriorate going forward, a pair trade taking a long position on UOB and an equal short on DBS shares will allow traders an opportunity to ‘lock-in’ to the wide spread that has been the result of the past year’s movements. The rationale here is to bet that going forward, a ‘reversion to mean’ may ensue- that is, to bet that UOB may outperform DBS in the period ahead. This may happen as UOB improves in its operations and report better numbers giving confidence back to investors so that they can relook and buy their stock once again, thus reversing the earlier switch out of the bank to its local competitors. The chart below highlights just what a trader could have gained by going ‘long’ on DBS and shorting UOB in a pair trade over the past year - a possible yield of approximately 8%. By reversing the trade now - long UOB, and short DBS in equal amounts - one is betting for the spread to narrow to ’zero’. The attraction in a pair trade is that very often, ‘market risk’ is eliminated or significantly reduced. In this case, the holder of the pair if playing the underperformance/over-performance of these two banks, need not have to over-account for the economic environment of their businesses.
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