• Strong MTM and trading income in 1Q19 unlikely to be sustainable.
• Remain cautious on non-performing assets (NPA) coverage.
• Dividend policy and near-term execution risks likely to continue to weigh on OCBC's share price.
• Downgrade to HOLD, Target Price S$11.50.

Dividend Policy Continues to Weigh on Share Price

• We downgrade OVERSEA-CHINESE BANKING CORP (OCBC, SGX:O39) to HOLD, and cut our Target Price to S$11.50. We remain cautious over OCBC’s non-performing assets (NPA) coverage which at 78% remains the lowest amongst its peers, even after additional provisions written in 1Q19.
• Even as OCBC is likely to see modest NIM expansion in 2Q19, we are less hopeful that MTM gains and strong net trading income seen in 1Q19 can be sustained. Though OCBC now has the highest CET1 ratio among peers (1Q19: 14.2%) post turning on its scrip dividends, its dividend payout ratio continue to lagged peers.
• We are of the view that OCBC’s dividend policy will continue to weigh on near-term OCBC share price performance as management has maintained the need for strong capital levels amid volatile markets as well as for opportunities in the Greater Bay Area which contributed 19% to OCBC’s profit before tax.

Where We Differ

• Our earnings forecasts are below consensus as we believe market volatility will continue to weigh on non-interest income.

Potential Catalysts

• Higher dividends. OCBC currently trades at 11SD below its average 10-year forward dividend payout ratio for OCBC, closer to its peers’ 50%, could be a re-rating catalyst. See OCBC's dividend history.

Valuation

• Downgrade to HOLD, Target Price cut to S$11.50. We see limited catalysts for the stock in the near-term.
• We arrive at our revised S$11.50 Target Price based on the Gordon Growth Model, as we update our cost of equity assumptions (to 11% from 10% arising from a higher beta). This is equivalent to 1.1x FY20F P/BV, which is below its average 10-year forward P/BV multiple.

Key Risks to Our View

• Asset quality trends. Further escalation of trade war may subject some companies to vulnerability. Should asset quality deteriorate, more provisions might be required. In the event the trade war escalates, it might trigger further risks to loan and fee growth, especially for OCBC’s Greater China exposure.

Critical Data Points to Watch

Keep watch on NIM uplift.

• In 3Q18, OCBC showed its first significant more expensive deposits across most regions. OCBC’s loan profile is largely earnings downside risks into FY20F.

Expect loan growth to moderate.

• Net profit is less sensitive to changes in loan growth: our sensitivity analysis shows that every 1- ppt rise in loan growth leads to 1% increase in net profit.

• OCBC differentiates itself from peers business. The bank's insurance business via 87.75%-owned subsidiary, GREAT EASTERN HOLDINGS (SGX:G07), remains a dominant product manufacturing in-house.
• Great Eastern Holdings tends to exhibit new business embedded values. These metrics have been growing robustly for Great Eastern Holdings.
• Since the acquisition of Bank of Singapore in 2010, its wealth management income has been added US$13bn to OCBC's AUM. In May 2017, OCBC further acquired National Bank of Australia’s Singapore and Hong Kong.

Source: DBS Research - 24 Jun 2019