As at the opening bell following the announcement of its FY2021 results on the morning of Feb 23, Oversea-Chinese Banking Corp’s (OCBC) share price fell 5.8% to $12.40 compared to the previous session’s close. Although OCBC's share price recovered to end at $12.56 on Feb 23, it slumped to $12 on Feb 24, following Russia's invasion of Ukraine.
The “first look” notes from analysts indicated that OCBC’s net profit was below expectations. “OCBC reported net profit of $973 million for 4QFY2021 (down 14% y-o-y and 20% q-o-q), below our forecast of $1,122 million,” writes Jonathan Koh, an analyst at UOB Kay Hian. Elsewhere, Maybank analyst Thilan Wickramasinghe writes in his report: “While rising rates could be a boon to interest income, [OCBC’s] larger dependence on markets-linked income sources exposes it to volatility and lowers earnings visibility in the current geopolitical backdrop.” He has downgraded OCBC to a “hold” from a “buy”.
For FY2021 ended December 2021, OCBC reported a net profit of $4.86 billion, up 35% y-o-y. Excluding Great Eastern Holdings, OCBC’s banking business recorded a net profit of $3.926 billion, up 41% y-o-y. Net interest income decreased 2% from the previous year to $5.86 billion, mainly attributable to a 7 basis points (bps) fall in net interest margin (NIM), despite a 3% increase in average asset balances. This decline was offset by robust growth in non-interest income, which climbed 14% to a record $4.74 billion from $4.17 billion in FY2020. Net fee income rose 12% to a new high of $2.25 billion.
In fact, OCBC’s pre-provisioning operating profit (PPOP) was at an alltime high of $6.656 billion. On the other hand, United Overseas Bank and DBS Group Holdings recorded their highest PPOP in FY2019 and FY2020 respectively.
So, what happened?
Allowances from impaired assets — the so-called specific provisions (SP) or expected credit loss (ECL) 3 — rose q-o-q from 24 basis point (bps) to 50 bps, taking total credit costs to 41 bps even after a write-back of $70 million in 4QFY2021. This did not compare well with DBS’s credit cost in 4QFY2021 of 6 bps, and UOB’s of 12 bps. (ECL 1 and 2 are usually referred to as general provisions).
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The rise in SPs was caused by project financing delays due to supply chain disruption brought about by the pandemic. “It arose from loans to a few project financing deals that were affected by supply chain disruption in Greater China and the international market,” says Darren Tan, group CFO at OCBC.
“In the fourth quarter, we have conservatively looked at some of the project financing that we have taken over the years. Those project delays are regarding to construction. We do know that over Covid, there has been difficulty in certain projects around the world such as the shortage of manpower, or logistic arrangement that has been causing delays. We’re taking a conservative view on this delay in the projects and thus leading to putting some provisions on some of the project financing deals that we have entered into earlier on,” OCBC group CEO Helen Wong explains. These are three chunky deals and is not systemic, she emphases.
OCBC is not alone in having exposures that have turned non-performing. In the UOB results briefing, group CFO Lee Wai Fai had guided that its additional NPL of $600 million in 4QFY2021 is from a Singapore account which is fully secured. “We are confident of recovery because the value of the collateral is higher,” says Lee, indicating that the collateral is likely to be property-related.
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On the other hand, DBS had full repayments of two significant exposures, causing NPL ratio to fall from 1.5% in 3QFY2021 to 1.3% in 4QFY2021. DBS also has the highest management overlay among the three banks, of $1.5 billion, followed by UOB with $1.2 billion. Management overlays are sums over and above those that banks are required to set aside as general provisions.
When asked about management overlay updates, CFO Tan says, “In terms of allowances, regulatory loss allowance reserve (RLAR) has been reduced from $874 million to $444 million in 4QFY2021 and is … one way to look at overlay. But if you were to define the allowances in the form of ECL 1 and 2, at this point in time, in terms of overlay, it is less than $100 million that we have set aside. The reason is because we have progressively built in some of the scenario into our ECL model as well.”
OCBC’s refreshed corporate strategy
Wong took the opportunity of OCBC’s results briefing to elaborate on the banking group’s three-year refreshed corporate strategy with an emphasis on four growth pillars taking advantage of global and Asian trends. For instance intra-Asian trade is on the rise, in particular the trade and capital flows between China and Asean.
