• OCBC's FY19-21F EPS raised by 2-4% on higher NIMs, driven by repricing and stronger trading income. FY19F credit cost raised to 20bp for OSV NPLs.
• FY19F NIM expansion could outperform OCBC’s “less than FY18’s 5bp” guidance if interest rates hold steady at current levels in 2H19.
• Maintain HOLD with a higher GGM-based Target Price of S$12.59.
• OCBC trades at 1.2x CY19 P/BV, below 1.4x long-term mean. 40-50% dividend payout unchanged.

Non-II Held Up by Strong Trading Income, But May be Unsustainable

• The rebound in OVERSEA-CHINESE BANKING CORP (OCBC, SGX:O39)’s trading income from a low of S$9m in 4Q18 to an all-time high of S$285m was due to strong investment and MTM gains at GREAT EASTERN HLDGS LTD (SGX:G07).
• Coupled with better wealth management fees (+16% q-o-q/-7% y-o-y), PPOP was boosted by 24% q-o-q/22% y-o-y in 1Q19. Other non-II was 4% weaker q-o-q (+1% y-o-y).
• Although making up for the weak +0.9% q-o-q (+8.4% y-o-y) showing in NII (due to an accounting method for a 90 day count in 1Q19 vs. 93 in 4Q18), we think that these market-related income lines could be unsustainable and may moderate over the upcoming quarters.

NIM +4bp Q-o-q to 1.76%; 5-6bp Expansion in FY19 Possible

• The +4bp q-o-q NIM expansion was a lagged result of OCBC’s stance of waiting for more stable interest rates before repricing its mortgage book. Loan yields rose +15bp in 1Q19, nimbly offsetting the +8bp increase in deposit costs as its fixed deposit base shrank 0.2% q-o-q.
• With its repricing exercise extending into Mar/Apr 2019 and 70% of its mortgage book being pegged to prime and board rates, we expect continued NIM expansion to come through in 2Q19. Management views the higher asset yields to be sustainable, and that a 5-6bp expansion in FY19 could be possible if rates remain at least at these levels in 2H19.
• We revise our NIM expectations by +5bp to 1.75% in FY19 (from 1.72%).

38bp Credit Cost on Write-down of OSVs; We Forecast 20bp in FY19

• About 70% of specific provisions in 1Q19 (or S$162m) were attributable to a further write-down of OSV-related NPLs. Unemployed vessels have been written-down to about 6% (3% if mobilisation costs included) while a 45-55% haircut had been applied on the current market value of OSVs pending/under employment. There has been no new NPA formation from the oil-and-gas sector and OCBC does not expect further provisions on this portfolio.
• That said, we revise our FY19 credit cost estimate upwards to 20bp (from 15bp) to incorporate this. Asset quality stayed benign – the rise in Indonesian NPLs were due to a shift of an OSV NPL in Vietnam to Indonesia, which is still pending employment.

40-50% FY19 Dividend Payout Guidance Maintained; M&A Possible

• Strong capital accretion alongside a scrip dividend scheme places OCBC’s CET-1 ratio at 14.2% – the highest amongst peers in 1Q19. Management keeps its 40-50% dividend payout guidance for FY19 as it guards against market volatility or more likely, for a potential M&A if the opportunity arises, possibly in the Greater China region.
• Downside risks include a Fed rate cut and further escalation of US-China trade tensions.

Mortgage Growth Could Pick Up in 3Q19

• OCBC’s +0.3% q-o-q loan growth was the weakest amongst peers. It maintained its guidance for FY19 loan growth at low-to mid-single digits. Notably, almost all the growth came mainly from Singapore and Indonesia. Loans in Malaysia and Greater China contracted for the second consecutive quarter.
• As with the industry trend, OCBC’s mortgage book contracted further by 2% q-o-q in 1Q19. OCBC’s mortgage book had started to contract since 3Q18 as pricing in this segment became exceedingly competitive. The bank has since come back into the market, although its effects on its balance sheet may only show up in 3Q19.

Higher Stage 1 ECLs Due to Riskier Macroeconomic Outlook

• Contrary to past quarters of write-backs, the bank also set aside S$20m in impairment provisions for non-impaired loans. This was due to the riskier macroeconomic outlook, which serves as one of the input into the expected credit loss (ECL) model. For the same reason, OCBC’s RWAs rose to S$204bn despite the weak credit growth in 1Q19; this figure was largely unchanged at S$199bn-200bn in FY18.

Source: CGS-CIMB Research - 11 May 2019