OCBC Bank - DBS Research 2017-10-26: Radiating Positive Vibes

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OVERSEA-CHINESE BANKING CORP O39.SI

OCBC - Radiating Positive Vibes

• Sounding even more positive; loan growth guidance tuned up to 7-8% over FY17-18F; NIM improvement sustainable.
• Asset quality issues have clearly stabilised; impact on IFRS9 under evaluation; more details during 4Q17 results.
• FY18-19F earnings revised up by 3-5% mainly from top-line changes (NIM, loan growth).
• Maintain BUY, TP raised to S$13.50.

Tuning an even more positive tone; reiterate BUY. 

• OCBC’s 3Q17 results is testimony to our positive view on the bank. Apart from its sustained strong showing of its non-interest income franchise (wealth management and insurance), its banking operations are picking up well. NIM is gradually improving and such trends should hold up going into 2018. 
• Positively, loan growth is strong with YTD loan growth at 5.5% vs our FY17 forecast of 7%. Management is now guiding for 7-8% loan growth for FY17-18. Wealth management and insurance operations are holding up well, and will remain a key differentiator of growth vs peers. 
• Asset quality indicators have clearly stabilised; a visible recovery would stage a strong re-rating catalyst for the bank. 
• There needs to be a further evaluation on the impact to the implementation of the IFRS9/SFRS109, pending clarity on certain aspects especially with regards to the tax treatment on general provisions. Capital enhancement measures are underway and should be made clear during the release of its FY17 results.

Where we differ: Staying above the rest. 

• Our FY17 earnings forecasts are left largely intact even after we marginally tweaked NIM and loan growth (-1bp for NIM, raised loan growth to 7.6% from 6.8%) but FY18-19 earnings forecasts are raised by 3-5% on stronger NIM traction (+4-5bps) and loan growth (from 5% to 7%).
• Sustained upward trajectory of SIBOR/SOR should re-rate NIM higher. Our earnings forecasts remain above consensus. We reiterate our BUY rating and nudged up our TP to S$13.50.

Potential catalyst: The end of asset quality woes. 

• Asset quality issues pertaining to the oil & gas segment have been dealt with, and sufficient provisions are said to have been made. There may be some tweaks necessary when IFRS9/SFRS109 is implemented. 
• More importantly, a visible improvement in asset quality contrary to stabilisation could mark a strong re-rating catalyst apart from better NIM, loan growth and non-interest income prospects.

Valuation

Reiterate BUY, TP at S$13.50. 

• Our TP of S$13.50 (12% ROE [raised], 4% growth, 9.5% cost of equity) following our earnings adjustments is equivalent to 1.3x FY18 BV, its 10-year mean P/BV multiple.

Key Risks to Our View

• Faltering NIM and non-interest income traction. Inability to see revenue generation from improved NIM as well as better wealth management and insurance income contribution could pose downside to our earnings forecasts.

WHAT’S NEW - Tuning an even more positive tone 

3Q17 results highlights 

3Q17 earnings above consensus; in line with our expectations. 

• OCBC's 3Q17 net profit came in at S$1,057m (- 2% q-o-q; +12% y-o-y) – above consensus; in line with our expectations. 
• Earnings were driven by strong top-line growth with improved NIM (+1bps q-o-q, +4bps y-o-y) and strong loan growth (+2% q-o-q, +11% y-o-y). YTD loan growth stood at 5.5%, on track to meet our 7% FY17 forecast.
• Deposits grew 1% q-o-q, +8% y-o-y. Expenses were kept in check with cost-to-income ratio at 42.4%, within its 40-45% guidance. Staff costs were slightly lower q-o-q while other costs were largely flat.

Softer q-o-q non-interest income from insurance and trading; strong trends noted y-o-y. 

• Non-interest income was a tad lower q-o-q, dragged by lower insurance and trading income but remained well supported by wealth management income.
• Bank of Singapore's (BOS) AUM grew 6% q-o-q, 53% y-o-y to US$95bn.

Provisions were lower q-o-q and y-o-y. 

• General provisions were lower q-o-q and y-o-y but specific provisions were higher at 24bps. However, specific provisions increased, driven by a number of restructured accounts which were continuing to service their repayment obligations but exhibited ongoing weakness and declining collateral values, particularly from the oil & gas segment. 
• The reassessment on collateral values are carried out every quarter. Notably, one of the specific provisions were made in relation to a China State Owned Enterprise (SOE) from the steel industry, had requested for their facility to be restructured.

Asset quality has stabilised. NPL ratio stood stable at 1.3%.

• New NPLs eased to S$409m (2Q17: S$445m; 3Q16 S$497m) indicating that trends are stabilizing, of which 38% or S$156m were related to the oil & gas sector. 
• The oil & gas exposure stood at 7% of total loans but its NPL ratio has stayed stable. The oil & gas sector NPLs are approximately half of OCBC’s total NPLs. 
• Overall loan loss coverage stood at 101%.

Strong capital levels. 

• Capital levels stayed robust with CET1 (fully loaded) at 12% and Total CAR at 16.2%. No interim dividend was declared. 
• Among peers, OCBC is the only bank that has turned off its scrip dividend tap. It prefers to wait for clarity on Basel 4. However, there would be some capital uplift when OCBC-Wing Hang and OCBC NISP adopts the Internal Ratings-Based (IRB) Approach for its capital computation, potentially lifting capital ratios by 20-30bps by the end of the year.

Regional operations doing well. 

