Oversea-Chinese Banking Corp (OCBC SP) - UOB Kay Hian 2016-10-28: 3Q16 ~ Stability In Asset Quality Due To Early Recognition Of NPLs

Oversea-Chinese Banking Corp (OCBC SP) - UOB Kay Hian 2016-10-28: 3Q16 ~ Stability In Asset Quality Due To Early Recognition Of NPLs OVERSEA-CHINESE BANKING CORP O39.SI

Oversea-Chinese Banking Corp (OCBC SP) - 3Q16 ~ Stability In Asset Quality Due To Early Recognition Of NPLs

  • The better results were due to robust contribution from life insurance and net trading income. 
  • The deterioration in asset quality was mild as new NPLs were offset by upgrades for loans conservatively recognised as NPLs last year. 
  • OCBC is better positioned to weather the slowdown in the domestic economy due to its conservative management and strong CET-1 CAR of 12.8%. 
  • Maintain BUY. Target price: S$10.45.


RESULTS

  • OCBC reported net profit of S$940m for 3Q16 (+12.3% yoy), above our forecast of S$840m and consensus estimate of S$863m.

Net interest income declined 6.3% yoy. 

  • Loans expanded 1.5% qoq but contracted 1.9% yoy (suffered sequential contraction in 4Q15 and 1H16). 
  • NIM compressed by 6bp qoq to 1.62% due to the steep decline in SIBOR and SOR, which impacted loan yield.

Sustainable growth from wealth management. 

  • Fee income increased 4.9% yoy, driven by wealth management (+11.5% yoy) and credit cards (+28.6% yoy). 
  • Bank of Singapore’s AUM expanded 20% yoy to US$62b, unaffected by the tax amnesty in Indonesia.

Robust performance for non-interest income. 

  • Contribution from life insurance normalised to S$164m compared vs the lacklustre contribution in 1H16 (1Q16: S$83m, 2Q16: S$108m) due to growth in the insurance business and mark-to-market gains from equity and bond portfolio. Net trading income was robust at S$163m (2Q16: S$108m).
  • OCBC also recognised gains of S$51m for sale of properties.
  • Management has imposed strict cost control and capped increase in operating expenses at 5.9% yoy. Cost-to-income ratio was a healthy 43.2%.

Mild deterioration in asset quality. 

  • NPL balance increased by a smaller S$97m or 5.1% qoq (2Q16: +9.4% qoq). NPL ratio edged higher by 0.04ppt to 1.19%. New NPLs moderated to S$497m (43% from O&G) and was cushioned by recoveries/upgrades of S$328m. NPLs from Malaysia increased by S$152m due to exposure to the O&G sector.
  • We estimated that NPLs for O&G increased by S$181m or 19.6% qoq to S$1,103m.
  • Conversely, NPLs from other sectors declined by S$61m or 4.3% qoq to S$1,374m.
  • Management disclosed that 60% of NPLs for the O&G sector are still being serviced (not overdue, 2Q16: 50%). The vulnerable offshore services segment accounted for 42% of exposure to O&G, of which 18% have already been classified as NPLs.


STOCK IMPACT


We view the 3Q16 results positively as the deterioration in asset quality was mild.

  • However, OCBC needs to rebuild loan loss coverage, which currently stands at only 101%, although management highlighted that coverage for unsecured NPLs was higher at 308%.

Realistic approach towards handling vulnerable O&G loans. 

  • Management was realistic with restructuring/rescheduling vulnerable exposure to the O&G sector since 3Q15 and recognised them as NPLs. While the strain on asset quality persists, OCBC has benefitted from its conservative approach as NPLs upgraded to performing loans have cushioned the negative impact from new NPLs. 


ESSENTIALS – HIGHLIGHTS FROM RESULTS BRIEFING


Arrested the contraction in loans. 

  • The drag from Chinese customers moving offshore borrowings in Hong Kong back onshore is largely over. Management expects moderate loan growth in 4Q16 and guided for low single-digit loan growth for 2017.

The domestic economies in Singapore, Malaysia and even China could be slow. 

  • Management intends to focus on financing cross-border investments to generate positive loan growth. It also foresees good prospects for expansion in wealth management.

Outstanding growth from OCBC NISP. 

  • OCBC NISP registered net profit of Rp444b in 3Q16, up 37% yoy. Loans expanded 7.3% yoy while NIM was stable at 4.49%. OCBC NISP benefitted from robust growth in non-interest income. NPL ratio was stable at 1.5%.

Worst is not over yet. 

  • Management expects another two quarters of stress from the O&G sector. Management engages professional valuers to revalue its collaterals every quarter and imposes a haircut of 30% to determine specific provisions required. Average LTV ratio for loans to the O&G sector is 50%.


EARNINGS REVISION/RISK

  • The domestic economy in Singapore has slowed with GDP growing at only 0.6% yoy and contracting 4.1% qoq on a seasonally adjusted basis in 3Q16 based on advance estimates. The operating environment for banks has become more difficult and uncertain. 
  • We increase our net profit forecast for 2016 by 2% due to the better performance in 3Q16. We have cut our net profit forecast for 2017 by 4.2% due to NIM compression from the steep decline in SIBOR and SOR.


VALUATION/RECOMMENDATION

  • Maintain BUY. 
  • We have rolled forward our valuation to 2017. Our target price of S$10.45 is based on 1.17x P/B, which is derived from the Gordon Growth Model (ROE: 9.1%, COE: 7.75% (Beta: 1.05x) and Growth: 0.0%). The stock provides an attractive dividend yield of 4.2%.


SHARE PRICE CATALYST

  • Growth from regional markets in Malaysia, Indonesia and China.
  • Non-interest income from wealth management, fund management and life insurance will expand in tandem with growing affluence in Asia.




Jonathan Koh CFA UOB Kay Hian | http://research.uobkayhian.com/ 2016-10-28
UOB Kay Hian SGX Stock Analyst Report BUY Maintain BUY 10.45 Up 10.300




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