Published October 29, 2009

COMMENTARY
Results bring cheer, but caution is in order

Three items mask flat net interest income for the third quarter

By CONRAD TAN
REPORTER
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IS THE worst over for Singapore banks? OCBC Bank's forecast-beating third-quarter results yesterday certainly raised hopes that banks here have turned the corner and are poised for a robust recovery.

But a closer look at the main drivers of its earnings suggests that caution is still in order.

OCBC's net profit of $450 million beat analysts' expectations by an unusually wide margin, even though the group suffered a $154 million hit - after tax and minority interests - to its bottom line from the redemption of GreatLink Choice structured investment products by insurance subsidiary Great Eastern Holdings.

Analysts surveyed by Reuters had forecast an average of $278 million in Q3 net profit for OCBC, while those polled by Bloomberg had expected $244 million.

Its outperformance appears to have been mainly due to two factors: lower provisions for bad loans and other assets than analysts had feared; and higher-than-expected trading and investment gains. On closer examination, both factors are a direct consequence of the recent recovery in financial markets.

Overall, OCBC's results provided some much-needed cheer to investors watching the Q3 earnings season.

The first was due mostly to a sharp fall in allowances for assets other than loans, mainly investment securities, to just $4 million for the third quarter, from $57 million for the second quarter, OCBC said. As a result, net allowances for loans and other assets fell by half to $52 million, from $104 million for Q2.

The second factor - higher-than-expected income from trading and gains from investment activities - is particularly interesting.

Just three items - profit from life assurance, net trading income and gains from investment securities - accounted for 86 per cent of OCBC's non-interest income for the third quarter, compared to 42 per cent in the previous quarter and 39 per cent a year earlier. And even if its non-interest income had not been reduced by $213 million due to the GreatLink Choice redemption, the same three items would have made up 56 per cent of the group's total non-interest income for the third quarter - still much higher than in the earlier periods.

The surge in profit from life assurance - to $209 million for Q3, from $125 million for Q2 - was due mainly to an increase in profit from Great Eastern's non-participating fund, which was in turn due to the recovery of the equity and bond markets.

Put simply, OCBC's latest results appear to have received a large boost from the recent rebound in equity and bond markets that both reduced its charges for asset impairment and swelled its income.

There is nothing wrong with that - the bank and its subsidiary, Great Eastern, deserve credit for taking advantage of the recovery in financial markets. But it does mean that a big chunk of OCBC's third-quarter income - the three non-interest income items made up 31 per cent of the group's total income for the period - came from sources that are inherently volatile and beyond its immediate control.

A look at the performance of its core lending business also suggests that the lending environment for Singapore banks remains difficult. Net interest income, which accounted for 59 per cent of OCBC's total income for the first nine months of the year, fell 3 per cent to $689 million for Q3, compared to $710 million for the previous quarter, as both its net interest margin and loan book shrank.

The bank's net interest margin - a measure of how profitable its lending activities are - is likely to remain under pressure from low interest rates and renewed competition from its rivals as consumer and business sentiment here improves. Encouragingly, however, the bank said that its average loan spreads were higher for the third quarter, compared to both the previous quarter and a year earlier.

The proportion of non-performing loans (NPLs) held by the bank also fell, to 1.8 per cent at the end of September, from 2.1 per cent at end-June - a pleasant surprise.

That is highly encouraging - but it is too soon to conclude that NPLs reached their peak in the second quarter. Whether that is indeed the case depends heavily on the strength of the economic recovery in the bank's core markets in Singapore and the rest of Asean, which in turn hinges on the recovery of major economies elsewhere.

Overall, OCBC's results provided much-needed cheer to investors watching the third-quarter earnings season in Singapore. But it will need another quarter or two of strong results - backed by improvements in its core lending business - to convince investors that it is well and truly back on the earnings growth path.