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Morningstar | OCBC Posts Solid 2Q Result; FVE Unchanged, and the Bank Remains Undervalued

In line with its peers, narrow-moat-rated Oversea-Chinese Banking Corporation wrapped up second-quarter earnings for the Singapore banks with a solid result. OCBC saw a 2.4% improvement in net interest income, driven by a 1% increase in loans on last quarter, in constant-currency terms. This was offset by flat net interest margin and softer fee and commission income against last quarter. The latter was expected, as capital market conditions weighted on wealth management and brokerage income. The weaker market conditions also resulted in steady assets under management at USD 126 billion as inflows offset the negative impact from mark-to-market of assets. Excluding the latter, management noted inflows were at a similar level to the previous quarter. We still assume a steady increase in assets under management underpinning fee-income growth over the medium term.

Asset quality was again a standout, supported by improved economic conditions, while the firm's nonperforming assets in the oil and gas sector were recognized last year. New nonperforming loans came in lower for another quarter, with credit cost tracking below 5 basis points. Management noted annual credit cost in a normalized environment should range between 15 and 20 basis points of total loans. OCBC’s capital position remains strong with its common equity Tier 1 ratio at 13.2%, within management's target of 12.5%-13.5%. We revise our more conservative credit cost assumption downward but also clip back our loan growth assumption over the medium term on the rising trade tension between the U.S. and China. There is no change to our fair value estimate of SGD 13.60, and we still see OCBC as undervalued. The first-half dividend of SGD 0.20 was 10% higher than last year, and our full-year dividend forecast of SGD 0.45 represents an attractive dividend yield of 3.8%.

Net interest margin was flat at 1.67% as margins in Hong Kong and Indonesia were pressured and a large proportion of loan growth was attributable to trade loans, which attracted thinner margins. However, management expects net interest margin to improve in the second half as its mortgage book is progressively repriced, and it maintained its earlier net interest margin guidance of 1.7%. Some repricing on the mortgage book happened in the second quarter, but the bank deferred an adjustment to its mortgage rate until an increase in interbank rates is sustained over the near term. For the Hong Kong and Indonesia operation, net interest margin was pressured, as the bank was unable to pass on rising funding costs to higher asset yield. We believe this was mainly attributable to the lower level of the current and savings account, or CASA, balance as a proportion of total deposits. While management noted its CASA balance in Hong Kong improved to 37%-38% from 28% at the time that OCBC acquired Wing Hang Bank, the proportion still trails larger peers in Hong Kong at more than 60%, on top of a smaller deposit base for OCBC. Excess U.S. deposits are used to fund the Hong Kong operation, as the acquisition of low-cost deposits, focusing on consumer and small to midsize enterprises, will take time.