OCBC - DBS Research 2018-05-08: All Eyes On NIM And Capital

OCBC - DBS Vickers 2018-05-08: All Eyes On Nim And Capital OVERSEA-CHINESE BANKING CORP SGX: O39

OCBC - All Eyes On NIM And Capital

  • Flat NIM and softer non-interest income dented q-o-q earnings; lowest credit cost level in five years,
  • Guiding for better NIM; potentially higher than guided 7- 8% loan growth for FY18F, credit costs to stay low at 15-20bps in this benign asset quality environment,
  • Non-interest income to be less volatile going forward following change in accounting policy; dent seen in 1Q18 due to restatement and reclassification,
  • Maintain BUY; Target Price at S$15.30; unlikely to see much higher dividends ahead given relatively lower capital levels vs peers.

What’s New

Flat NIM and softer non-interest income dented q-o-q earnings.

  • OCBC’s 1Q18 earnings of S$1,112m was higher by 6.5% q-o-q, 31.4% y-o-y, but it was below expectations (ours and consensus). 
  • Key disappointments were in NIM and non-interest income.

Flattish top-line growth.

  • NIM was flat q-o-q but up 6bps y-o- y, weakest trend noted among peers. While we saw loan yields price up along with higher interest rates, funding costs caught up at a quicker pace. 
  • Positively, loan growth was strong at 4% q-o-q, 10% y-o-y mainly from housing loans, loans to financial institutions, investment and holding companies and general commerce. 
  • Deposits were higher by 2% q-o-q, 9% y-o-y but CASA proportion declined to 47% (1Q17: 50%; 4Q17: 49%), largely due to a corporate account shifting out funds into investments.

Better market-related fee income offset by lower trading income and gain from investment securities.

  • Non-interest income was led mainly by better wealth management, fund management and brokerage income. Bank of Singapore’s (BOS) assets under management (AUM) rose to US$102bn (4Q17: US$99bn). 
  • Despite a change in accounting regulations for insurance operations (Great Eastern Holdings, GEH), we note an increase q-o-q and a more pronounced increase y-o-y after restatement. New business embedded value (NBEV) margin increased due to focus towards regular premium products but this was at the expense of total weighted net sales and NBEV growth. However, non-interest income was dampened by lower trading income from lower non-customer flows (GEH-related) and significantly lower gains from sale of investment securities.

Expenses in check.

  • Expenses were 4% lower q-o-q but 6% higher y-o-y; similar trends to peers. But because of a softer growth in overall revenue line, cost-to-income ratio rose to 44% from 41% q-o-q (still within 40-45% guidance).

Provisions were significantly lower (lowest among peers) at only S$12m (1Q17: S$178m; 4Q17: S$168m).

  • Credit cost was at only 4bps (1Q17: 27bps; 4Q17: 28bps), lowest noted since 1Q13. Absolute NPLs were flattish while new NPL formation normalised to below S$300m. 
  • NPL ratio eased to 1.4% from 1.5% a quarter ago.

Lowest capital levels among peers.

  • Capital levels were lower due to a redemption of US$1bn subordinated notes. CET1 was lower at 13.1% while Tier-1 CAR was flat at 14.2%. Total CAR was lower at 15.8%. Although these ratios were above regulatory requirements, they stack at the lowest among peers. 
  • No dividends were declared in 1Q18.

Key takeaways from the analyst briefing

Clarification on GEH’s accounting rule change.

  • The introduction of SFRS(I)9 changes the way insurance income contribution feeds into OCBC’s income statement. GEH chose to classify 70% of its investment instruments into the category fair value to other comprehensive income (FVOCI) for which, movements in valuation in this portfolio will be booked in reserves, while another 30% of investments are classified as fair value to profit and loss (FVTPL), which as it states, movements in valuations (mark-to-market) will be seen in the profit & loss account. 
  • GEH’s investments are 64% bonds, with the remaining portion in equities. And within its equity portfolio, 30% is classified as FVTPL. Going forward, there should be less volatility with respect to the insurance income contribution line, as noises from the non- par profits have been removed. 
  • What remains a little volatile would be the mark-to-market movement of its equity investments which are classified as FVTPL.

Great Eastern Malaysia divestment still pending decision.

  • Discussion to divest 30% of Great Eastern Malaysia to meet regulatory requirements is still ongoing. Options available are via an IPO (listing) or a private placement (to a Malaysian fund, likely government related). Management is still currently weighing options to see which is best for shareholders. It is unlikely to be completed by June 2018 as initially expected. 
  • As long as OCBC is seen to be making progress to meet the regulatory requirement, it is acceptable by the Malaysian Central Bank, Bank Negara Malaysia.

No hope for much higher dividends given lack of excess capital.

  • OCBC’s capital ratios stack the lowest among peers currently, and management said that while they would be comfortable with a CET1 above 12.5%, they mentioned that optimally, a 12.5-13.5% level would be preferred. This rules out any possible chance of a much higher dividend, as seen in peers, in the near term. The scrip dividend might be reinstated should the need for more capital arise. 
  • Should loan growth be stronger than high single digit as guided, CET1 may dip below 13.1% by year-end. OCBC-WHB’s adoption of the internal ratings based (IRB) rating approach for its capital computation will only be done by end-FY19.

NIM should rise sequentially, possible higher loan growth.

  • Although one of the key upsets was a flat NIM q-o-q, it was explained that this was due to lower loan yields and higher funding costs from its Indonesian operations, higher funding costs from long-term funds raised with foreign currencies, more switches into fixed deposits from CASA, as well as lower yields from trade loans (but this was compensated by higher fees). That said, the repricing effect from rising rates should still see NIM on an increasing trend going forward. 
  • The re-pricing period for loans is estimated to average at three months. We have forecasted NIM to rise by 9bps. NIM uplift will likely arise from its Singapore operations and gradually its Hong Kong operations (as the 1-month (loan pricing) and 3-month (deposit pricing) HIBOR gap narrows), but stresses will likely continue to be seen in Indonesia.
  • Separately, the 4% q-o-q loan growth was unusually strong, stemming from trade loans, construction, leveraged loans from BOS products as well as OCBC-WHB. While it continues to guide for high single-digit loan growth, possibility of a sustained strong growth in trade loans (but at the expense of NIM), could pose upside risk.

Credit costs will be lower than oil & gas crisis levels.

  • The 4- bp credit cost level recorded in 1Q18 would unlikely be repeated. There were soft hints guiding credit cost to be 15- 20bps (we have forecasted 21-22bps over FY128-20F).
  • Regardless, credit costs going forward will almost certainly be lower than levels during the oil & gas crisis which were at 23-33bps. NPLs from the oil & gas sector declined, but expectations of recoveries are still not noticeable.

Valuation and recommendation

Maintain BUY, Target Price at S$15.30.

  • Our Target Price is maintained at 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 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.

Key risks lie in

  1. inability to deliver NIM expansion,
  2. volatility in trading income and insurance income,
  3. inability to contain credit costs at these low levels,
  4. insufficient capital which may require OCBC to resort back to scrip dividends.
  • That said, with our assumption on credit costs higher than guided, a lower-than-expected credit cost could buffer adjustments of the risks highlighted above.

Sue Lin LIM DBS Vickers | Rui Wen LIM DBS Vickers | https://www.dbsvickers.com/ 2018-05-08
SGX Stock Analyst Report BUY Maintain BUY 15.300 Same 15.300