OCBC Bank - DBS Research 2018-11-02: More Catalysts Ahead


OCBC Bank - More Catalysts Ahead

  • Long-awaited NIM expansion finally here with a 5-bp increase q-o-q largely on mortgage portfolio repricing. 
  • Post scrip dividends in 2Q18, CET1 ratio of 13.6% now compares well to peers; ability to pay higher dividends removes overhang on stock price due to lower dividend yield. 
  • Non-interest income supported by higher net trading gain against lower wealth management income. 
  • Upgrade to BUY, Target Price of S$13.20 on higher ROE assumptions of c.12%. 

NIM expansion a positive catalyst, higher dividends to come?

  • OCBC’s NIM has been largely flattish in the last four quarters on slower loan repricing amid higher cost of funds. In 3Q18, OCBC started to reprice its mortgage portfolio and we expect to see the full impact in 4Q18. OCBC has also released some of the excess USD liquidity built up in 2H17 after its internal assessment.
  • Post turning on of scrip dividends in 2Q18, CET1 ratio of 13.6% now compares well to peers and we believe that OCBC has the ability to pay higher dividends. This may remove the overhang on the stock price due to its lower dividend yield compared to peers and should be viewed as a positive catalyst. OCBC currently has a dividend yield of c. 3.6% compared to its peers’ dividend yield of c. 5%.
  • As such, we upgrade our call to BUY with a Target Price of S$13.20.

Where We Differ:

  • Our earnings forecasts remain higher than consensus as we believe that OCBC will benefit from lower credit costs compared to historical levels (post the implementation of IFRS9) in the current benign environment.

Potential Catalysts:

Sustained NIM deliveries and higher dividends.

  • Further NIM expansion could further boost earnings in a rising interest rate environment. A higher dividend yield for OCBC, closer to its peers’, could be a re-rating catalyst. However, in the event that trade war escalates, it might trigger further risks to loan growth.

Key Risks to Our View:

  • Asset quality trends. Further escalation of trade war may subject some companies to vulnerability. Should asset quality turn malign, more specific provisions might be required. In the event that trade war escalates, it might trigger further risks to loan and fee growth, especially for OCBC’s Greater China exposures.

WHAT’S NEW - Yet another record quarter

Another record quarter for OCBC.

  • OCBC’s 3Q18 earnings of S$1,245m was higher by 9% q-o-q and 16% y-o-y, ahead of consensus expectations by c.8% and in-line with ours.
  • Net interest income grew 4% q-o-q and 9% y-o-y due to increasing NIM and strong loan growth.
  • Non-interest income was relatively flat q-o-q and y-o-y, led by strong net trading income (mainly treasury-related income from customer flows) against weaker wealth management and insurance income.
  • Wealth management income declined 6% q-o-q and 2% y-o-y largely led by declines in insurance income. In the meantime, private banking AUM at US$105m increased 3% q-o-q and 11% y-o-y as Bank of Singapore continued to see net new money inflows.

NIM uptick finally came through.

  • After four consecutive quarters of flattish NIM, OCBC delivered a strong 5-bp improvement q-o-q and 6-bp improvement y-o-y to 1.72%. This was largely attributed to repricing of mortgage loans in Singapore, as well as release of excess USD amassed in 2H17 in anticipation of stronger loan demand that did not materialise.
  • OCBC saw improved margins in Singapore, Malaysia and Greater China against a higher loan-to-deposit ratio (LDR). Increases in loan yields outpaced the increase in cost of deposits.

Asset quality continues to be benign.

  • Provisions were higher (lowest among peers since 1Q18) at S$49m (3Q17: S$156m; 2Q18: S$21m). Credit cost was only at 8bps (3Q17: 24bps; 2Q18: 3bps). Absolute NPLs were flattish while new NPL formation continues to normalise at c.S$300m levels. NPL ratio remained stable at 1.4%, similar to a quarter ago.
  • According to management, while the NPLs are scattered with no industry concentration, going forward, there may be concerns of general slowdown in the economy depending on developments of US-China trade tensions.
  • While the credit environment remains benign, OCBC has stepped up on its credit procedures in Indonesia and China as a prudent measure.

Broad-based loan growth.

  • Loan growth was largely broad-based at 2% q-o-q and 10% y-o-y, mainly driven by USD loans. Deposits declined marginally q-o-q but increased 7% y-o-y with CASA proportion moving to 47.5% (3Q17: 50.5%; 2Q18: 47.7%). As such, LDR continued to rise to 88.5% (2Q18: 85.9%) as loans grew faster than deposits.
  • Capital levels improved. Post turning on of scrip dividends, CET1 was higher at 13.6% (2Q18: 13.2%), while Tier-1 CAR and Total CAR were higher at 14.4% and 16.1% respectively.

Key takeaways from analyst briefing

Scrip dividend may be turned off; potential for higher dividends.

  • Post scrip dividend being turned on in 2Q18, CET1 ratio is now at 13.6% which is above the management's comfortable range of 12.5-13.5%. Management has also reaffirmed their commitment to a steady, predictable quantum of 40-50% dividend payout ratio.
  • We believe that there may be potential for higher dividends now that OCBC has shored up some capital. At 40% dividend payout ratio, it translates to c.44 Scts.

Full impact of repricing to be seen in 4Q18’s NIM.

  • According to management, of the 5-bp improvement in NIM, 1-1.5bps can be attributed to the release of excess USD amassed, while the remaining is largely due to repricing of loans. As repricing had started in 3Q18, the full impact will be seen in 4Q18 and we expect a slight uptick in NIM going forward.

Guidance into 2019.

  • OCBC continues to see loan growth at a mid-to-high single digit into FY2019 and for credit costs to normalise over time to 12-15bps. OCBC expects NIM to remain steady with a slight bias on the positive side.

Hong Kong Life Insurance updates.

  • OCBC has started rediscussing potential options as the disposal deal had lapsed and is keen to divest it. The buyer, First Origin International Limited, has forfeited the deposit of c. S$124m to the seller, OCBC Wing Hang (WHB) which we expect to be recognised in 4Q18.

Pending outcome on Great Eastern Malaysia.

  • GEH is still in discussions with authorities on the alternatives should it divest 30% of its stake in Great Eastern Malaysia. Should the divestment occur, there may be potential for a one-off dividend payment from the sale proceeds.

Valuation and Recommendation

Upgrade to BUY, Target Price of S$13.20.

  • We arrive at our Target Price of S$13.20 (12% ROE, 3% growth, 10% cost of equity) on higher ROE assumptions (previous: c. 11%), equivalent to c.1.3x FY19F P/BV, at its average 10-year forward P/BV multiple.
  • We revised our earnings marginally by -3% to -4% largely on lower non-interest income expectations going forward and our earnings still remain higher than consensus.
  • We believe that OCBC will continue to benefit from the rising rate cycle. With NIM expansion now visible and CET1 ratio at 13.6% above OCBC’s comfortable range, this may remove overhang on the stock price due to its lower dividend yield compared to peers should OCBC decide to pay higher dividends.

Sue Lin LIM DBS Group Research | https://www.dbsvickers.com/ 2018-11-02
SGX Stock Analyst Report BUY UPGRADE HOLD 13.20 UP 12.400