OCBC fell 0.9% from its 52-weeks high yesterday to close at $10.49. In Macquarie Equities Research (MER) report published last Tuesday (27th January), OCBC is MER’s least preferred pick as compared to the other two local banks. MER maintained its ‘Neutral” recommendation with a 12-month price target of $10 on OCBC, read on for more excerpts…..
 
Event
MER believes the commodity finance exposure of OCBC accounts for 9% of total loans. OCBC provides hardly any disclosure on its commodity finance exposure. Based on MER’s stress test, MER believes that S$1.4bn of commodity related losses are possible.
 
Impact
Quantifying the commodity finance exposure – OCBC has commodity finance exposure of S$22bn (incl off balance sheet and derivatives), which is about 1.0x of tangible book value based on MER’s estimates.
 
Stressing the commodity finance exposure – Based on MER’s assumptions of (i) 10% defaults in the commodity finance related exposure and 60% specific impairments and (ii) S$89m revenue losses on these defaults, MER estimates S$1.4bn total pre-tax losses in its stress test. This compares to 28% of MER’s pre-tax profit estimate for 2015E.
 
Lower probability of stress test losses occurring – In MER’s valuation, MER discounts for a 50% probability that these losses will occur. OCBC provides very little transparency on its commodity finance exposure but part of it likely relates to trade finance MER believes.
 
Earnings and target price revision
No change in EPS estimates. Yesterday, MER adjusted its cost of equity estimate by assuming a disposal of Orchard Gateway which will lower the capital shortfall. MER slightly increased its Target Price to S$10.00 from S$9.50.
 
Price catalyst
12-month price target: S$10.00 based on a Price to Book methodology.
 
Catalyst: delivery on merger synergies, capital, property disposals
 
MER’s action and recommendation
MER maintained its Neutral recommendation with a Target Price of S$10.00.
 
MER remains guarded on the value realization from the Wing Hang Bank (WHB) acquisition. Revenue based synergies are unlikely to come through and integration and restructuring costs over the next 12 months will likely be a headwind.
 
MER is not yet concerned about significant asset quality deterioration, but MER notes OCBC has the lowest loan loss provisioning ratio among the Singapore banks. Credit cost should rise from here as loan loss provisions normalise.
 
Earnings per share (EPS) growth will be weak at 4%-5% because of scrip dividends to lift currently low capital ratios of 10.6% MER believes. MER thinks a minimum of 12% fully loaded Common Equity Tier 1 (CET 1) ratio is necessary for the Singapore banks which suggests a capital shortfall above S$1bn for OCBC (2015E). This could be addressed with the disposal of Orchard Gateway MER believes.
 
OCBC remains MER’s least preferred pick among the Singapore banks.

Source: Macquarie Research - 6 Feb 2015