Oversea-Chinese Banking Corp - UOB Kay Hian 2016-04-22: Bullish On Asset Quality; Neutral On Acquisition

Oversea-Chinese Banking Corp - UOB Kay Hian 2016-04-22: Bullish On Asset Quality; Neutral On Acquisition OVERSEA-CHINESE BANKING CORP OCBC O39.SI 

Oversea-Chinese Banking Corporation (OCBC SP) - Bullish On Asset Quality; Neutral On Acquisition 

  • We are neutral on the acquisition of Barclays WIM Singapore and Hong Kong as valuation is fair but contribution to bottom line is unlikely to be significant. 
  • We like OCBC for its conservative and proactive management of exposure to the O&G sector while its fully-loaded CET-1 CAR has caught up with peers’. 
  • Maintain BUY with target price of S$10.68. 


WHAT’S NEW 


 Expanding franchise in private banking with acquisition of Barclays WIM. 

  • OCBC’s wholly owned private banking subsidiary, Bank of Singapore (BOS), has entered into an agreement to acquire the wealth & investment management business of Barclays WIM in Singapore and Hong Kong (Barclays WIM) for US$320m cash. 
  • Barclays WIM will be transferred to BOS at zero NAV. 

 The acquisition strengthens OCBC’s wealth management franchise. 

  • Barclays WIM has a base of 1,800 high net worth clients. BOS will benefit from wealth creation within China as Barclays WIM has relationships with more than half of the top-50 names on Forbes China Billionaires List. 
  • Barclays WIM has a talent pool of 88 experienced relationship managers (RMs), who have an average of more than five years with Barclays WIM. Thus, BOS’ base of RMs will increase from 300 to about 400. The acquisition also increases BOS’ AUM by US$18.3b, or 33%, to US$73.3b. 

 Acquisition of Barclays WIM is fairly priced. 

  • The purchase price represents P/AUM of 1.75%. DBS paid a similar P/AUM of 1.75% for the acquisition of Societe Generale’s private banking business in Asia (AUM: US$12.6b), which was completed in Oct 14. 
  • This is a relatively small acquisition and will be funded by internal cash from BOS. Contribution to bottom line is unlikely to be significant, given the cost-to-income ratio of the private banking business is usually high, ranging from 60% to 90%. 
  • Management expects the acquisition to be accretive to OCBC’s EPS and ROE after the first year. The transaction is expected to complete towards end-16. 

 Reviewing previous acquisition of ING Asia Private Bank. 

  • OCBC acquired ING Asia Private Bank (IAPB) (AUM: US$15.8b), subsequently renamed as BOS, for US$1,446m, or a hefty P/AUM of 9.15% in Jan 10. P/AUM would be lower at 5.67% if we adjust for IAPB’s surplus capital of US$550m, which is still expensive relative to comparable acquisitions. Valuations work out to be 18.1x PE, based on IAPB’s normalised earnings for 2008, and 1.59x P/B. 
  • Growth at BOS was dominated by net fees & commissions, which expanded at 5-year CAGR of 23.1% and accounted for 55.7% of total income in 2014. Net interest income grew at a slower 16.1%. Its NIM is a paltry 0.95% as loans extended to high net worth clients are well collateralised. Net trading income, primarily from forex transactions, accounted for a sizeable 13.9% of total income. 
  • Total income grew at a 5-year CAGR of 21.7% as customer flows recovered after the global financial crisis (GFC). NIM expanded 12bp to 0.95% while CIR improved from 83.6% to 74.9% over the past five years. ROE was decent at 8.9% in 2014, although lower than OCBC’s group ROE at 12.3%. 
  • ROIC is at best 6.4% as OCBC has overpaid for IAPB, even if we assume that the size of OCBC’s original private banking business is small relative to IAPB. Also, BOS’ net profit of US$92.1m in 2014 was lower than IAPB’s US$102.4m in 2007 before the GFC. 


STOCK IMPACT 


 1Q16 results preview. 

  • We expect OCBC to record a net profit of S$860m for 1Q16, down 10.4% qoq and 13.4% yoy. Loans would have grown marginally by 0.9% qoq and 1.2% yoy with strength in the Ringgit offset by weakness in the US$. 
  • We expect NIM to have receded slightly by 1bp qoq to 1.73% but still 11bp higher yoy. Net interest income could have increased 5.5% yoy. We expect fees to have declined 2% qoq but flat yoy due to weakness from market-sensitive sources. 
  • We expect robust contribution from life insurance at S$180m, especially as government bond yields have declined in both Singapore and Malaysia. 
  • We expect NPL ratio to have increased marginally by 0.1ppt to 1.0% and specific provisions at 35bp. 

 Conservative guidance for 2016. 

  • Management expects low-single-digit loan growth in 2016. Demand for loans is weak in Singapore. Some customers are looking at overseas expansion. Management expect single-digit growth for housing loans due to drawdown of existing loans and booking of new loans. 
  • NIM is expected to be slightly higher than the average of 1.67% in 2015. 

 Conservative and proactive management of exposure to O&G sector. 

  • OCBC has extended loans of S$12.4b to the oil & gas (O&G) sector, or 5.9% of its total loans (2014: S$13.8b). The offshore support services segment, related to the chartering of barges, tugs, support vessels and rigs, is more vulnerable and accounted for a significant 47% of OCBC’s O&G loans. 
  • OCBC approaches customers in the offshore support services segment to re-negotiate lending terms to ensure that vessels continue to be chartered and deployed. We estimate NPLs for the O&G sector to have increased from S$21m last year to S$822m currently (42% of total NPLs). This amount represents 6.6% of OCBC’s exposure to the O&G sector and 14% of its exposure to the offshore support services segment. These loans has already been restructured and recognised as NPLs. 
  • OCBC has taken some specific provisions for exposure to the O&G sector in 2015. Current loan loss coverage is a healthy 122.9%. Management looks at expected cash flows from loans, value of collaterals based on forced sale prices and outstanding balance to determine the required amount of specific provisions. 

 Caught up with peers in capital adequacy. 

  • OCBC’s CET-1 CAR is 11.8% based on full implementation of Basel III. Its CET-1 CAR has caught up with its peers (DBS: 12.4% and UOB: 11.7%). 


EARNINGS REVISION/RISK 

  • We maintain our existing earnings forecasts. 

VALUATION/RECOMMENDATION 

  • Our target price is S$10.68, based on 1.26x P/B, derived from the Gordon Growth Model (ROE: 9.8%, COE: 7.8% (Beta: 1.0x) and Growth: 0%). 

SHARE PRICE CATALYST 

  • Growth from commercial banking businesses in regional markets, such as Malaysia, Indonesia and Greater China. 
  • Non-interest income from wealth management and life insurance will expand in tandem with growing affluence in Asia.



Jonathan Koh CFA UOB Kay Hian | http://research.uobkayhian.com/ 2016-04-22
UOB Kay Hian SGX Stock Analyst Report BUY Maintain BUY 10.68 Same 10.68


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