• OCBC demonstrated heightened sensitivity to rising interest rates with NIM growing 16bp q-o-q to 1.71% in 2Q22 aided by:
  1. strong pass-through from the Fed’s rate hikes to domestic interest rates, and
  2. strengthened funding franchise with CASA ratio improving 13ppt to 60.9% over the past three years.
• This is the second consecutive quarter of excellence in execution with ROE above 10%.
• OCBC provides dividend yield of 4.7%/5.2% for 2022/2023. Maintain BUY.

OCBC's 2Q22 Results

• OCBC (SGX:O39) reported net profit of S$1,481m for 2Q22 (up 28% y-o-y and up 9% q-o-q), above our forecast of S$1,137m.
• Moderate loan growth. Loans expanded 8.4% y-o-y and 1.4% q-o-q in 2Q22 driven by Singapore (+8% y-o-y), Greater China (+8% y-o-y) and network customers expanding in OECD countries (the UK and the US) (+25% y-o-y). By industry sector, building & construction and professionals & individuals grew 17% and 14% y-o-y respectively.
• Higher CASA ratio enhances sensitivity to rising interest rates. The sizeable NIM expansion of 13bp y-o-y and 16bp q-o-q to 1.71% in 2Q22 was due to:
  1. the hike in US Fed Funds Rate having strong pass-through to domestic interest rates with SORA and three-month SIBOR rising 105bp and 112bp q-o-q respectively to 1.66% and 1.91%, and
  2. OCBC's CASA ratio improving 13ppt to 60.9% over the past three years.
• Exit NIM was 1.81% for the month of June. Management foresees NIM exceeding 1.8% by end-22. We expect Singapore to have contributed to the bulk of OCBC's NIM expansion.
• Market-sensitive sources of fees suffered steep drop. Fees and commissions were down 15% y-o-y and 9% q-o-q. Loans and trade-related fees grew 5% y-o-y. Market-sensitive sources wealth management and brokerage & fund management dropped 25% and 15% y-o-y respectively due to lacklustre market sentiment.
• Contributions from life and general insurance were resilient at S$423m, up 66% y-o-y, due to higher operating profit and mark-to-market gains (decline in insurance contract liabilities due to utilisation of a higher discount rate to value these liabilities). Net trading income was strong at S$267m supported by customer flows.
• Operating expenses increased 10.1% y-o-y in 2Q22. Staff costs increased by 10.3% y-o-y due to annual salary increments and higher headcount to support growth.
• Asset quality has improved. NPL balance dropped 8% q-o-q while NPL ratio receded 0.1ppt q-o-q to 1.3% in 2Q22. New NPL formation moderated to S$182m, lower than S$296m in 1Q22. OCBC benefitted from strong recoveries/upgrades for NPLs of S$419m due to oil & gas accounts in Singapore and repayment from customers in Malaysia and Indonesia after their loan relief programmes ended.
• Muted provisions as asset quality stays benign. Total provisions were only S$72m in 2Q22, which were 69% lower y-o-y. General provisions were S$66m with additional general provisions set aside for updates in its macroeconomic variables (MEV) model, partially offset by write-back from credit upgrades.
• OCBC has declared an interim dividend of S$0.28 per share for 1H22 (1H21: S$0.25 per share), representing a payout ratio of 44%.

Three-year Strategy Refresh

• OCBC plans to tap on four growth drivers:
  1. rising wealth in Asia through hubs in Singapore and Hong Kong,
  2. ASEAN-China trade and investment flows,
  3. new economy and high-growth industries, and
  4. transition to a sustainable low-carbon world.
• It will invest to strengthen its comprehensive regional franchise and accelerate digital transformation.

Positive Outlook for 2022

• OCBC expects growth in net interest income from rising interest rates to more than offset pressure on non-interest income. Management guided mid-single-digit loan growth for 2022. Credit costs are expected to be at the low end of the previous guidance of 20-25bp.

• Exposure to Mainland China. OCBC has exposure of S$6.8b onshore in Mainland China as of Jun 22, equivalent to 2.3% of total loans. One third of the exposure or S$2.3b (0.8% of total loans) relates to the real estate sector. They are primarily network customers from Singapore and Hong Kong who expanded into China. It has small exposure to residential mortgages for completed projects in Shanghai and the Pearl River Delta region.

• Residential mortgage portfolio remains resilient. Average total debt servicing ratio for its portfolio of residential mortgages is low at 40% based on interest rate of 3.5%. Average loan-to-value ratio is below 50%. 85% of the residential mortgages are for owner occupation.

OCBC - Earnings Forecast Revision & Recommendation

• We raised our earnings forecast OCBC by 13% for 2022 and 9% for 2023 due to the strong 2Q22 results and OCBC’s higher sensitivity to rising interest rates.
• Maintain BUY. Our target price of S$16.18 for OCBC is based on 1.3x 2023F P/B, derived from the l (ROE: 10.9%, COE: 8.5%, growth: 0.5%).

Source: UOB Kay Hian Research - 4 Aug 2022