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Morningstar | OCBC Reports Another Solid 3Q Result; Bank Remains Undervalued

Narrow-moat-rated Oversea-Chinese Banking Corp, or OCBC, posted another solid quarterly result as expected. We believe the bank remains undervalued against a fair value estimate of SGD 13.60. Annualised return on equity for the third quarter was steady at 12.6% and we assume steady increases in the medium term. This is supported by stronger economic conditions with rising U.S. interest rates. This will flow through to improve net interest margins, or NIM, for the bank. This was reflected in this result in a material increase in net interest income. We also favour the bank’s sizable wealth management operation, which will underpin fee income growth in the medium term. Assets under management were up 3% quarter on quarter to USD 105 billion. This is despite a lower mark-to-market valuation for its assets given the softer capital market conditions masking strong inflow for the quarter.

A repricing of the mortgage book provided a lift to NIM with NIM improving to 1.72% from 1.67% in the third quarter. This was in line with guidance in last quarter, where NIM in the second quarter was flat as the bank repriced its mortgage book at a slower pace. The repricing has now flowed through to deliver higher yields on the asset side. On the liabilities side, management noted a reduction in excess liquidity, particularly on U.S. dollar, which was accumulated in the second half of fiscal 2017 in anticipation of faster growth in trade. The rising trade tension will result in slower loan demand, particularly on trade finance. As such, the bank let some U.S. dollar deposits run-off, though the bank’s liquidity position on U.S. dollar remains strong with loan/deposit ratio for the currency close to 70%. Likewise, the overall liquidity position for the bank remains prudent. Group loan/deposit ratio was 88.5%, slightly higher than last quarter and mainly due to run-off in U.S. dollar deposits as mentioned above. There is no change to our view the bank, along with banks in the region, will benefit from the normalisation of U.S. interest rates in the medium term.

Contrary to our more conservative view last quarter, when we adjusted our full-year loan growth lower on concerns over rising trade tension between the U.S. and China, the bank posted another strong quarter-on-quarter loan growth of 2%. This appears to be a little early as most banks in the region continue to see strong loan demand in the second half. However, loan growth is expected to slow in fiscal 2019 and management is guiding for loan growth in the mid-to-high single-digit range. This is supported by its overseas operation and is in line with our thesis its regional exposure will continue to deliver strong growth.

While we have adjusted our credit cost assumption lower last quarter, credit cost remains extraordinarily low and continues to track below our forecast. New nonperforming assets for the quarter of SGD 338 million are tracking in line with previous quarters. Most banks in the region reported similar low level of new nonperforming assets this quarter and credit quality remains strong. Management noted in a normalised business environment, credit cost should track between 12 to 15 basis points on total loans. Our assumption conservatively factored in a higher level in the medium term. The bank remains well capitalised with common equity Tier 1 ratio rising 40 basis points to 13.6%.