“We’re looking at four growth pillars, and another four pillars to reinforce our strengths,” Wong says. The four growth pillars are not new to OCBC’s investors. The first pillar is to strengthen the wealth hub capabilities in Singapore, Hong Kong, Dubai and London. “We want to extend our Global Wealth platform. This is across all customer segments, from Bank of Singapore to OCBC premier customers that started to run across all segments in 2021. We are accelerating the building up of relationship bankers to capture growth. And we want to deepen cooperations with financial institutions, particularly in China, and with regional banks such as Ping An bank,” Wong indicates.
The second pillar speaks to trade and investment flows between China and Asean. OCBC plans to deepen its coverage of technology, trade and logistics and supply and value chains in the China-Asean corridor. “We’ve just increased personnel in the China business office that’s in Malaysia, as an example. We continue our partnership with Bank of Ningbo,” Wong says. In addition, OCBC has built partnerships with Bank of Shanghai, China-Guangzhou Bank, China-Citic Bank, and Ping An Bank.
The third pillar is the new economy where OCBC plans to explore opportunities in rapidly evolving world of digital assets and currency. “Things that we look at actively would be tokenisation and also how we offer training for our customers in digital assets,” Wong says.
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The fourth pillar is sustainability. OCBC is ahead on sustainability targets. For instance, it plans to be carbon neutral this year, ahead of both DBS and UOB. On the sustainable finance front, OCBC’s “25 by 25” target was met well ahead of schedule — that is disbursing $25 billion of sustainable loans by 2025. Wong has set a new target of doubling its sustainable finance target to $50 billion by 2025.
On capital management, OCBC plans a sustainble growth targeting banking income and banking profits to grow more than 10% CAGR in three years. “We’re targeting loans to growth more than 10% CAGR and we will manage our liquidity accordingly. CASA (current account, savings account) has been growing satisfactorily, but we’ll manage our funding with a wide range of liquidity to support this growth. We also will tightly manage expenses in line with the revenue growth,” Wong says.
Wong says she will look at inorganic growth where the opportunity arises but that is supplementary to the main strategy.
Plenty to look forward to
“Looking at the future, I think we have to say, we expect economic recovery momentum to carry on Asia is expected to be among the fastest growth region. This would drive growth trajectory for OCBC,” Wong says.
Despite the headwinds of inflation, high energy prices and geopolitical pressures, rising interest rates could be a tailwind. “We see the potential increase in interest rates to provide a gradual interest income uplift guidance for 2022. We expect NIM to be between 1.5% to 1.55%. But with a potential upside as interest rates rise,” Wong adds. “In general, a 1% rise across the year will increase our NIM by about 18 basis points and that would translate to close to $700 million in net interest income.”
Kenneth Lai, head of global treasury at OCBC, expects interest rates will continue to go up. “After the comments from the US Federal Reserve, given the Russia-Ukraine crisis, that they wouldn’t deter from from the interest rate hikes, the question really is whether you’ll see a 25 bp hike or a 50 bp hike in March,” Lai says. The markets are pricing in about six hikes for the year, he adds.
The pace of rate hikes could also depend on the equity and bond markets, Lai points out. If the markets tank, the Fed would still hike, but perhaps not aggressively. “We believe the hikes will continue, because I think the Fed is behind the curve. Whether you’ll see six hikes this year or not, that’s the question that remains to be seen, obviously taking into account how badly the equity markets sell off,” Lai says.
Operationally, Wong has guided for mid-to-high single-digit loan growth, and credit costs of between 20 to 25 bps. Credit costs are likely to come in, in the lower part of the range, she says.
“One important thing about growing the bank to serve our customers regionally is to be able to continue to invest in how customers open accounts with us and maintain those operating accounts with us. So one emphasis is on our transaction banking capabilities, where we have been over the last year winning a lot of mandates,” Wong says.
Transaction banking is usually conducted by customers through their main accounts with the bank. It also provides the bank with CASA, which is the lowest cost of funding.
“Of course, we remain watchful for potential headwinds. And I do hope that Omicron is the final disruptive phase of this pandemic, and Covid-19 evolves into a livable and dynamic,” Wong says.
The market has not been kind to OCBC. For the record, based the closing price on Feb 23 and its NAV, the stock is trading a P/NAV of 1.1x and dividend yield of 4.46%. Should investors heed the analysts or should they take an attractive dividend yield and wait for Wong to deliver growth, a higher ROE and higher dividends given that the dividend strategy is for a 40% to 50% payout ratio? Investors will have to decide.
