OCBC - DBS Research 2016-12-07: Riding high on rising rates

OVERSEA-CHINESE BANKING CORP O39.SI

OCBC - Riding high on rising rates

Upgrade to BUY, TP raised to S$10.30; earnings raised by 5-8% on higher NIM.
Rising rates also bode well for insurance business; keep watch on its wealth management space.
Loan growth to stay muted.
Asset quality to stabilise in 2017; earlier-than-expected recovery poses upside risk to earnings.

Expectations on rising interest rates from December 2016 should start to spell a new phase for higher NIM. Our FY17-18F earnings are raised by 5-8% on higher NIM expectation, bearing in mind loan growth will likely stay sluggish and funding costs stay stable. We expect credit costs to decline in FY17F as the bulk of NPL issues have been addressed.
OCBC’s key differentiating factor lies in its insurance business which gives it a more holistic wealth management platform, which we believe the market may be under-appreciating.

We expect NIM to rise by 8bps in FY17F and stabilise going into FY18F.
This will be the key driver to top line amid another expected sluggish year for loan growth. Our sensitivity analysis indicates that for every additional 25bps increase in SIBOR, OCBC’s NIM will rise by 7bps, holding other variables constant, and this would lead to a further 4% uplift to earnings.
Positively, life insurance businesses correlate positively to rising interest rates but this may be balanced off by volatile unrealised mark-to-market gains/losses along the way.

New NPL formation has reduced in 3Q16 but more negotiations are expected to emerge from the oil & gas sector, hence new NPL formation would still be prevalent for another 1-2 quarters.
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$10.30 after our earnings upgrade by 5-8% over FY17-18F on higher NIM assumptions. This implies 1.1x FY17F BV and is derived from the Gordon Growth Model (10.5% ROE, 3% growth, 9.6% cost of equity).
A new catalyst has emerged – rising rates bode well for NIM and insurance business.

Further upset in asset quality. We have assumed that the peak of NPLs would be seen in 2Q16.
Overall credit costs should decline from here but NPL ratio may stay at similar levels.
A prolonged deterioration in the oil & gas sector, coupled with additional stress from SME, could pose downside risk to earnings.

LIM Sue Lin DBS Vickers | http://www.dbsvickers.com/ 2016-12-07

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