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Morningstar | OCBC and UOB Post Weaker 4Q Result, in Line with Global Peers

In line with banks in the region and globally, narrow-moat-rated Oversea-Chinese Banking Corp, or OCBC, and United Overseas Bank, or UOB, reported weaker fourth-quarter results, mainly driven by lower trading income and weaker fee and commission income. The lower fee and commission income were attributable to the wealth management division as investors stayed on the side lines in the quarter while loan-related fees also declined. Net profit for UOB fell 12% quarter on quarter while mark-to-market losses for OCBC’s insurance business saw a greater decline at 26%. Nevertheless, both banks posted solid gains for the full year with OCBC’s net profit up 11% for the full year to SGD 4.49 billion and UOB up 18% to SGD 4 billion. We believe the adverse capital market conditions in the fourth quarter were largely a one-off which impacted the more cyclical income lines in trading. Trading conditions have improved in early 2019 with capital markets bouncing back from the dismal performance at the end of last year. OCBC’s mark to market losses were also accounting-related as the losses are unrealised. The underlying performance for the banks remained strong with net interest income higher, underpinned by stronger loan growth and improving net interest margin.

Management of both banks were generally positive on the outlook for 2019. Loan growth is expected to grow at low- to mid-single digits with small increments to net interest margins, or at least steady. Our fair values for OCBC and UOB are unchanged at SGD 13.60 and SGD 30, respectively. With OCBC’s share price trading at a 16% discount to our fair value, we continue to see value in the bank and like the bank’s sizable wealth management operation. The wealth management division secured USD 10 billion net new money in 2019. Assets under management were up USD 4 billion to SGD 125 billion with the difference attributable to the mark-to-market of valuation.

OCBC accumulated a large deposit at the end of the year, which management noted weighed on net interest margin. Average deposits increased 8.8% increase quarter on quarter with the loan to deposit ratio declining by 210 basis points to 86.4%. Net interest margin will improve as the deposits are redeployed to higher yielding assets in the coming year. Repricing of its loan book, particularly in mortgages, will support a net interest margin increase. As noted in previous quarters, management did not reprice its mortgage book as aggressively and decided to moderate increases over time. Management guided net interest margin to increase but the magnitude will be lower than the 5 basis point seen in 2018. Our forecast assumes slight increases over the next two years and steady margins thereafter.

Common equity Tier 1 ratio of 14% continues to track above guidance of a range of 12.5% to 13.5%. Management cited prudence given the uncertainty in economic conditions and current stage of the business cycle. The final dividend of SGD 0.23 takes full year dividend to SGD 0.43 and represents a dividend payout ratio of 40%. This remains below peer UOB’s 50% payout and DBS’s 55%. While the lower payout is a negative relative to peers, OCBC’s conservatism in holding excess capital is in line with the bank’s historic norms.

Non-performing assets climbed to 1.49% of total loans from 1.38% last quarter. This was again attributable to the oil and gas sector as collateral backing the non-performing loans were valued lower. Despite a recovery in oil price last year, a low level of new investments in the sector saw charter rates remaining subdued. While this was a slight surprise, the overall magnitude of the increase was small and the asset quality for the underlying loan book remains strong. Credit cost for the full year was low at 11 basis points and we continue to assume this to normalise in the medium term as economic conditions slow. Our assumption forecasts steady increase with average credit cost of 15 basis points, at the high end of long-term guidance of 12 to 15 basis points on a normalised basis.

For UOB, net interest margin was largely steady at 1.8%. The loan to deposit ratio was higher at 88.2% compared with 85.7% as the bank was slower in accumulating deposits. However, the bank has competed more aggressively for deposits in January. Management noted net interest margin is likely to be flat with slight upside, largely attributable to higher pricing for its mortgage book. We also assume slight increase in net interest margin for UOB over the next two years.

Similar to peers, the level of non-performing loans was benign with non-performing loans declining to 1.5% of total loans from 1.6% last quarter. There was a slight increase in new non-performing assets in the fourth quarter at SGD 609 million, compared with sub SGD 500 million the last three quarters. The increase in non-performing assets were specific with management not seeing a deterioration in asset quality for the overall loan portfolio. Credit cost is expected to climb slightly in 2019 to a range between 20 to 25 basis points of total loans. We assume steady increases toward long term guidance of 28 basis points over our medium term forecast. The bank’s balance sheet remains strong with Common Equity Tier 1 ratio at 13.9%.

The bank’s digital bank strategy is proceeding with a soft launch already in place, and a full launch is expected in March. The first market targeted is Thailand given its existing footprint in the country and management is seeking to compliment the digital strategy with its existing branches. As previously noted, services offered on the platform will include some basic financial products, such as unsecured lending of small denomination and tenure.