OCBC - DBS Research 2017-02-15: Positives already in the vault

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OVERSEA-CHINESE BANKING CORP O39.SI

OCBC - Positives already in the vault

• 4Q/FY16 earnings were below expectations dragged by higher provisions; weak non-interest income trends noted.
• Worst is not over for NPLs; rate hike sentiment mostly priced in at current valuations.
• Better loan growth outlook but NIM uplift might be muted; credit costs may stay high.
• Downgrade to HOLD; TP unchanged at S$10.30.

Positive sentiments priced in; downgrade to HOLD.

• Expectations on rising interest rates have largely been priced in at current valuations. 
• While we expect NIM to improve, the extent of improvement may be curbed by competitive pressures. Positively, loan growth outlook has improved and combined with a slightly higher NIM, top-line growth should shine in 2017. 
• Credit costs may still stay high (albeit lower than FY16) but NPL issues are not over and could still pose an overhang to share price performance. 
• 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.

4Q/FY16 earnings dragged by higher provisions. 

• The weaker 4Q/FY16 results were due to four factors: 
  1. Extremely weak loan demand and the bank’s cautious stance on loan origination, 
  2. Higher provisions, which were largely related to the oil & gas segment, especially in 4Q16, 
  3. Lower contribution from insurance business, 
  4. Lower overall non-interest income (ex-insurance) largely from lower trading income arising from slower customer flows.
• Improved loan growth outlook but worst of NPLs is not over.

Loan growth is expected to be better in 2017 at mid-single-digit levels. 

• There is room for NIM uplift from rate hikes but the extent of increase could be muted due to competitive pressures which might limit widened credit spreads. 
• Credit cost may still stay high as the worst of NPLs might not be over. That said, earnings growth in 2017 should be strong, driven by topline growth, thanks to higher NIM and loan growth traction.

Valuation

• Our TP at S$10.30 implies 1.1x FY17F BV and is derived from the Gordon Growth Model (10.5% ROE, 3% growth, 9.6% cost of equity). 
• We believe that the rate hike sentiment is partially priced in while asset quality prospects still appear murky. These could limit upside to the share price performance.

Key Risks to Our View

• 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/ 2017-02-15

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