OCBC Bank - DBS Research 2018-01-04: Good Gets Better

OCBC - DBS Vickers 2018-01-04: Good Gets Better OVERSEA-CHINESE BANKING CORP O39.SI

OCBC - Good Gets Better

  • Stronger loan growth momentum expected following strong macro key data; NIM improvement sustainable and visible.
  • Asset quality issues have clearly stabilised; impact on IFRS9 under evaluation; more details during 4Q17 results.
  • FY18-19 loan growth tweaked higher resulting in marginal adjustment to earnings.
  • Maintain BUY, TP raised to S$14.00.

Tuning an even more positive tone; reiterate BUY. 

  • OCBC’s 3Q17 results is testimony to our positive view on the bank. Apart from its sustained strong showing of its non-interest income franchise (wealth management and insurance), its banking operations are picking up well. 
  • NIM is gradually improving and such trends should hold up in 2018. Positively, loan growth is strong with YTD loan growth at 5.5% vs our FY17 forecast of 7%. Management guided for 7-8% loan growth for FY17-18. 
  • Wealth management and insurance operations are holding up well, and will remain a key differentiator of growth vs peers. 
  • Asset quality indicators have clearly stabilised; a visible recovery would stage a strong re-rating catalyst for the bank. There needs to be a further evaluation on the impact to the implementation of the IFRS9/SFRS109, pending clarity on certain aspects especially with regards to the tax treatment on general provisions. 
  • Capital enhancement measures are underway and should be made clear during the release of its FY17 results in February 2018.

Where we differ: Staying above the rest. 

  • Following the positive macro dataset released, we have further tuned up our loan growth assumption for FY18-19 to 8% (from 7%), lifting our FY18-19 earnings forecasts marginally. Sustained upward trajectory of SIBOR/SOR should re-rate NIM higher (+4-5bps). 
  • Our earnings forecasts remain above consensus. We reiterate our BUY rating and nudged up our TP to S$14.00.

Potential catalyst: The end of asset quality woes. 

  • Asset quality issues pertaining to the oil & gas segment have been dealt with, and sufficient provisions are said to have been made. There may be some tweaks necessary when IFRS9/SFRS109 is implemented.
  • More importantly, a visible improvement in asset quality contrary to stabilisation could mark a strong re-rating catalyst apart from better NIM, loan growth and non-interest income prospects.

Key Risks to Our View

  • Faltering NIM and non-interest income traction. Inability to see revenue generation from improved NIM as well as better wealth management and insurance income contribution could pose downside to our earnings forecasts.

Reiterating Positive Vibes 

Improving loan demand; loan growth guidance to 7-8%.

  • Loan growth has been strong YTD at 5.5%, driven by housing loans, trade finance, overseas loan demand and Hong Kong-based companies (from OCBC-WHB). The first three quarters of 2016 were extremely volatile and the bank took a cautious stance. Loan growth started to pick up in 4Q16, and the momentum has stayed strong till now.
  • Management has toned up loan growth guidance to 7-8% for FY17 and is expecting this trend to continue to 2018. Our loan growth forecast is tuned up closer to 8% (from 7%) for FY18-19.

NIM to gradually improve. 

  • NIM traction has been sluggish up to 3Q17 as SIBOR/SOR has finally only edged up meaningfully in recent months. The re-pricing effect takes approximately 90 days. As such, NIM uplift would be more meaningful in the coming quarters. 
  • Sustained upward trajectory of SIBOR/SOR should re-rate NIM higher by 4-5bps for FY18-19.

Implementation of IFRS9/SFRS109; impact to be evaluated; clarify during 4Q17 results. 

  • The Monetary Authority of Singapore (MAS) has released the proposed amendment to regulatory requirements pertaining to credit loss under the IFRS9/SFRS109. Singapore is the first in the region to clarify its methodology. 
  • The SFRS 109 requires banks to maintain a minimum of 1% collective impairment allowance and specific allowance will be set aside on a case-by-case basis. The Expected Credit Loss (ECL) model includes more forward-looking information to assess credit quality of the bank’s underlying financial assets. 
  • OCBC has excess general provision reserves but it has not deliberated what it will do with it at this point – either to claw it back to retained earnings or to set it aside as additional provisions prior to the implementation of this accounting standard. OCBC has never reduced general provisions to offset specific provisions. It appears that smoothening out earnings by adding or using general provision reserves will no longer be allowed. 
  • Impact to OCBC is still under evaluation as the shift of excess general provision reserves into equity may have tax implications.

Possible changes to the provision run rate will be clearer from 1Q18 trends.

  • Asset quality woes related to oil & gas has stabilised; waiting for a recovery. It feels too early to call for a recovery of the sector although early signs have been seen with chartering activities picking up. The oil & gas cycle should see a trough soon. However, capital expenditure for this sector has yet to be visible. 
  • OCBC was one of the earlier banks to start classifying NPLs from as early as 3Q15. No new names have been identified and additional provisions were mostly related to declining collateral values. The bank has not taken possession of any of the collateral and over time, cash flows are expected to improve. There could be one more account from the oil & gas sector that may be classified in 4Q17.

GEH exploring options for its Malaysian operations, as reported. 

  • Great Eastern Holdings (GEH) is reported to have engaged at least one Malaysian bank to explore selling its stake in its Malaysian operations. It has also been noted that several other foreign insurance companies operating in Malaysia (including Prudential Malaysia and Tokio Marine Insurance Malaysia) could be exploring similar options. This move is in reaction to Bank Negara Malaysia’s (BNM) stricter enforcement of the 70% foreign ownership cap on insurers, which was issued back in 2009. 
  • We understand the timeline could be fluid, and negotiations could be managed on a case-by-case basis. In our view, there are three viable options for these companies to pare down their stakes:
    1. List (IPO) 30% of their shares to the public;
    2. joint-venture with a local partner; or
    3. divest to local institutional investors. 
  • OCBC’s official stance on this is “GEH is exploring options to meet the necessary requirements”.

Valuation & Recommendation 

Maintain BUY, TP raised to S$14.00. 

  • Corresponding to our earnings upgrade, our revised TP of S$14.00 is based on the Gordon Growth Model (12% ROE, 4% growth [raised], 9.5% cost of equity) which is equivalent to 1.4x FY18 BV, its 10- year mean P/BV multiple. 
  • OCBC’s key differentiating factor lies in its insurance business which gives it a more holistic wealth management platform, which we believe is still under-appreciated by the market. 
  • Solid 3Q17 earnings was testimony to its non-interest income franchise. Asset quality issues pertaining to the oil & gas segment have been dealt with, and sufficient provisions are said to have been made. 
  • A visible improvement in asset quality contrary to stabilisation could be an added re-rating catalyst apart from better NIM, loan growth and non-interest income prospects.

Sue Lin LIM DBS Vickers | http://www.dbsvickers.com/ 2018-01-04
DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 14.00 Up 13.500