• OCBC's regional operations saw improvements q-o-q and y-o-y, except OCBC NISP which saw a slight dip in earnings q-o-q due to higher provisions.
• OCBC-WHB, which contributes 8% to group pre-tax profit saw its earnings soar in 3Q17, thanks to a significant rise in its non-interest income. The narrowing of the 1-month and 3- month HIBOR gap helped cushion NIM but its overall NIM fell due to its treasury book from its China operations. Asset quality indicators were benign. 
• OCBC Malaysia, which contributes 16% to the group pre-tax profit, also saw improved performance as NIM stabilised and provisions eased. Its asset quality indicators were stable. 
• OCBC NISP, which contributes 6% to group pre-tax profit however, saw a dip in earnings q-o-q from higher provisions and lower revenues.

Outlook 

Sounding even more positive; earnings raised further. 

• We sensed a strong stance of optimism from the analyst briefing, even more positive compared to 2Q17 which prompted us then to upgrade our rating to a BUY. 
• We reiterate our BUY rating with TP lifted to S$13.50 after raising FY18-19F earnings by 3-5%.

Asset quality woes related to oil & gas has stabilised; waiting for a recovery. 

• It feels too early to call for a recovery of the sector although early signs have been seen with chartering activities picking up. The oil & gas cycle should see a trough soon. 
• However, capital expenditure for this sector has yet to be visible. OCBC was one of the earlier banks to start classifying NPLs from as early as 3Q15. No new names have been identified and additional provisions were mostly related to declining collateral values. The bank has not taken possession of any of the collateral and over time, cash flows are expected to improve. There could be one more account from the oil & gas sector that may be classified in 4Q17.

Improving loan demand; raising loan growth guidance to 7- 8%. 

• Loan growth has been strong YTD at 5.5%, driven by housing loans, trade finance, overseas loan demand and Hong Kong-based companies (from OCBC-WHB). The first three quarters of 2016 were extremely volatile and the bank took a cautious stance. Loan growth started to pick up in 4Q16, and the momentum has stayed strong till now.
• Management has toned up loan growth guidance to 7-8% for FY17 and is expecting this trend to continue to 2018. We had raised our loan growth forecast to 6.8% but are now tuning it up further to 7.6% for FY17; we are now raising loan growth for FY18-19 to 7% each year (from 5% previously).

NIM to gradually improve. 

• NIM traction has been sluggish up to 3Q17 as SIBOR/SOR has finally only edged up meaningfully in recent months. The re-pricing effect takes approximately 90 days. As such, NIM uplift would be more meaningful in the coming quarters. Sustained upward trajectory of SIBOR/SOR should re-rate NIM higher. 
• While we toned our NIM for FY17 by 1bps, we raised it by 4-5bps for FY18-19.

Events/items to watch by year-end 

Implementation of IFRS9/SFRS109; impact to be evaluated; clarify during 4Q17 results. 

• The Monetary Authority of Singapore (MAS) has released the proposed amendment to regulatory requirements pertaining to credit loss under the IFRS9/SFRS109. Singapore is the first in the region to clarify its methodology. 
• The SFRS 109 requires banks to maintain a minimum of 1% collective impairment allowance and specific allowance will be set aside on a case-by-case basis. The Expected Credit Loss (ECL) model includes more forward-looking information to assess credit quality of the bank’s underlying financial assets. 
• OCBC has excess general provision reserves but it has not deliberated what it will do with it at this point – either to claw it back to retained earnings or to set it aside as additional provisions prior to the implementation of this accounting standard. 
• OCBC has never reduced general provisions to offset specific provisions. It appears that smoothening out earnings by adding or using general provision reserves will no longer be allowed. 
• Impact to OCBC is still under evaluation as the shift of excess general provision reserves into equity may have tax implications. Possible changes to the provision run rate will be clearer from 1Q18 trends.

GEH exploring options for its Malaysian operations, as reported. 

• Great Eastern Holdings (GEH) is reported to have engaged at least one Malaysian bank to explore selling its stake in its Malaysian operations. It has also been noted that several other foreign insurance companies operating in Malaysia (including Prudential Malaysia and Tokio Marine Insurance Malaysia) could be exploring similar options. This move is in reaction to Bank Negara Malaysia’s (BNM) stricter enforcement of the 70% foreign ownership cap on insurers, which was issued back in 2009. 
• We understand the timeline could be fluid, and negotiations could be managed on a case-by-case basis. In our view, there are three viable options for these companies to pare down their stakes:
  1. List (IPO) 30% of their shares to the public;
  2. joint-venture with a local partner; or
  3. divest to local institutional investors. 
• OCBC’s official stance on this is “GEH is exploring options to meet the necessary requirements”.

NAB acquisition; disposal of HK Life to be completed by 4Q17. 

• Its acquisition of National Australian Bank’s (NAB) portfolio will likely only be completed and fully consolidated by end-FY17 but the impact would be small. 
• Separately, the disposal of HK Life to be also likely be concluded by year-end.

Valuation & Recommendation 

 Maintain BUY, TP raised to S$13.50. 

• Corresponding to our earnings upgrade, our revised TP of S$13.50 is based on the Gordon Growth Model (12% ROE [raised], 4% growth [raised], 9.5% cost of equity) which is equivalent to 1.3x FY18 BV, its 10-year mean P/BV multiple. 
• OCBC’s key differentiating factor lies in its insurance business which gives it a more holistic wealth management platform, which we believe is still under-appreciated by the market. Solid 2Q17 earnings was testimony to its non-interest income franchise.
• Asset quality issues pertaining to the oil & gas segment have been dealt with, and sufficient provisions are said to have been made. A visible improvement in asset quality contrary to stabilisation could be an added re-rating catalyst apart from better NIM, loan growth and non-interest income prospects.

Sue Lin LIM DBS Vickers | Singapore Research Team DBS Vickers | http://www.dbsvickers.com/ 2017-10-26

DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 13.50 Up 12.800