OCBC – 2Q11 results (POEMS)

HOLD (Maintained)

Closing Price SGD 9.69

Target Price SGD 10.00 (+3.2%)

▪ 1H11 core net profit of S$1.17 billion and revenue of S$2.8 billion met 50% and 47% of our full year forecasts respectively.

▪ OCBC reported 2Q11 NPAT of S$577 million (-13% q-q; +15% y-y). Revenue of $1.41 billion was flat q-q but gained 14% y-y; Results were below expectations.

▪ 27% y-y loans growth resulted in 15% y-y increase in NII. NIMs however fell by 3 bps q-q and by 9 bps y-y to 1.87%.

▪ Expense ratio increased in 2Q11 to 44% and LDR jumped to 89%. ROE and ROA saw quarterly decline to 11.4% and 1.14% respectively.

▪ OCBC announced interim dividend of $0.15, 1 cent below our estimate.

▪ At 1.65x PB, 15x PE and with DY of 3%, OCBC is fairly valued in our opinion. NPAT missed estimates by 3% still we maintain our Hold recommendation and fair value of S$10.00.

The positives:

a. Loans growth was spectacular and resulted in increase in net interest income. NII grew

15% y-y; 5.5% q-q to $827 million, ahead of our expectations by 2%. In FY10, rapidly falling NIMs eroded the positive impact from stellar loan growth. For 2011, flattening of NIMs coupled with continued strong loans growth enable NII to grow. The significant increase in NII for FY11 is somewhat a prelude to the potential explosive growth we can expect when yield curve steepens and NIMs finally begin to edge up.

b. Gross loans grew 27% y-y; 9% q-q to $121 billion. Growth was broad based with large increases to commerce, housing, non bank FI and investment holding companies.

c. Improvement in group’s credit quality saw NPL fall from 0.9% to 0.8% in 2Q11 but we see pockets of weaknesses.

d. Wealth management contributed 25% of group’s revenue versus 22% in previous year. AUM grew 12% in the first 6 months to US$29.6 billion. Despite WM segment being a significant growth driver, we have no further statistics to show the potential of this segment as management refused to share, citing competition issues.

e. OCBC’s Islamic banking segment continues to build strength with another 5 branches expected in Malaysia by end of the year. Group had refocused their branding strategy to target the young bumis.

f. Corporate banking business continued to exhibit strength growing 35% y-y; 10% q-q to $579 million (37% of total revenue). Operating profit after allowances grew 24% y-y; 11% q-q to $379 million. Both net interest income and fee, commission income contributed to bottomline.

The Negatives:

g. NIMs fell by 3 bps to 1.87% in 2Q11 due to shift in loan mix to less risky loans such as

trade-related financing. Competitive loan pricing as well as weaknesses in mortgage loans also contributed to lower NIMs.

h. Though NPL improved, we note pockets of weaknesses. Classified debt securities jumped from $13 million in previous quarter to $110 million. Substandard loans from greater China also increased from $7 million to $26 million and from $46 million to $126 million in Other Asia Pacific region.

i. Expense ratio increased from 41.5% in previous quarter to 43.7% in 2Q11 due to higher staff cost and compensation.

j. LDR currently at 89% which means loan growth either has to slow (management expects 21% y-y growth for FY11) or the deposit base must be ramped up. This may mean increase in cost of funding for the bank which in turn may erode NIMs further.

Other developments:

Insurance revenue fell by 23% q-q to $137 million. Trading income was also lower by 46% q-q to $41 million. The two items resulted in lower earnings but we see these as temporary weaknesses.

Another blip in earnings for this quarter was also due to an increase in portfolio allowances of $56 million. Under MAS regulations, bank has to set aside 1% loan allowances even though the bank does not think default or credit deterioration will occur. Over time however, the larger loan book should see higher contribution from net interest income.

OCBC sees OCBC NISP as a key player to the group’s expansion in Indonesia. Recently there had been a lot of talk about the Indonesian government setting limits to shareholdings in local banks. In general, the international banking community had feedback to the government that such a move may undermine future investments in local entities. But if government insists and the new policy is implemented, It will be a setback to OCBC. We deem it speculative to price such policy changes in our valuation.

Valuations:

Base on previous trading close, OCBC trades at 1.65x PB. Its earnings meet 47% of our FY11

forecast (including divestment gains from property in 1Q11; earnings meet 48.4%), and since

it has not exceed our expectations, there is no reason for an upgrade. Annualised EPS is

$0.664 giving us a PE of 14.6x which is also not particularly. OCBC also announced interim

dividend of 15 cents, 1 cent below our forecast amount. If the bank maintains full year

dividend payment of 30 cents contrary to our expected 32 cents, then dividend yield will only be about 3% vs 3.3%. OCBC is not as attractive compared to DBS (1.3x PB, 12x PE, 3.7%

DY). We hence maintain our HOLD recommendation and fair value estimate of S$10.00.