The Positives
+ The disappearance of allowances. Allowances for loans and assets declined 93% to S$12mn. It almost disappeared. Singapore operations had no provisions. The rationale given was an overprovision in the prior quarter. Recall that in 4Q17, OCBC made specific allowances of S$1bn, but managed to offset this with an S$887mn write-back. The current underwhelming credit cost is expected to rise from this quarter 2 bps to 15-20 bps in FY18e.
+ Asset quality is getting better. After the horrible spike of S$1.3bn of NPAs last quarter, no surprise that asset quality is improving. New gross NPAs was S$297mn, the lowest in twelve quarters.
+ Loans growth is healthy. Loans grew 9.7% YoY in 1Q18. Growth was driven by general commerce, trade finance and financial intermediaries (property funds) loans. Hong Kong dollar loans grew 14%, but US dollar and ringgit loans grew at 3% YoY.
The Negatives
– Trading/Investment gains fell. OCBC generated around S$240mn in trading and investment securities gains per quarter in FY17. 1Q18 saw this more than halved to S$102mn. This excludes the S$231mn investment loss in the comprehensive income from FVOCI. The mark to market weakness in equity and debt market was significant for the insurance business. Higher interest rates will result in bond portfolios losses, but this will be offset somewhat by lower life assurance contract liabilities.
– NIM was marginally softer than expected. NIM had been rising every QoQ for OCBC in FY17. However, in 1Q18, NIM was surprisingly flat, when other banks saw sequential improvement. The reason for weakness is a decline in Indonesia NIMs. There is price pressure on the middle market (SME) loan segment especially with the authorities advocating single digit lending interest rates. Hong Kong is also not capturing a much larger improvement in margins due to their weaker CASA of around 20%.
Outlook
OCBC growth may be more timid than expected. 1Q18 earnings was boosted by an unsustainably low (or non-existent) allowance. This kept us from shaving our FY18e profit estimates. Unless we enter into a more vibrant capital market, investment income will remain a drag on earnings. Upside in NIMs will be capped by Indonesia (inability to raise pricing) and Hong Kong (lack of CASA franchise).
Figure 1: 2018e Guidance vs. PSR estimates
Investment Actions
We raised our target price to S$14.90 (previously S$13.94). Nevertheless, our rating has been downgraded to ACCUMULATE due to the share price performance. The improvement in target price was due to higher terminal growth rates. Our FY18e earnings were generally unchanged.
