OCBC - DBS Research 2016-10-27: Asset quality remains an issue

OVERSEA-CHINESE BANKING CORP O39.SI

OCBC - Asset quality remains an issue

3Q16 earnings were lifted by better insurance and wealth management income; provisions were higher; NPL ratio rose to 1.2%.
NPL issues have yet to peak; new NPL formation remains prevalent largely from the oil & gas segment; staying watchful on SME loans.
Slight pick up in loan growth expected in 4Q16 and going into 2017.

Maintain HOLD, TP raised to S$8.60 as we roll forward valuation base to 2017.

The focus in 2016 would likely be on managing expenses and containing asset quality.
Loan growth is expected to be at low single digits while NIM would likely stay flat at current levels.
Higher credit costs are imputed given the vulnerability of its oil & gas exposure which currently stands at 6% of total loans.
The underlying business of its insurance segment measured by total weighted new sales and new business embedded value remains robust.
Outlook is uninspiring but dividend yields could support valuations.

3Q16 earnings were lifted by better insurance and wealth management income. NIM slipped by 2bps while loans grew 2% q-o-q (-2% y-o-y). Expenses remained well controlled.
Provisions (both general and specific provisions) were higher. One-third of specific provisions were related to the oil & gas sector.
New NPL formation eased to S$497m (2Q16: S$924m), 43% of these were from the oil & gas sector. 60% of its oil & gas NPLs are still performing, currently servicing either interest or principal or both. NPL ratio rose to 1.2%. Excluding the oil & gas sector, NPL ratio was largely stable at 0.7%. Separately, capital ratios remained strong.

Although the new NPL formation has reduced during the quarter, the peak is far from near. More negotiations are expected to emerge from the oil & gas sector, hence new NPL formation would still be prevalent.
Management hinted that NPL ratio would unlikely hit the high of 2.1% that it recorded at the peak of the Global Financial Crisis (GFC).
The SME portfolio will be closely monitored as this segment tends to be vulnerable in a prolonged soft economic environment.

Our TP is raised to S$8.60 after rolling forward the valuation base to 2017. This implies 0.9x FY17F BV and is derived from the Gordon Growth Model (11% ROE, 3% growth, 12% cost of equity). Valuations could be held up by dividend yield of 4%.
We believe the stock will likely trade range-bound until a new catalyst emerges for the Singapore banks.

Further upset in asset quality. We have assumed higher credit cost and NPL ratio in FY16F, but a more severe-than- expected deterioration in asset quality related to the oil & gas and commodity segments could pose downside risk.

LIM Sue Lin DBS Vickers | http://www.dbsvickers.com/ 2016-10-27

DBS Vickers SGX Stock Analyst Report HOLD Maintain HOLD 8.60 Up 8.400