After the Fed ended its Federal Open Market Committee (ROMC) on Wednesday night, most Asian markets ended in the red. The STI was no exception and dipped 2.5% for the day. Locally, financials led the decline and all three local banks were among the top five laggards for the day. DBS (-3.2%, $15.60), OCBC (-2.8%, $10.04) and UOB (-2.8%, $19.77).
 
MER downgraded OCBC on 20 May, giving the bank an ‘underperform’ rating with a 12-month price target of $9.82. Shortly after, MER released another report on 13 Jun, some excerpts are shown below. 

Event
The sharp rise in 10-year Singapore Government Bond (SGB) yields in the past few days and the fall in Singapore equities could negatively impact OCBC’s 2Q13 results due to the mark-to-market impact of unrealized losses on the income statement of its insurance subsidiary, Great Eastern (GE SP).

Impact
Along with the stock market sell-off, 10-year SGB yields have spiked in recent days, climbing 40bp WoW to reach 2.19% on June 12. This amounts to a 65bp increase since 1Q13. In MER’s view, this could point toward a relatively weak 2Q13 for OCBC’s profitability.

Discussions with the Singapore bankers indicate that they had already shifted to low duration securities, in which case MER would see the steeper yield curve as marginally positive for future bank earnings. MER sees it as “marginally positive” because of the prevalent use of short-term rates to benchmark loan pricing. And short term rates, e.g. 3-month SIBOR, have hardly budged.

But OCBC is not just a bank. Insurance assets are 18% of OCBC Group assets as of 1Q13, which in MER’s view makes OCBC most exposed to the spiking SGB yields, and also higher US Treasury yields and lower equities pricing. The fact that the Malaysian bond yields have not moved (and stock prices remain reasonably robust) is somewhat a mitigation but the 2Q13 earnings number could still be weaker than recent comps.

MER’s action and recommendation
Lest MER is accused of extreme short-termism, they should note that day-to-day interest rate and stock market fluctuations do not change MER’s fundamental view on OCBC’s valuation. But they may have an impact on short-term profitability due to the mark-to-market impact on GE’s investment portfolio. Thus, MER thinks the shares could continue to be sold down if interest rates continue to spike in June ahead of 2Q13 results, to be released in July.

On 12 Jun 9.04am, OCBC was trading at $10.07 which is close to MER’s target price at 1.4x 2013E P/BV, which is based on the median of six valuation methodologies and implies 11.3% long-term sustainable ROE. MER thinks this is fair value for the business but MER’s sense is that investors may get an opportunity for better value in the weeks ahead.

Source: Macquarie Research - 21 Jun 2013