OCBC Bank - DBS Research 2018-04-26: Staying Above The Rest

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OVERSEA-CHINESE BANKING CORP O39.SI

OCBC Bank - Staying Above The Rest

• NIM improvement across operations expected; credit cost should be back to pre-oil & gas era
• Strong and sustainable non-interest income trends; slight glitch in insurance contribution from new accounting rules.
• FY18-19F earnings raised by 4% each year on higher NIM and lower credit costs.
• Maintain BUY, Target Price lifted to S$15.30; a much anticipated catalyst would be higher dividends.

Staying positive; maintain BUY.

• NIM uptrend is a given in this current operating environment. Management guided for 7-8% loan growth for FY18. 
• Wealth management and insurance operations are holding up well, and will remain a key differentiator of growth vs peers. However, a change in accounting treatment for insurance income may cause a glitch in earnings. We have only assumed that insurance income contribution increases by 5% y-o-y. 
• Management did guide that credit costs should be back to pre-oil & gas levels which ranged from 15-17bps over FY10-14; OCBC started providing for its oil & gas exposure from as early as 3Q15. At this juncture, we have conservatively assumed credit cost will hover around 21-22bps over FY18-20F (previously assumed 26bps across FY18-20F).
• Further earnings upside could be possible. What remains an overhang would be the much anticipated higher dividend payout. OCBC was the only bank that did not raise dividends in FY17.

Where we differ: Staying above the rest.

• We have tuned our credit cost lower to 21-22bps; we believe this is where we could differ significantly from consensus. 
• Management indicated that credit cost would remain benign in this current operating environment and possibly reflect the pre-oil & gas crisis levels. Our earnings forecasts remain above consensus after further raising FY18-19F earnings by 4% each year largely on lower credit cost.

Potential catalyst: Sustained positive deliveries, minimal surprise in insurance income trends, higher dividends.

• Asset quality issues are a thing of the past. Lower-than-expected credit cost could further boost earnings. In the meantime, sustained positive deliveries from NIM and loan growth should support valuations. 
• We remain hopeful that the change in accounting rules would not dampen its insurance income contribution too much. A much anticipated catalyst would be higher dividends, which we think would be announced as early as its 1H18 results.

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.

WHAT’S NEW - Higher highs

Trends to watch in 1Q18.

• OCBC is expected to book an improved quarter in 1Q18. Key trends to watch include:
  1. NIM improvement across locations of its operations. Notable uplift should be seen in its Singapore operations, followed by Malaysia and Hong Kong. OCBC-WHB should see the gapping spread between its loan and deposit pricing easing and would mean its HK operational NIM should also improve. Contrary to peers, OCBC has its Indonesian operations which is doing well (expecting double-digit loan growth, stable asset quality).
  2. Strong loan growth across the region (vs deposit growth) which could drive loan-to-deposit ratio higher could further lift NIM. OCBC has guided for 7-8% loan growth in FY18F.
  3. Strong quarter for non-interest income. Expect strong treasury flows and sustained wealth management income uptrend. We understand that assets under management (AUM) should have easily surpassed US$100bn (Dec 17: US$99bn). However, there might be some volatility for its insurance income contribution. While we expect Great Eastern Holdings (GEH) to post strong 1Q18 figures, its non-operational profit (from its non-par fund profit) could be stripped out and placed under other comprehensive income, under a new accounting rule (IFRS4 for insurance companies; which is equivalent to IFRS9 for banks).
  4. Significantly lower provisions. OCBC did not guide for any credit cost range. But if we were to assume that credit cost should fall back to the pre-oil & gas crisis levels, it could well dip below 20bps (OCBC’s credit cost ranged from 15-17bps over FY10-14; OCBC started providing for its oil & gas exposure from as early as 3Q15).
  5. Slightly higher (seasonal) costs in 1Q18.

Room for higher dividend payout.

• A much anticipated catalyst would be higher dividends, which we think would be announced as early as its 1H18 results. OCBC was the only bank that did not raise dividends in FY17. 
• Although its capital ratios stack the lowest among peers currently, assuming OCBC sticks to a minimum of its 40% payout on core earnings and is comfortable with a minimum CET1 ratio of 12.5%, we believe there could be room for some dividend upside from here. 
• We have nevertheless assumed that dividend per share would increase slightly to 40 Scts (FY17: 37 Scts) for now, with a corresponding 31% payout ratio based on our FY18F earnings.

Earnings Revision:

Raising NIM, lowering credit costs.

• With a sustained SOR/SIBOR uptrend expected, we are now forecasting NIM to accelerate by 8bps in FY18F (from 6bps) and 3bps in FY19F. Our loan growth forecasts are largely in line with guidance, hence no change to that. Management indicated that credit cost should remain benign based on current operating environment. Note that OCBC does not have a habit of buffering up general provisions.
• We had previously assumed that credit cost would decline marginally to 26bps in FY18F from 27bps in FY17F. But reassessing the current operating environment, our previous assumption may be too high. We now expect credit cost to hover around 21-22bps over FY18-20F (from 26bps across FY18-20F previously).
• All in, this led us to raise our FY18-19F earnings by 4% for each year. We have introduced FY20F earnings estimates. Note that OCBC’s pre-oil & gas crisis credit cost ranged from 15-17bps over FY10-14; OCBC started providing for its oil & gas exposure from as early as 3Q15. There could be further upside to our earnings forecasts should such trends revert.

Valuation & Recommendation

Maintain BUY, Target Price raised to S$15.30. 

• With our earnings revisions, our Target Price is now raised to S$15.30. 
• OCBC is currently trading at 1.4x FY18F BV which is equivalent to the 10-year mean P/BV, already above the 10-year mean P/BV of 1.3x. 
• Our revised Target Price is equivalent to 1.5x FY18F BV, above the 10-year mean P/BV and is based on the Gordon Growth Model assuming 12.5% ROE, 9.4% cost of equity and 4% growth.

Sue Lin LIM DBS Vickers | Rui Wen LIM DBS Vickers | http://www.dbsvickers.com/ 2018-04-26

SGX Stock Analyst Report BUY Maintain BUY 15.30 Up 14.000