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Morningstar | OCBC Investor Day Highlights Progress on Its Digital Strategy; Valuation Remains Attractive

OCBC’s investor day highlighted the progress of the bank’s digital strategy and prospects going forward. The generally positive economic conditions underpinning income growth over the medium term allow the bank to maintain a consistent level of technology investments, in our view. Management expects the benefit to progressively flow through by 2023, targeting a cost/income ratio of 40% from the current level in the mid-40s. Similar to its peers, income is already benefiting from previous investments as revenue from digital customers exceeds that from traditional customers. This applies to both the consumer and small and midsize enterprise segments, with the proportion of customers increasing materially over the past four years. Management noted that technology should allow the bank to reach a new customer base that it had not previously considered, leading to higher income and contributing to a decline in cost/income ratio. We have factored in a steady decline in the cost/income ratio in our explicit forecast period.

Our fair value estimate of SGD 13.60 is unchanged, and we still see the bank as undervalued after a pullback in equity markets in recent months. We still prefer OCBC between the three Singapore banks, as it trades at the largest discount to our fair value estimate. While the bank’s lower-than-peer capital position did not see a special dividend, its underlying fundamentals remain strong. This is reflected in our narrow economic moat rating, as we still believe the bank benefits from competitive advantage in cost advantage and switching costs. We believe these advantages can be strengthened by its technological investments with a higher takeup of multiple products enhancing switching costs for clients, and maintaining the bank’s market share in low-cost deposits.

The application of technology will need to be complemented by a change in the bank’s culture to one similar to those at technology companies, where risk-taking is encouraged. While branch headcount has declined by 15%, employees will be retrained for more value-added responsibilities and branches will be redesigned. On its branch network, management noted that Malaysia is the only location where the bank is expected to increase its branches. The 330 branches in the country currently are limited to the four major cities in the country. Employee expense for the three Singapore banks saw an annualised 5%-8% increase in the first half, driven by both increased headcount and higher salary per employee. In our recent meetings, the banks have noted that the headcount increase is attributable to the technology segment, which also attracts higher salaries.

The development of applications internally will depend on the functionality and capabilities within the bank. An internal human resources application took eight weeks to create, while the bank is trialling an off-the-shelf application to detect anti-money-laundering, or AML, activities based on a cluster of information, rather than set parameters. The bank also has a long incubator program, Open Vault, which works with early-stage financial technology firms to help them scale up. Exclusivity for the applications is only limited to certain geographies and time-to-market. The temporary exclusivity is to not constrain the startups.

Other applications showcased include an artificial-intelligence-based chatbot "Emma" for home loan enquiries. Machine learning is also being applied for improvements and broadening of other tasks. Other AI-based technology includes the AML solution above, and management expects the benefits from AI technology to come through after five years. Biometrics in facial recognition is also being tested at a branch. For small to midsize enterprises, the bank has created a dashboard containing information from the client’s third-party software, such as accounting software Quicken. This provides visual on inventory levels, receivables, and working capital, as examples.

The bank’s payment platform PayAnyone competes with DBS’s PayLah and UOB’s Mighty. All three are built on top of Singapore’s electronic transfer system Network for Electronic Transfer. NETS was established in 1985 by several banks and handles card services, electronic payment, and cheque processes. Certain limitations and constraints from the above apps, such as funding of wallets on PayLah for transfer to non-DBS customers, and transfer limited to interbank customers on PayAnyone, have seen all banks participating in a common platform in PayNow. While payment platforms generally do not make money, the value is in the customer data. The latter is also key to the bank forming partnerships with narrow-moat-rated Starhub, the second-largest telco in Singapore.

OCBC will not explore entry into a new geography with a virtual bank. Management’s strategy is not to be a transactional bank, and it remains firm in operating in geographies where it can provide a full suite of products in commercial banking, wealth management, and insurance. This is different from its peer DBS Group, which is operating a virtual bank in India and Indonesia. UOB announced its virtual bank strategy at the last result.