Oversea-Chinese Banking Corp - Phillip Securities 2016-02-19: Macro headwinds prevail but reasonable valuation in sight

OVERSEA-CHINESE BANKING CORP OCBC O39.SI

Oversea-Chinese Banking Corp - Macro headwinds prevail but reasonable valuation in sight

4Q15 NPAT of S$0.96bil rose +6% q-q driven by a 281% jump of life assurance profit.
Net interest income grew +2% q-q on the back of 8bps increase in NIMs.
NPL stable q-q at 90bps. Management continues to see a challenging regional economy.

Management expects loans growth in low single digit and FY16, we expect its NIMs to stabilise at about 1.7%.
Downgrade to "NEUTRAL” with a lower TP S$7.85, pegged at 0.95x FY16F PBR.

Declines in general commerce and commodity related loans have offset the continued growth in construction and housing loans so overall loans books declined by 1% q-q, marking the first quarterly decline since 1Q12.
USD loans growth declined by 4% q-q which we view as corollary to declining corporate loans owing to weak investment sentiment and also a result of the bank’s emphasis to prioritize quality of loans over quantity of loans.
HKD loans was down 0.7% q-q, marking the first decline in the last 5 quarters of reporting after the Wing Hang acquisition.
Deposits fell 2% q-q led by a steeper drop in fixed deposits (-3.8% q-q) while CASA rose 0.7%. We view this as a part of the liability management to minimise cost of funds and keep NIMs optimal. As a result, LDR is up, reaching 84.6% (3Q15: 83.5%).

We expect that OCBC will maintain the LDR in the range of 83% to 85% under a weak yet competitive lending and deposits market in 2016.
Management has guided that loans growth will be in a “low single digit” range and NIMs will slightly higher than “the average NIMs in 2015”.
We estimate NIMs to settle at about 1.7%.

Under a weak economic environment, we expect a double whammy where loans cannot be priced higher without compromising quality and prices are also capped by competition meanwhile costs of funds are at risk of rising if the threat of capital outflow from the region reappears.
OCBC’s average cost of funds in 2015 is 112bps.

Of the S$12.4bn, S$5.8bn are loans related to offshore support services which the management deems as higher risks. As of this reporting period, 14% of S$5.8bn has been assigned to NPL. However, management is cautious of the remaining valued because there is potential for these loans to deteriorate and be assigned to NPL if oil price remains low till end of 2016.
In our model we assumed 16% of the S$5bn (S$800mn) to be assigned to new NPLs in 2016 and an additional S$1bn allowance set aside. Under this circumstance, we expect the allowance to NPL cover to be lower than 120% in FY16 (c.124% in FY15).

Management views that the exposure to mainland China are not likely to be under stress. Of the S$56bn customer loans to Greater China, only S$6bn belong to mainland China.
Breaking down further, S$3bn are loans to large Chinese SOEs and S$3bn are loans via Wing Hang. And from Wing Hang’s mainland China loan exposure, 65% of the S$3bn loans are mortgage loans to Hong Kong people who purchased Chinese mainland real estate and 35% are commercial and SME loans. Wing Hang’s mainland Chinese SMEs and commercial loan exposure are mostly secured and are assessed on business cash flow.
Management highlighted only 1% of Wing Hang’s mainland Chinese loans are unsecured.

Overall fee and commission income in 4Q15 was down 1% q-q because of a weaker performance from wealth management (WM) fees.
We expect wealth management income to continue facing headwinds from a volatile markets. The extreme volatile equities market after 3Q15 had impacted WM income because clients became trepid and stayed away from markets.

Improved earnings in the 4Q15 was attributed to 20% q-q increase in premium income and recovering from the mark to market loss in Great Eastern Holding’s bond investment.

Our new TP is based on 5% discount to FY16F book value, reflecting muted growth prospects in a challenging economic environment and market’s uncertainty about the oil and gas sector.
Our new NPL formation assumes oil price to remain below the cost of production for offshore oil (approx. US$70 per barrel) and we assume charter rates to remain unfavourable for offshore capital equipment in 2016.
We expects that low oil price over an extended period of time would impact the income statement rather than the balance sheet.
The lack of propitious growth levers from other segments of loan books is emphatic of a turn in the credit cycle.

Jeremy Teong Phillip Securities | http://www.poems.com.sg/ 2016-02-19

Phillip Securities SGX Stock Analyst Report NEUTRAL Downgrade BUY 7.85 Down 14.87